Tableof Contents

 

 

 

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**(MarkOne)**

 

| x                                                           | ** ** | **Quarterly report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**  |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                  | ** ** | ** **                                                                                               |
| **for the quarterly  period ended September 30, 2008** |
| ** **                                                  | ** ** | ** **                                                                                               |
| **or**                                                      |
| ** **                                                  | ** ** | ** **                                                                                               |
| **o**                                                       | ** ** | **Transition report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |

** **

**for the transition period from                    to**

** **

**Commission file number   001-14431**

** **

**American States WaterCompany**

(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**                        | ** ** | **91773-1212**                    |
| (Address of Principal Executive Offices)                       |       | (Zip Code)                        |

** **

**(909) 394-3600**

(Registrant’sTelephone Number, Including Area Code)

** **

**Not Applicable**

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

 

**Commission file number   001-12008**

 

**Golden State Water Company**

(Exact Name of Registrant as Specified in ItsCharter)

 

| **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)

** **

**Not Applicable**

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

 

Indicate by check mark whether Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

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

 

Indicate by check mark whether the Registrant isa large accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See definition of “large accelerated filer”,“accelerated filer” and smaller reporting company” in Rule 12b-2 of theExchange Act. (Check one):

 

**American States Water Company**

 
| Large accelerated  filer o |   | Accelerated filer x |   | Non-accelerated filer  o |   | Smaller reporting  company o |
|----------------------------|--------|---------------------|--------|--------------------------|--------|------------------------------|

 

**Golden State Water Company**

 
| Large accelerated  filer o |   | Accelerated filer o |   | Non-accelerated filer  x |   | Smaller reporting  company o |
|----------------------------|--------|---------------------|--------|--------------------------|--------|------------------------------|

 

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

 

| American States Water Company |   | Yes   ̈ | No  x |
|-------------------------------|--------|-------------|-------|
| Golden State Water Company    |   | Yes   ̈ | No  x |

 

Asof November 5, 2008, the number of Common Shares outstanding, of AmericanStates Water Company was 17,288,918 shares. As of November 5, 2008, all of the134 outstanding Common Shares of Golden State Water Company were owned byAmerican States Water Company.

 

GoldenState Water Company meets the conditions set forth in General Instruction(H)(1)(a) and (b) of Form 10-Q and is therefore filing thisForm, in part, with the reduced disclosure format for Golden State WaterCompany.

 

 

 

----

Tableof Contents

 

**AMERICAN STATES WATER COMPANY**

**and**

**GOLDEN STATE WATER COMPANY**

**FORM 10-Q - INDEX**

 
| **Part I**  | **Financial Information**                                                                                                          | ** ** |
|------------------|------------------------------------------------------------------------------------------------------------------------------------|------------|
|             |                                                                                                                               | ** ** |
| Item 1:          | Financial  Statements                                                                                                              | 1          |
|             |                                                                                                                               |       |
|             | Consolidated  Balance Sheets of American States Water Company as of September 30, 2008  and December 31, 2007            | 2          |
|             |                                                                                                                               |       |
|             | Consolidated Statements of Income of American States  Water Company for the Three Months Ended September 30, 2008 and 2007    | 4          |
|             |                                                                                                                               |       |
|             | Consolidated Statements of Income of American States  Water Company for the Nine Months Ended September 30, 2008 and 2007     | 5          |
|             |                                                                                                                               |       |
|             | Consolidated  Statements of Cash Flow of American States Water Company for the Nine Months  Ended September 30, 2008 and 2007 | 6          |
|             |                                                                                                                               |       |
|             | Balance  Sheets of Golden State Water Company as of September 30, 2008 and December 31,  2007                            | 7          |
|             |                                                                                                                               |       |
|             | Statements  of Income of Golden State Water Company for the Three Months Ended September 30,  2008 and 2007                   | 9          |
|             |                                                                                                                               |       |
|             | Statements  of Income of Golden State Water Company for the Nine Months Ended September 30,  2008 and 2007                    | 10         |
|             |                                                                                                                               |       |
|             | Statements of Cash Flow  of Golden State Water Company for the Nine Months Ended September 30,  2008 and 2007                 | 11         |
|             |                                                                                                                               |       |
|             | Notes to  Consolidated Financial Statements                                                                                        | 12         |
|             |                                                                                                                               |       |
| Item 2:          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                        | 28         |
|             |                                                                                                                               |       |
| Item 3:          | Quantitative  and Qualitative Disclosures About Market Risk                                                                        | 66         |
|             |                                                                                                                               |       |
| Item 4:          | Controls and  Procedures                                                                                                           | 66         |
|             |                                                                                                                               |       |
| Item 4T:         | Controls and  Procedures                                                                                                           | 66         |
|             |                                                                                                                               |       |
| **Part II** | **Other  Information**                                                                                                             |       |
|             |                                                                                                                               |       |
| Item 1:          | Legal Proceedings                                                                                                                  | 67         |
|             |                                                                                                                               |       |
| Item  1A:        | Risk  Factors                                                                                                                      | 67         |
|             |                                                                                                                               |       |
| Item 2:          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                       | 67         |
|             |                                                                                                                               |       |
| Item 3:          | Defaults  Upon Senior Securities                                                                                                   | 67         |
|             |                                                                                                                               |       |
| Item 4:          | Submission  of Matters to a Vote of Security Holders                                                                               | 67         |
|             |                                                                                                                               |       |
| Item 5:          | Other Information                                                                                                                  | 67         |
|             |                                                                                                                               |       |
| Item  6:         | Exhibits                                                                                                                           | 68         |
|             |                                                                                                                               |       |
|             | Signatures                                                                                                                         | 69         |

 

----

Tableof Contents

 

#### **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.

 

Certaininformation and footnote disclosures normally included in financial statements,prepared in accordance with accounting principles generally accepted in theUnited States of America, have been condensed or omitted pursuant to such rules andregulations. In the opinion of management, all adjustments consisting of normalrecurring items and estimates necessary for a fair statement of results for theinterim period have been made.

 

It issuggested that these financial statements be read in conjunction with thefinancial statements and notes thereto in the latest Annual Report on Form 10-Kof American States Water Company and its wholly-owned subsidiary, Golden StateWater Company.

 

FilingFormat

 

AmericanStates Water Company (hereinafter “AWR”) is the parent company of Golden StateWater Company (hereinafter “GSWC”), Chaparral City Water Company (hereinafter “CCWC”)and American States Utility Services, Inc. (hereinafter “ASUS”) and itssubsidiaries.

 

Thisquarterly report on Form 10-Q is a combined report being filed by twoseparate Registrants: AWR and GSWC. For more information, please see Note 1 tothe Notes to Consolidated Financial Statements and the heading entitled Generalin Item 2 - Management’s Discussion and Analysis of Financial Condition andResults of Operations. References in this report to “Registrant” are to AWR andGSWC collectively, unless otherwise specified. GSWC makes no representations asto the information contained in this report relating to AWR and itssubsidiaries, other than GSWC.

 

**Forward-LookingInformation**

 

Certainmatters discussed in this report (including the documents incorporated hereinby reference) are forward-looking statements intended to qualify for the “safeharbor” from liability established by the Private Securities Litigation ReformAct of 1995. These forward-looking statements can generally be identified assuch because the context of the statement will include words such as Registrant“believes,” “anticipates,” “expects” or words of similar import. Similarly,statements that describe Registrant’s future plans, objectives, estimates orgoals are also forward-looking statements. Such statements address futureevents and conditions concerning the ability to raise capital, capitalexpenditures, earnings, litigation, rates, water sales, water quality and otherregulatory matters, adequacy of water supplies, the ability of GSWC and CCWC torecover electric, 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 which affect avariety of matters, including customer demand, water and energy supply costsand pension and post-retirement benefit costs; future weather and climaticconditions; the effects of conservation; delays in customer payments,processing of requests for equitable adjustments or price redeterminations ongovernment contracts; potential assessments for failure to comply with theterms of contracts with the U.S. government; and legislative, legalproceedings, regulatory and other circumstances affecting anticipated revenuesand costs.

 

1

----

Tableof Contents

 

**AMERICANSTATES WATER COMPANY****CONSOLIDATED BALANCE SHEETS**

**ASSETS**

**(Unaudited)**

 
| **(in thousands)**                                                                                       | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Utility Plant, at cost**                                                                                    | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Water                                                                                                         |       | $                            | 1,043,539  |                        | $          | 982,708 |   |
| Electric                                                                                                      |       | 65,566                       |       | 65,078                      |       |
|                                                                                                          |       | 1,109,105                    |       | 1,047,786                   |       |
| Less -  Accumulated depreciation                                                                              |       | (340,591                     | )          | (316,038                    | )          |
|                                                                                                          |       | 768,514                      |       | 731,748                     |       |
| Construction  work in progress                                                                                |       | 46,945                       |       | 44,631                      |       |
| Net utility  plant                                                                                            |       | 815,459                      |       | 776,379                     |       |
|                                                                                                          |       |                         |       |                        |       |
| **Other Property and Investments**                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Goodwill                                                                                                      |       | 12,393                       |       | 11,354                      |       |
| Other property  and investments                                                                               |       | 10,720                       |       | 10,245                      |       |
| Total other  property and investments                                                                         |       | 23,113                       |       | 21,599                      |       |
|                                                                                                          |       |                         |       |                        |       |
| **Current Assets**                                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and cash  equivalents                                                                                    |       | 1,241                        |       | 1,698                       |       |
| Accounts  receivable-customers (less allowance for doubtful accounts of $627 in 2008  and $539 in 2007)       |       | 19,345                       |       | 16,095                      |       |
| Unbilled revenue                                                                                              |       | 19,777                       |       | 16,035                      |       |
| Receivable from  the U.S. government (less allowance for doubtful accounts of $303 in 2008 and  $496 in 2007) |       | 7,964                        |       | 7,556                       |       |
| Other accounts  receivable (less allowance for doubtful accounts of $298 in 2008 and $629 in  2007)           |       | 2,943                        |       | 4,154                       |       |
| Income taxes  receivable                                                                                      |       | 2,528                        |       | 60                          |       |
| Materials and  supplies, at average cost                                                                      |       | 1,817                        |       | 1,576                       |       |
| Regulatory  assets – current                                                                             |       | 11,023                       |       | 5,187                       |       |
| Prepayments and  other current assets                                                                         |       | 1,943                        |       | 2,765                       |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts                                  |       | 5,599                        |       | 3,842                       |       |
| Deferred income  taxes – current                                                                         |       | 2,212                        |       | 4,047                       |       |
| Total current  assets                                                                                         |       | 76,392                       |       | 63,015                      |       |
|                                                                                                          |       |                         |       |                        |       |
| **Regulatory and Other Assets**                                                                               | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Regulatory  assets                                                                                            |       | 77,385                       |       | 82,539                      |       |
| Other accounts  receivable                                                                                    |       | 10,085                       |       | 9,723                       |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts                                  |       | 7,037                        |       | 2,284                       |       |
| Deferred income  taxes                                                                                        |       | 209                          |       | 28                          |       |
| Other                                                                                                         |       | 10,503                       |       | 8,331                       |       |
| Total regulatory  and other assets                                                                            |       | 105,219                      |       | 102,905                     |       |
|                                                                                                          |       |                         |       |                        |       |
| **Total Assets**                                                                                              |       | $                            | 1,020,183  |                        | $          | 963,898 |   |

 

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

 

2

----

Tableof Contents

 

**AMERICAN STATES WATER COMPANY****CONSOLIDATED BALANCE SHEETS**

**CAPITALIZATION AND LIABILITIES**

**(Unaudited)**

 
| **(in thousands)**                                                      | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Capitalization**                                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Common shares, no par value, no stated value                                 |       | $                            | 184,520    |                        | $          | 181,796 |   |
| Earnings reinvested in the business                                          |       | 126,481                      |       | 120,333                     |       |
| Total common shareholders’ equity                                       |       | 311,001                      |       | 302,129                     |       |
| Long-term debt                                                               |       | 266,945                      |       | 267,226                     |       |
| Total capitalization                                                         |       | 577,946                      |       | 569,355                     |       |
|                                                                         |       |                         |       |                        |       |
| **Current  Liabilities**                                                     | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Notes payable to banks                                                       |       | 65,500                       |       | 37,200                      |       |
| Long-term debt – current                                                |       | 618                          |       | 609                         |       |
| Accounts payable                                                             |       | 37,618                       |       | 29,091                      |       |
| Income taxes payable                                                         |       | —                       |       | 398                         |       |
| Accrued employee expenses                                                    |       | 6,131                        |       | 6,228                       |       |
| Accrued interest                                                             |       | 5,230                        |       | 2,467                       |       |
| Unrealized loss on purchased power contracts                                 |       | 788                          |       | 1,554                       |       |
| Regulatory liabilities – current                                        |       | —                       |       | 173                         |       |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       | 5,280                        |       | 2,641                       |       |
| Deferred income  taxes – current                                        |       | 35                           |       | —                      |       |
| Other                                                                        |       | 13,771                       |       | 13,890                      |       |
| Total current liabilities                                                    |       | 134,971                      |       | 94,251                      |       |
|                                                                         |       |                         |       |                        |       |
| **Other  Credits**                                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Advances for construction                                                    |       | 85,082                       |       | 84,479                      |       |
| Contributions in aid of construction – net                              |       | 100,865                      |       | 98,657                      |       |
| Deferred income taxes                                                        |       | 84,848                       |       | 82,480                      |       |
| Unamortized investment tax credits                                           |       | 2,268                        |       | 2,336                       |       |
| Accrued pension and other postretirement benefits                            |       | 20,774                       |       | 20,851                      |       |
| Regulatory liabilities                                                       |       | 458                          |       | 557                         |       |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       | 4,189                        |       | 2,037                       |       |
| Other                                                                        |       | 8,782                        |       | 8,895                       |       |
| Total other credits                                                          |       | 307,266                      |       | 300,292                     |       |
|                                                                         |       |                         |       |                        |       |
| **Commitments  and Contingencies (Note 7)**                                  |       | —                       |       | —                      |       |
|                                                                         |       |                         |       |                        |       |
| **Total  Capitalization and Liabilities**                                    |       | $                            | 1,020,183  |                        | $          | 963,898 |   |

 

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

 

3

----

Tableof Contents

 

**AMERICANSTATES WATER COMPANY****CONSOLIDATED STATEMENTS OF INCOME**

**FOR THETHREE MONTHS**

**ENDEDSEPTEMBER 30, 2008 AND 2007**

**(Unaudited)**

 
| ** **                                                            | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| **Operating Revenues**                                                | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Water                                                                 |       | $                                                    | 69,365     |   | $ | 65,445 |   |
| Electric                                                              |       | 6,743                                                |       | 6,289 |   |
| Contracted  services                                                  |       | 9,153                                                |       | 4,108 |   |
| Total operating  revenues                                             |       | 85,261                                               |       | 75,842 |   |
|                                                                  |       |                                                 |       |   |   |
| **Operating Expenses**                                                | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Water purchased                                                       |       | 15,087                                               |       | 14,740 |   |
| Power purchased  for pumping                                          |       | 3,484                                                |       | 3,517 |   |
| Groundwater  production assessment                                    |       | 2,791                                                |       | 2,666 |   |
| Power purchased  for resale                                           |       | 3,345                                                |       | 3,176 |   |
| Unrealized loss  on purchased power contracts                         |       | 3,741                                                |       | 896 |   |
| Supply cost  balancing accounts                                       |       | (490                                                 | )          | (1,541 | ) |
| Other operating  expenses                                             |       | 7,366                                                |       | 7,004 |   |
| Administrative  and general expenses                                  |       | 16,307                                               |       | 11,789 |   |
| Depreciation and  amortization                                        |       | 7,882                                                |       | 7,439 |   |
| Maintenance                                                           |       | 4,027                                                |       | 3,897 |   |
| Property and  other taxes                                             |       | 3,461                                                |       | 2,820 |   |
| ASUS  construction expenses                                           |       | 5,117                                                |       | 1,903 |   |
| Net loss on sale  of property                                         |       | —                                               |       | 11 |   |
| Total operating  expenses                                             |       | 72,118                                               |       | 58,317 |   |
|                                                                  |       |                                                 |       |   |   |
| **Operating Income**                                                  |       | 13,143                                               |       | 17,525 |   |
|                                                                  |       |                                                 |       |   |   |
| **Other Income and Expenses**                                         | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Interest expense                                                      |       | (5,428                                               | )          | (5,347 | ) |
| Interest income                                                       |       | 293                                                  |       | 590 |   |
| Other                                                                 |       | (30                                                  | )          | 102 |   |
| Total other  income and expenses                                      |       | (5,165                                               | )          | (4,655 | ) |
|                                                                  |       |                                                 |       |   |   |
| **Income from operations before income  tax expense**                 |       | 7,978                                                |       | 12,870 |   |
|                                                                  |       |                                                 |       |   |   |
| Income tax  expense                                                   |       | 3,426                                                |       | 5,241 |   |
|                                                                  |       |                                                 |       |   |   |
| **Net Income**                                                        |       | $                                                    | 4,552      |   | $ | 7,629 |   |
|                                                                  |       |                                                 |       |   |   |
| **Weighted Average Number of  Shares Outstanding**                    |       | 17,268                                               |       | 17,197 |   |
| **Basic Earnings Per Common Share**                                   |       | $                                                    | 0.26       |   | $ | 0.44 |   |
|                                                                  |       |                                                 |       |   |   |
| **Weighted Average Number of  Diluted Shares**                        |       | 17,404                                               |       | 17,239 |   |
| **Fully Diluted Earnings Per  Share**                                 |       | $                                                    | 0.26       |   | $ | 0.44 |   |
|                                                                  |       |                                                 |       |   |   |
| **Dividends Declared Per Common Share**                               |       | $                                                    | 0.250      |   | $ | 0.235 |   |

 

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

 

4

----

Tableof Contents

 

**AMERICANSTATES WATER COMPANY**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**FOR THENINE MONTHS**

**ENDEDSEPTEMBER 30, 2008 AND 2007**

**(Unaudited)**

 
| ** **                                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Operating Revenues**                                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Water                                                                 |       | $                                                   | 186,824    |   | $ | 176,598 |   |
| Electric                                                              |       | 21,754                                              |       | 21,413 |   |
| Contracted  services                                                  |       | 25,938                                              |       | 29,347 |   |
| Total operating  revenues                                             |       | 234,516                                             |       | 227,358 |   |
|                                                                  |       |                                                |       |   |   |
| **Operating Expenses**                                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Water purchased                                                       |       | 36,119                                              |       | 35,690 |   |
| Power purchased  for pumping                                          |       | 7,819                                               |       | 8,308 |   |
| Groundwater  production assessment                                    |       | 8,056                                               |       | 7,494 |   |
| Power purchased  for resale                                           |       | 10,179                                              |       | 10,372 |   |
| Unrealized gain  on purchased power contracts                         |       | (766                                                | )          | (1,578 | ) |
| Supply cost  balancing accounts                                       |       | (1,269                                              | )          | (3,451 | ) |
| Other operating  expenses                                             |       | 22,415                                              |       | 20,160 |   |
| Administrative  and general expenses                                  |       | 46,077                                              |       | 38,460 |   |
| Depreciation and  amortization                                        |       | 23,485                                              |       | 21,616 |   |
| Maintenance                                                           |       | 12,569                                              |       | 11,223 |   |
| Property and  other taxes                                             |       | 9,220                                               |       | 8,593 |   |
| ASUS construction  expenses                                           |       | 13,426                                              |       | 19,232 |   |
| Net gain on sale  of property                                         |       | —                                              |       | (594 | ) |
| Total operating  expenses                                             |       | 187,330                                             |       | 175,525 |   |
|                                                                  |       |                                                |       |   |   |
| **Operating Income**                                                  |       | 47,186                                              |       | 51,833 |   |
|                                                                  |       |                                                |       |   |   |
| **Other Income and Expenses**                                         | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Interest expense                                                      |       | (16,100                                             | )          | (16,413 | ) |
| Interest income                                                       |       | 1,429                                               |       | 1,742 |   |
| Other                                                                 |       | 91                                                  |       | 234 |   |
| Total other  income and expenses                                      |       | (14,580                                             | )          | (14,437 | ) |
|                                                                  |       |                                                |       |   |   |
| **Income from operations before  income tax expense**                 |       | 32,606                                              |       | 37,396 |   |
|                                                                  |       |                                                |       |   |   |
| Income tax  expense                                                   |       | 13,467                                              |       | 15,461 |   |
|                                                                  |       |                                                |       |   |   |
| **Net Income**                                                        |       | $                                                   | 19,139     |   | $ | 21,935 |   |
|                                                                  |       |                                                |       |   |   |
| **Weighted Average Number of  Shares Outstanding**                    |       | 17,252                                              |       | 17,091 |   |
| **Basic Earnings Per Common Share**                                   |       | $                                                   | 1.10       |   | $ | 1.26 |   |
|                                                                  |       |                                                |       |   |   |
| **Weighted Average Number of  Diluted Shares**                        |       | 17,378                                              |       | 17,132 |   |
| **Fully Diluted Earnings Per  Share**                                 |       | $                                                   | 1.10       |   | $ | 1.26 |   |
|                                                                  |       |                                                |       |   |   |
| **Dividends Declared Per Common Share**                               |       | $                                                   | 0.750      |   | $ | 0.705 |   |

 

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

 

5

----

Tableof Contents

 

**AMERICANSTATES WATER COMPANY**

**CONSOLIDATEDSTATEMENTS OF CASH FLOW**

**FOR THENINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands)**                                                      | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Cash  Flows From Operating Activities:**                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income                                                                   |       | $                                                   | 19,139     |   | $ | 21,935 |   |
| Adjustments for  non-cash items:                                             |       |                                                |       |   |   |
| Depreciation and amortization                                                |       | 23,485                                              |       | 21,616 |   |
| Provision for doubtful accounts                                              |       | 661                                                 |       | 562 |   |
| Deferred income taxes and investment tax credits                             |       | 4,276                                               |       | 2,090 |   |
| Unrealized gain on purchased power contracts                                 |       | (766                                                | )          | (1,578 | ) |
| Stock-based compensation expense                                             |       | 1,097                                               |       | 674 |   |
| Net gain on sale of property                                                 |       | —                                              |       | (594 | ) |
| Other – net                                                             |       | 401                                                 |       | 303 |   |
| Changes in  assets and liabilities:                                          |       |                                                |       |   |   |
| Accounts receivable – customers                                         |       | (3,902                                              | )          | (5,036 | ) |
| Unbilled revenue                                                             |       | (3,742                                              | )          | (3,003 | ) |
| Other accounts receivable                                                    |       | 855                                                 |       | 428 |   |
| Receivable from the U.S. government                                          |       | (423                                                | )          | 173 |   |
| Materials and supplies                                                       |       | (241                                                | )          | (227 | ) |
| Prepayments and other current assets                                         |       | 822                                                 |       | 1,016 |   |
| Regulatory assets — supply cost balancing accounts                      |       | (1,269                                              | )          | (3,451 | ) |
| Costs and estimated earnings in excess of billings  on uncompleted contracts |       | (6,510                                              | )          | (1,343 | ) |
| Other assets                                                                 |       | (1,719                                              | )          | (1,572 | ) |
| Accounts payable                                                             |       | 6,168                                               |       | 1,295 |   |
| Income taxes receivable/payable                                              |       | (2,866                                              | )          | 1,342 |   |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       | 4,791                                               |       | 383 |   |
| Accrued pension and other postretirement benefits                            |       | (77                                                 | )          | 815 |   |
| Other liabilities                                                            |       | 3,162                                               |       | 6,395 |   |
| Net cash provided                                                            |       | 43,342                                              |       | 42,223 |   |
| **Cash  Flows From Investing Activities:**                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Construction expenditures                                                    |       | (58,987                                             | )          | (32,832 | ) |
| Business acquisition                                                         |       | (2,298                                              | )          | — |   |
| Proceeds from sale of property                                               |       | —                                              |       | 612 |   |
| Net cash used                                                                |       | (61,285                                             | )          | (32,220 | ) |
| **Cash  Flows From Financing Activities:**                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from issuance of Common Shares                                      |       | 708                                                 |       | 690 |   |
| Proceeds from stock option exercises                                         |       | 666                                                 |       | 3,097 |   |
| Receipt of advances for and contributions in aid of  construction            |       | 4,339                                               |       | 5,655 |   |
| Refunds on advances for construction                                         |       | (3,339                                              | )          | (4,326 | ) |
| Repayments of long-term debt                                                 |       | (272                                                | )          | (273 | ) |
| Net change in notes payable to banks                                         |       | 28,300                                              |       | (3,000 | ) |
| Dividends paid                                                               |       | (12,934                                             | )          | (12,040 | ) |
| Other                                                                        |       | 18                                                  |       | 605 |   |
| Net cash provided (used)                                                     |       | 17,486                                              |       | (9,592 | ) |
| **Net  (decrease) increase in cash and cash equivalents**                    |       | (457                                                | )          | 411 |   |
| **Cash  and cash equivalents, beginning of period**                          |       | 1,698                                               |       | 3,223 |   |
| **Cash and cash equivalents, end  of period**                                |       | $                                                   | 1,241      |   | $ | 3,634 |   |

 

*The accompanying notes are anintegral part of these consolidated financial statements*

 

6

----

Tableof Contents

 

**GOLDENSTATE WATER COMPANY**

**BALANCESHEETS**

**ASSETS****(Unaudited)**

 
| **(in thousands)**                                                                                | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Utility  Plant, at cost**                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                   |       |                         |       |                        |       |
| Water                                                                                                  |       | $                            | 979,292    |                        | $          | 922,459 |   |
| Electric                                                                                               |       | 65,566                       |       | 65,078                      |       |
|                                                                                                   |       | 1,044,858                    |       | 987,537                     |       |
| Less - Accumulated depreciation                                                                        |       | (321,505                     | )          | (298,856                    | )          |
|                                                                                                   |       | 723,353                      |       | 688,681                     |       |
| Construction work in progress                                                                          |       | 45,299                       |       | 43,552                      |       |
| Net utility plant                                                                                      |       | 768,652                      |       | 732,233                     |       |
|                                                                                                   |       |                         |       |                        |       |
| **Other  Property and Investments**                                                                    | ** ** | 7,739                        |       | 7,838                       | ** ** |
|                                                                                                   |       |                         |       |                        |       |
| **Current  Assets**                                                                                    | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                              |       | 532                          |       | 1,389                       |       |
| Accounts receivable-customers (less allowance for  doubtful accounts of $603 in 2008 and $519 in 2007) |       | 18,929                       |       | 15,741                      |       |
| Unbilled revenue                                                                                       |       | 19,403                       |       | 15,701                      |       |
| Inter-company receivable                                                                               |       | 148                          |       | 563                         |       |
| Other accounts receivable (less allowance for  doubtful accounts of $275 in 2008 and $442 in 2007)     |       | 2,044                        |       | 3,195                       |       |
| Materials and supplies, at average cost                                                                |       | 1,714                        |       | 1,562                       |       |
| Regulatory assets – current                                                                       |       | 10,952                       |       | 5,116                       |       |
| Prepayments and other current assets                                                                   |       | 1,746                        |       | 2,595                       |       |
| Deferred income taxes - current                                                                        |       | 2,111                        |       | 3,845                       |       |
| Total current assets                                                                                   |       | 57,579                       |       | 49,707                      |       |
|                                                                                                   |       |                         |       |                        |       |
| **Regulatory  and Other Assets**                                                                       | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Regulatory assets                                                                                      |       | 77,385                       |       | 82,539                      |       |
| Other accounts receivable                                                                              |       | 10,085                       |       | 9,723                       |       |
| Other                                                                                                  |       | 9,588                        |       | 7,933                       |       |
| Total regulatory and other assets                                                                      |       | 97,058                       |       | 100,195                     |       |
|                                                                                                   |       |                         |       |                        |       |
| **Total  Assets**                                                                                      |       | $                            | 931,028    |                        | $          | 889,973 |   |

 

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

 

7

----

Tableof Contents

 

**GOLDENSTATE WATER COMPANY**

**BALANCESHEETS**

**CAPITALIZATIONAND LIABILITIES**

**(Unaudited)**

 
| **(in thousands)**                            | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Capitalization**                                 | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Common shares,  no par value, no stated value      |       | $                            | 194,381    |                        | $          | 163,180 |   |
| Earnings  reinvested in the business               |       | 127,277                      |       | 115,261                     |       |
| Total common  shareholder’s equity            |       | 321,658                      |       | 278,441                     |       |
| Long-term debt                                     |       | 260,660                      |       | 260,941                     |       |
| Total  capitalization                              |       | 582,318                      |       | 539,382                     |       |
|                                               |       |                         |       |                        |       |
| **Current Liabilities**                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Long-term debt -  current                          |       | 318                          |       | 309                         |       |
| Accounts payable                                   |       | 31,011                       |       | 24,402                      |       |
| Inter-company  payable                             |       | 11,145                       |       | 23,764                      |       |
| Income taxes  payable to Parent                    |       | 790                          |       | 2,469                       |       |
| Accrued employee  expenses                         |       | 5,420                        |       | 5,677                       |       |
| Accrued interest                                   |       | 5,065                        |       | 2,424                       |       |
| Unrealized loss  on purchased power contracts      |       | 788                          |       | 1,554                       |       |
| Regulatory  liabilities - current                  |       | —                       |       | 173                         |       |
| Deferred income taxes - current                    |       | 70                           |       | —                      |       |
| Other                                              |       | 13,353                       |       | 13,459                      |       |
| Total current  liabilities                         |       | 67,960                       |       | 74,231                      |       |
|                                               |       |                         |       |                        |       |
| **Other Credits**                                  | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Advances for  construction                         |       | 80,303                       |       | 78,917                      |       |
| Contributions in  aid of construction - net        |       | 88,462                       |       | 87,323                      |       |
| Deferred income  taxes                             |       | 80,962                       |       | 78,805                      |       |
| Unamortized  investment tax credits                |       | 2,268                        |       | 2,336                       |       |
| Accrued pension  and other postretirement benefits |       | 20,774                       |       | 20,851                      |       |
| Other                                              |       | 7,981                        |       | 8,128                       |       |
| Total other  credits                               |       | 280,750                      |       | 276,360                     |       |
|                                               |       |                         |       |                        |       |
| **Commitments and Contingencies  (Note 7)**        |       | —                       |       | —                      |       |
|                                               |       |                         |       |                        |       |
| **Total Capitalization and  Liabilities**          |       | $                            | 931,028    |                        | $          | 889,973 |   |

 

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

 

8

----

Tableof Contents

 

**GOLDENSTATE WATER COMPANY**

**STATEMENTSOF INCOME**

**FOR THETHREE MONTHS**

**ENDEDSEPTEMBER 30, 2008 AND 2007**

**(Unaudited)**

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(in thousands)**                               | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| **Operating Revenues**                                | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Water                                                 |       | $                                                    | 67,316     |   | $ | 63,180 |   |
| Electric                                              |       | 6,743                                                |       | 6,289 |   |
| Total operating  revenues                             |       | 74,059                                               |       | 69,469 |   |
|                                                  |       |                                                 |       |   |   |
| **Operating Expenses**                                | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Water purchased                                       |       | 14,889                                               |       | 14,472 |   |
| Power purchased  for pumping                          |       | 3,293                                                |       | 3,319 |   |
| Groundwater  production assessment                    |       | 2,791                                                |       | 2,666 |   |
| Power purchased  for resale                           |       | 3,345                                                |       | 3,176 |   |
| Unrealized loss  on purchased power contracts         |       | 3,741                                                |       | 896 |   |
| Supply cost  balancing accounts                       |       | (490                                                 | )          | (1,541 | ) |
| Other operating  expenses                             |       | 6,055                                                |       | 5,943 |   |
| Administrative  and general expenses                  |       | 13,054                                               |       | 9,997 |   |
| Depreciation and  amortization                        |       | 7,252                                                |       | 6,925 |   |
| Maintenance                                           |       | 3,289                                                |       | 3,706 |   |
| Property and  other taxes                             |       | 2,791                                                |       | 2,738 |   |
| Net loss on sale  of property                         |       | —                                               |       | 11 |   |
| Total operating  expenses                             |       | 60,010                                               |       | 52,308 |   |
|                                                  |       |                                                 |       |   |   |
| **Operating Income**                                  |       | 14,049                                               |       | 17,161 |   |
|                                                  |       |                                                 |       |   |   |
| **Other Income and Expenses**                         |       |                                                 |       |   |   |
| Interest expense                                      |       | (5,018                                               | )          | (4,995 | ) |
| Interest income                                       |       | 284                                                  |       | 570 |   |
| Other                                                 |       | (22                                                  | )          | 77 |   |
|                                                  |       | (4,756                                               | )          | (4,348 | ) |
|                                                  |       |                                                 |       |   |   |
| **Income from operations before  income tax expense** |       | 9,293                                                |       | 12,813 |   |
|                                                  |       |                                                 |       |   |   |
| Income tax  expense                                   |       | 3,945                                                |       | 5,205 |   |
|                                                  |       |                                                 |       |   |   |
| **Net Income**                                        |       | $                                                    | 5,348      |   | $ | 7,608 |   |

 

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

 

9

----

Table of Contents

 

**GOLDENSTATE WATER COMPANY**

**STATEMENTSOF INCOME**

**FOR THENINE MONTHS**

**ENDEDSEPTEMBER 30, 2008 AND 2007**

**(Unaudited)**

 
| ** **                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands)**                               | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Operating Revenues**                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Water                                                 |       | $                                                   | 181,235    |   | $ | 170,762 |   |
| Electric                                              |       | 21,754                                              |       | 21,413 |   |
| Total operating  revenues                             |       | 202,989                                             |       | 192,175 |   |
|                                                  |       |                                                |       |   |   |
| **Operating Expenses**                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Water purchased                                       |       | 35,572                                              |       | 35,058 |   |
| Power purchased  for pumping                          |       | 7,365                                               |       | 7,841 |   |
| Groundwater  production assessment                    |       | 8,056                                               |       | 7,494 |   |
| Power purchased  for resale                           |       | 10,179                                              |       | 10,372 |   |
| Unrealized gain  on purchased power contracts         |       | (766                                                | )          | (1,578 | ) |
| Supply cost  balancing accounts                       |       | (1,269                                              | )          | (3,451 | ) |
| Other operating  expenses                             |       | 17,799                                              |       | 17,274 |   |
| Administrative  and general expenses                  |       | 36,655                                              |       | 33,168 |   |
| Depreciation and  amortization                        |       | 21,746                                              |       | 20,214 |   |
| Maintenance                                           |       | 10,408                                              |       | 10,513 |   |
| Property and  other taxes                             |       | 8,200                                               |       | 8,300 |   |
| Net gain on sale  of property                         |       | —                                              |       | (594 | ) |
| Total operating  expenses                             |       | 153,945                                             |       | 144,611 |   |
|                                                  |       |                                                |       |   |   |
| **Operating Income**                                  |       | 49,044                                              |       | 47,564 |   |
|                                                  |       |                                                |       |   |   |
| **Other Income and Expenses**                         |       |                                                |       |   |   |
| Interest expense                                      |       | (15,035                                             | )          | (15,196 | ) |
| Interest income                                       |       | 1,370                                               |       | 1,631 |   |
| Other                                                 |       | 69                                                  |       | 176 |   |
|                                                  |       | (13,596                                             | )          | (13,389 | ) |
|                                                  |       |                                                |       |   |   |
| **Income from operations before  income tax expense** |       | 35,448                                              |       | 34,175 |   |
|                                                  |       |                                                |       |   |   |
| Income tax  expense                                   |       | 14,576                                              |       | 14,195 |   |
|                                                  |       |                                                |       |   |   |
| **Net Income**                                        |       | $                                                   | 20,872     |   | $ | 19,980 |   |

 

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

 

10

----

Tableof Contents

 

**GOLDENSTATE WATER COMPANY**

**STATEMENTSOF CASH FLOW**

**FOR THENINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007**

**(Unaudited)**

 
| ** **                                                        | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands)**                                           | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Cash  Flows From Operating Activities:**                        | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income                                                        |       | $                                                   | 20,872     |   | $ | 19,980 |   |
| Adjustments for  non-cash items:                                  |       |                                                |       |   |   |
| Depreciation and amortization                                     |       | 21,746                                              |       | 20,214 |   |
| Provision for doubtful accounts                                   |       | 628                                                 |       | 383 |   |
| Deferred income taxes and investment tax credits                  |       | 4,180                                               |       | 2,214 |   |
| Unrealized gain on purchased power contracts                      |       | (766                                                | )          | (1,578 | ) |
| Stock-based compensation expense                                  |       | 940                                                 |       | 609 |   |
| Net gain on sale of property                                      |       | —                                              |       | (594 | ) |
| Other — net                                                  |       | 377                                                 |       | 276 |   |
| Changes in  assets and liabilities:                               |       |                                                |       |   |   |
| Accounts receivable - customers                                   |       | (3,810                                              | )          | (4,837 | ) |
| Unbilled revenue                                                  |       | (3,702                                              | )          | (2,874 | ) |
| Other accounts receivable                                         |       | 783                                                 |       | 167 |   |
| Materials and supplies                                            |       | (152                                                | )          | (227 | ) |
| Prepayments and other current assets                              |       | 849                                                 |       | 1,029 |   |
| Regulatory assets - supply cost balancing accounts                |       | (1,269                                              | )          | (3,451 | ) |
| Other assets                                                      |       | (1,524                                              | )          | (1,643 | ) |
| Accounts payable                                                  |       | 4,236                                               |       | 2,442 |   |
| Inter-company receivable/payable                                  |       | 338                                                 |       | (1,012 | ) |
| Income taxes payable from Parent                                  |       | (1,679                                              | )          | 262 |   |
| Accrued pension and other postretirement benefits                 |       | (77                                                 | )          | 815 |   |
| Other liabilities                                                 |       | 3,032                                               |       | 6,297 |   |
| Net cash provided                                                 |       | 45,002                                              |       | 38,472 |   |
|                                                              |       |                                                |       |   |   |
| **Cash  Flows From Investing Activities:**                        | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Construction expenditures                                         |       | (55,455                                             | )          | (31,501 | ) |
| Proceeds from sale of property                                    |       | —                                              |       | 612 |   |
| Net cash used                                                     |       | (55,455                                             | )          | (30,889 | ) |
|                                                              |       |                                                |       |   |   |
| **Cash  Flows From Financing Activities:**                        | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from issuance of Common Shares to Parent                 |       | 30,000                                              |       | — |   |
| Receipt of advances for and contributions in aid of  construction |       | 4,197                                               |       | 5,303 |   |
| Refunds on advances for construction                              |       | (3,047                                              | )          | (4,126 | ) |
| Repayments of long-term debt                                      |       | (272                                                | )          | (273 | ) |
| Net change in inter-company borrowings                            |       | (12,510                                             | )          | 4,400 |   |
| Dividends paid                                                    |       | (8,800                                              | )          | (12,900 | ) |
| Other                                                             |       | 28                                                  |       | 549 |   |
| Net cash provided (used)                                          |       | 9,596                                               |       | (7,047 | ) |
|                                                              |       |                                                |       |   |   |
| **Net  (decrease) increase in cash and cash equivalents**         |       | (857                                                | )          | 536 |   |
| **Cash  and cash equivalents, beginning of period**               |       | 1,389                                               |       | 1,735 |   |
| **Cash and cash equivalents, end  of period**                     |       | $                                                   | 532        |   | $ | 2,271 |   |

 

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

 

11

----

Tableof Contents

 

**AMERICANSTATES WATER COMPANY****AND****GOLDEN STATE WATER COMPANY****NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1 — Summary of Significant AccountingPolicies:**

 

General / Nature of Operations: American States Water Company (“AWR”) is the parent company 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”), Old Dominion Utility Services, Inc. (“ODUS”), Palmetto State Utility Services, Inc. (“PSUS”) and Old North Utility Services, Inc. (“ONUS”). GSWC is a public utility engaged principally in the purchase, production, distribution and sale of water in California serving approximately 255,000 water customers. GSWC also distributes electricity in several San Bernardino Mountain communities serving approximately 23,000 electric customers. The California Public Utilities Commission (“CPUC”) regulates GSWC’s water and electric business, including properties, rates, services, facilities and other matters. CCWC is a public utility regulated by the Arizona Corporation Commission (“ACC”) serving over 13,000 customers in the town of Fountain Hills, Arizona and a portion of the City of Scottsdale, Arizona. ASUS performs water and wastewater related services and operations on a contract basis. There is no direct regulatory oversight by either the CPUC or the ACC of the operation or rates of the contracted services provided by ASUS and its wholly owned subsidiaries or by AWR. The consolidated financial statements include the accounts of AWR, GSWC, CCWC  and ASUS and its subsidiaries.  AWR’s assets, revenues and operations are primarily those of GSWC.

 

ASUS, through its wholly-owned subsidiaries, has entered into agreements with the U.S. government to operate and maintain the water and/or wastewater systems at various military bases pursuant to 50-year fixed price contracts, which are subject to periodic price redeterminations and modifications for changes in circumstances.  In September and October of 2007, ASUS was awarded contracts to operate and maintain the water and wastewater systems at Fort Jackson, South Carolina and at Fort Bragg/Pope AFB, North Carolina, respectively. These contracts  have substantially similar terms as the agreements previously executed by ASUS with the U.S. government.  PSUS commenced operations at Fort Jackson on January 2, 2008 and ONUS commenced operations at Fort Bragg on March 1, 2008, both following the expiration of transition periods.

 

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. Investments in partially-owned affiliates are accounted for by the equity method when Registrant’s ownership interest exceeds 20%. 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 revenues 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, 2007 filed with the SEC.

 

12

----

Tableof Contents

 

GSWC’sRelated Party Transactions: GSWC and other subsidiariesprovide and receive various services to and from their parent, AWR, and amongthemselves.   On August 25, 2008,AWR amended its $85 million syndicated credit facility, to increase theaggregate bank commitments by $30 million to $115 million. AWR borrows underthis facility and provides funds to its subsidiaries, including GSWC, insupport of their operations.   GSWC alsohas the right to obtain letters of credit under this facility. Amounts owed toAWR by GSWC for borrowings under this facility represent the majority of GSWC’sinter-company payables on GSWC’s balance sheets as of September 30, 2008and December 31, 2007. The interest rate charged to GSWC is sufficient tocover AWR’s interest cost under the credit facility. GSWC also allocatescertain corporate office administrative and general costs to its affiliatesusing allocation factors agreed upon by the CPUC.

 

Sales and UseTaxes:  GSWC billscertain sales and use taxes levied by state or local governments to itscustomers. Included in these sales and use taxes are franchise fees, which GSWCpays to various municipalities (based on ordinances adopted by thesemunicipalities) in order to use public right of way for utility purposes. GSWCbills these franchise fees to its customers based on a CPUC-authorized rate.These franchise fees, which are required to be paid regardless of GSWC’sability to collect from the customer, are accounted for on a gross basis. GSWC’sfranchise fees billed to customers and recorded as operating revenue wereapproximately $718,000 and $716,000 for the three months ended September 30,2008 and 2007, respectively, and $2,052,000 and $2,069,000 for the nine monthsended September 30, 2008 and 2007, respectively. When GSWC acts as anagent, and the tax is not required to be remitted if it is not collected fromthe customer, the taxes are accounted for on a net basis.

 

New AccountingPronouncements:   In September 2006,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 157, *“Fair Value Measurements”*.  SFAS No. 157 defines fair value,establishes a framework for measuring fair value in accordance with generallyaccepted accounting principles, and expands disclosures about fair valuemeasurements. SFAS No. 157 is effective for financial statementsissued for fiscal years beginning after November 15, 2007.   In February 2008, the FASB delayed theeffective date of SFAS No. 157 for certain nonfinancial assets and liabilitiesuntil January 1, 2009.  Thesenonfinancial items include assets and liabilities that are recognized anddisclosed at fair value in the financial statements on a nonrecurring basis,such as Registrant’s reporting units measured at fair value in a goodwillimpairment test and asset retirement obligations.  As it applies to its financial instruments,Registrant implemented the new standard effective January 1, 2008.  The partial adoption of SFAS No. 157for financial assets and liabilities did not have any impact on Registrant’sconsolidated financial position, results of operations or cash flows.   However, it does require additionaldisclosures.  See Note 4 for informationand related disclosures regarding the fair value measurements on Registrant’s derivatives.  The carrying value of other financial assetsand liabilities, including cash, accounts receivable, accounts payable andshort-term debt, approximate fair value due to their short maturities orvariable-rate nature of the respective borrowings.  Long-term debt is not carried at fair value,but SFAS No. 107, *“Disclosures about FairValue of Financial Instruments”*requires fair value disclosure on anannual basis.  Registrant’s pension andpostretirement plan assets are comprised of actively traded debt and equitysecurities, and therefore the market related value is equal to the fair valueof plan assets which  is used to computethe funded status recognized in Registrant’s financial statements.

 

In February 2007, the FASB issued SFAS No. 159,“*The Fair Value Option for Financial Assetsand Financial Liabilities”*. SFAS No. 159 allows measurement at fair value of eligible financialassets and liabilities that are not otherwise measured at fair value. Theelection to measure a financial asset or liability at fair value can be made onan instrument-by-instrument basis and is irrevocable. The difference between “carryingvalue” and “fair value” at the election date is recorded as a transitionadjustment to beginning retained earnings. Subsequent changes in fair value arerecognized in earnings. SFAS No. 159 also establishes additionaldisclosure requirements designed to facilitate comparisons between companiesthat choose different measurement attributes for similar type assets andliabilities. SFAS No. 159 was effective for Registrant’s fiscal yearbeginning January 1, 2008. Registrant has not elected to apply the fair value option to any of itsfinancial assets and liabilities. Therefore, the adoption of SFAS No. 159did not have any impact on Registrant’s consolidated financial position,results of operations or cash flows.

 

In March 2007, theFASB Emerging Issues Task Force (“EITF”) issued EITF No. 06-11, *“Accounting for Income Tax Benefits of Dividends onShare-Based Payment”,* which concludes that a realized income taxbenefit from dividends or dividend equivalents that are charged to retainedearnings and are paid to employees and directors for equity classified asnonvested equity shares, nonvested equity share units, and outstanding equityshare options should be recognized as an increase in additional paid-incapital. Registrant has commenced recognizing this tax 

 

13

----

Tableof Contents

 

benefit as an increase inadditional paid-in capital beginning January 1, 2008. The impact of thischange was not material to Registrant’s consolidated financial statements.

 

In December 2007, the SEC issued Staff AccountingBulletin (“SAB”) No. 110, *“Share-Based Payment”.*Effective January 1, 2008, Registrant adopted the guidance of  SAB No. 110, which requires Registrantto develop expected option terms by reviewing detailed external informationabout employee exercise behavior.  Thesimplified method is no longer permitted if such information is available.  As a result of the new guidance, Registrant’sexpected term used for options granted in 2008 was 5 years as compared to 6years which was derived under the simplified method used for grants in prioryears.

 

In December 2007,the FASB issued SFAS No. 141(R) (revised 2007), *“Business Combinations”*.SFAS No. 141(R) which establishes principles and requirementsfor how the acquirer of a business recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, and anynoncontrolling interest in the acquiree. SFAS No. 141(R) alsoprovides guidance for recognizing and measuring the goodwill acquired in thebusiness combination and determines what information to disclose to enableusers of the financial statement to evaluate the nature and financial effectsof the business combination. SFAS No. 141(R) is effective forfinancial statements issued for fiscal years beginning after December 15,2008. Accordingly, any business combinations Registrant engages in will berecorded and disclosed following existing accounting standards until January 1,2009.

 

In December 2007,the FASB also issued SFAS No. 160, “*NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51*”.The objective of SFAS No. 160 is to improve the relevance, comparability,and transparency of the financial information that a reporting entity providesin its consolidated financial statements by establishing accounting andreporting standards for the noncontrolling interest in a subsidiary and for thedeconsolidation of a subsidiary. This statement applies to all entities thatprepare consolidated financial statements, except not-for-profit organizations.  SFAS No. 160 amends ARB 51 to establishaccounting and reporting standards for the noncontrolling interest in asubsidiary and for the deconsolidation of a subsidiary. It also amends certainof ARB 51’s consolidation procedures for consistency with the requirements of SFASNo. 141(R). SFAS No. 160 is effective for financial statementsissued for fiscal years beginning after December 15, 2008.  Registrant is evaluating the potential impactof SFAS No. 160; however, this standard is not expected to have anymaterial impact on Registrant’s future consolidated financial statements anddisclosures.

 

In March 2008, theFASB issued SFAS No. 161, *“Disclosures aboutDerivative Instruments and Hedging Activities,”* (“SFAS No. 161”). SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133,*“Accounting for Derivative Instruments and HedgingActivities.”*  SFAS No. 161 requires qualitativedisclosures about objectives and strategies for using derivatives, quantitativedisclosures about fair value amounts of gains and losses on derivativeinstruments and disclosures about credit-risk-related contingent features inderivative agreements.  This statement is effective for financialstatements issued for fiscal years beginning after November 15,2008.  Registrant is currently assessing the impact of SFAS No. 161on its consolidated financial position and results of operations.

 

In May 2008, theFASB issued SFAS No. 162, *“The Hierarchy ofGenerally Accepted Accounting Principles”.*  SFAS No. 162 identifies the sources ofaccounting principles and the framework for selecting the principles to be usedin the preparation of financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles in theUnited States.  SFAS No. 162 will beeffective 60 days following the SEC’s approval of the Public Company AccountingOversight Board amendments to AU Section 411(*The Meaning of**Present Fairly inConformity With Generally Accepted Accounting Principles*). The FASBdoes not expect SFAS No. 162 will result in a change in current practice.However, transition provisions have been provided in the unusual circumstancethat the application of the provisions of SFAS No. 162 results in a changein practice.  Registrant does not expectany impact as a result of adopting SFAS No. 162.

 

Other accountingstandards that have been issued or proposed by the FASB or otherstandards-setting bodies that do not require adoption until a future date arenot expected to have a material impact on Registrant’s consolidated financialstatements upon adoption.

 

14

----

Table of Contents

 

**Note 2 — Regulatory Matters:**

 

In accordance with accountingprinciples for rate-regulated enterprises, Registrant records regulatoryassets, which represent probable future revenue associated with certain coststhat will be recovered from customers through the ratemaking process, andregulatory liabilities, which represent probable future reductions in revenueassociated with amounts that are to be credited to customers through theratemaking process. At September 30, 2008, Registrant had approximately$13.4 million of regulatory assets not accruing carrying costs. Of this amount,$4.9 million relates to deferred income taxes representing accelerated taxbenefits flowed-through to ratepayers, which will be included in ratesconcurrently with recognition of the associated future tax expense, and a $5.9million “non-yielding” regulatory asset related to general rate case memorandumaccounts to be recovered over 12 - 24 months. The remainder relates to other expenses that do not provide for recoveryof carrying costs that Registrant expects to recover in rates over a shortperiod.  Regulatory assets, lessregulatory liabilities, included in the consolidated balance sheets are asfollows:

 
| **(In thousands)**                             | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **GSWC**                                            |       |                         |       |                        |       |
| Electric supply  cost balancing account             |       | $                            | 16,193     |                        | $          | 18,318 |   |
| Water supply  cost balancing accounts               |       | 12,035                       |       | 8,525                       |       |
| Costs deferred  for future recovery on Aerojet case |       | 20,822                       |       | 21,244                      |       |
| Pensions and  other postretirement obligations      |       | 10,542                       |       | 11,443                      |       |
| Flow-through  taxes, net                            |       | 4,933                        |       | 5,220                       |       |
| Electric  transmission line abandonment costs       |       | 3,041                        |       | 3,157                       |       |
| Asset retirement  obligations                       |       | 3,809                        |       | 3,547                       |       |
| Low income rate  assistance balancing accounts      |       | 4,948                        |       | 4,147                       |       |
| General rate  case memorandum accounts              |       | 5,933                        |       | 7,162                       |       |
| Santa Maria  adjudication memorandum accounts       |       | 4,039                        |       | 4,005                       |       |
| Refund of water  right lease revenues               |       | (2,521                       | )          | (2,945                      | )          |
| Other regulatory  assets, net                       |       | 4,563                        |       | 3,659                       |       |
| Total GSWC                                          |       | $                            | 88,337     |                        | $          | 87,482 |   |
| **CCWC**                                            |       |                         |       |                        |       |
| Asset retirement  obligations                       |       | $                            | 54         |                        | $          | 52 |   |
| Other regulatory  liabilities, net                  |       | (441                         | )          | (538                        | )          |
| Total AWR                                           |       | $                            | 87,950     |                        | $          | 86,996 |   |

 

Regulatory matters are discussed in detail inthe consolidated financial statements and the notes thereto included in the Form 10-Kfor the year ended December 31, 2007 filed with the SEC.  The discussion below focuses on significantmatters and changes since December 31, 2007.

 

***Supply Cost Balancing Accounts:***

 

***Electric Supply Cost Balancing Account***—Electricpower costs incurred by GSWC’s Bear Valley Electric Service (“BVES”) divisioncontinue to be charged to its electric supply cost balancing account. Theunder-collection in the electric supply cost balancing account is $16.2 millionat September 30, 2008.  Of thisamount, approximately $3.7 million relates to the under-collection remaining asof September 30, 2008 that was incurred during the energy crisis in late2000 and 2001, discussed below.  Theremaining $12.5 million in the electric supply cost balancing account relatesto $3.3 million from the tariff charged to GSWC by Southern California Edison (“Edison”)for the abandonment of a transmission line upgrade discussed below, and $9.2million for changes in purchased energy and power system delivery costsincluding interest, also discussed below.

 

The CPUC has authorizedGSWC to collect a surcharge from its customers of 2.2¢ per kilowatt hourthrough August 2011, to enable GSWC to recover an under-collection ofapproximately $23.1 million at the end of 2001 which had been incurredduring the energy crisis in late 2000 and 2001. GSWC sold 31,939,690 and 31,294,179kilowatt hours of electricity to its BVES customers for the three months ended September 30,2008 and 2007, respectively, and sold 105,354,442 and 104,702,201 kilowatthours of electricity to its customers for the nine months ended September 30,2008 and 2007, respectively. As a result of the surcharge, the supply costbalancing account was reduced by approximately $720,000 and $684,000 for thethree months September 30, 2008 and 2007, respectively, and $2,361,000 and$2,265,000 for the nine months ended September 30, 2008 and 2007,respectively.  

 

15

----

Tableof Contents

 

Approximately $19.4million of the $23.1 million under-collection incurred during the energy crisisin late 2000 and 2001 has been recovered through this surcharge. GSWCanticipates the surcharge, based on projected electricity sales, to besufficient for it to recover by August 2011 the amount of theunder-collected balance incurred during the energy crisis. However, in 2011, ifGSWC has not fully recovered the amount of this under collection, GSWC willseek regulatory approval of any amounts not recovered through this surcharge.

 

Changes in purchasedenergy and power system delivery costs also impact the electric supply costbalancing account. The purchased energy costs that are recorded in the supplycost balancing account are subject to a price cap by terms of a 2001 settlementwhich was subsequently approved in a CPUC decision. The BVES division of GSWCis allowed to include its actual recorded purchased energy costs up to aweighted annual average  cost of $77 permegawatt-hour (“MWh”) through August 2011 in its electric supply costbalancing account. To the extent that the actual weighted average annual costfor power purchased exceeds the $77 per MWh amount, GSWC will not be able toinclude these amounts in its balancing account and such amounts will beexpensed.  There were no amounts expensedover the $77 per MWh cap during the three months ended September 30, 2008and 2007 and the nine months ended September 30, 2008.  During the nine months ended September 30,2007, the amount expensed was $29,000.

 

Charges to GSWC by Edisonassociated with the transportation of energy over Edison’s power system and theabandonment of a transmission line upgrade have increased under Edison’s tariffto levels that exceed the amounts authorized by the CPUC in BVES retail powerrates to its customers. The incremental cost increase to GSWC from the tarifffor the abandonment of a transmission line upgrade, which is not currentlyincluded in rates, is $38,137 per month. The incremental costs not included in rates have been included in thebalancing account at September 30, 2008 for subsequent recovery fromcustomers, subject to CPUC approval.

 

The power system deliverycosts are not subject to the $77 per MWh price cap referenced above.  Other components, such as interest accrued onthe cumulative under-collected balance and power lost during transmission, alsoaffect the balance of the electric supply cost balancing account.

 

In summary, for the threemonths ended September 30, 2008 and 2007, the under-collection decreasedby approximately $378,000 and $345,000, respectively, and $2,125,000 and$1,534,000 for the nine months ended September 30, 2008 and 2007,respectively.

 

***Water Supply Cost Balancing Accounts—***Aspermitted by the CPUC, Registrant maintains water supply cost balancingaccounts for GSWC to account for under-collections and over-collections ofrevenues designed to recover such costs. The supply cost balancing accounts track differences between the currentcost for supply items (water, power, and pump taxes) charged by GSWC’ssuppliers and the cost for those items incorporated into GSWC’s rates.Under-collections (recorded as regulatory assets) occur when the current costexceeds the amount in rates for these items and, conversely, over-collections(recorded as regulatory liabilities) occur when the current cost of these itemsis less than the amount in rates. Typically, under-collections or over-collections, when they occur, aretracked in the supply cost balancing accounts for future recovery or refundthrough a surcharge (in the event of an under-collection) or through asurcredit (in the event of an over-collection) on customers’ bills.  Registrant accrues interest on its supplycost balancing accounts at the rate prevailing for 90-day commercialpaper.  Registrant does not maintain asupply cost balancing account for CCWC.

 

For the three monthsended September 30, 2008 and 2007, approximately $1.8 million and $1.7million of under-collections (including interest), respectively, were recordedin the water supply cost balancing accounts. For the nine months ended September 30, 2008 and 2007,approximately $3.9 million and $4.3 million of under-collections (includinginterest), respectively, were recorded in the water supply cost balancingaccounts. Amortization of surcharges that are in rates to recoverunder-collections from customers and surcredits that are in rates to refundover-collections to customers also increased or decreased the water supply costbalancing accounts, as applicable. During the three and nine months ended September 30, 2008,approximately $860,000 and $613,000, respectively, of net under-collectionamortization  decreased the water supplycost balancing accounts.   During thethree and nine months ended September 30, 2007, approximately $195,000 and$765,000, respectively, of net over-collection amortization increased the watersupply cost balancing accounts.

 

16

----

Table of Contents

 

As of September 30,2008, there is approximately $12.0 million net under-collection in the watersupply cost balancing accounts.  Of thisamount, approximately $8.2 million relates to GSWC’s Region III customerservice area.  In May 2008, the CPUCapproved a surcharge to begin recovering $7.0 million of this under-collectionover 24 months.   The remaining $1.2 million for Region III will beincluded for recovery in a future filing. Further, the remaining $3.8 million net under-collections in the watersupply cost balancing accounts relate to GSWC’s Region I net under-collectionof $1.9 million and Region II’s net under-collection of $1.9 million.  Currently, there are surcharges in place inRegion I expiring in 2009 and 2010 to recover this under-collection. Asurcredit in Region II to refund a previous over-collection expired in August 2008.   During the fourth quarter of 2008, GSWCintends to file for supply expense offsets in Regions II and III to reduce thelevel of under-collections being accumulated.

 

On August 21, 2008,the CPUC issued a final decision which approved a settlement agreement betweenGSWC and the CPUC’s Division of Ratepayer Advocates (“DRA”) regardingconservation rate design.  As a result ofthis decision, GSWC is permitted to establish a modified cost balancing account that will permit GSWC to  recover supply costs  related to changes in water supply mix. GSWCintends to implement this  modifiedsupply cost balancing account in November 2008.  This account will  replace the current water supply costbalancing account procedure for costs incurred after the modified supply costbalancing account is implemented.

 

***CostsDeferred for Future Recovery:***

 

In1999, GSWC sued Aerojet-General Corporation (“Aerojet”) for contaminating theSacramento County Groundwater Basin, which affected certain GSWC wells. On arelated matter, GSWC also filed a lawsuit against the State of California (the “State”).The CPUC authorized memorandum accounts to allow for recovery, from customers,of costs incurred by GSWC in prosecuting the cases against Aerojet and theState, less any recovery from the defendants or others.  On July 21, 2005, the CPUC authorizedGSWC to collect approximately $21.3 million of the Aerojet litigationmemorandum account, through a rate surcharge, which will continue for no longerthan 20 years. Beginning in October 2005, new rates went into effect tobegin amortizing the memorandum account over a 20-year period.  A rate surcharge generating approximately$299,000 and $309,000 was billed to customers during the three months ended September 30,2008 and 2007, respectively, and $789,000 and $813,000 during the nine monthsended September 30, 2008 and 2007, respectively.  GSWC will keep the Aerojet memorandum accountopen until the earlier of full amortization of the balance or20 years.  However, no costs will beadded to the memorandum account, other than on-going interest charges approvedby the CPUC decision. Pursuant to the decision, additional interest ofapproximately $111,000 and $273,000 was added to the Aerojet litigationmemorandum account during the three months ended September 30, 2008 and2007, respectively, and $367,000 and $827,000 was added to this account duringthe nine months ended September 30, 2008 and 2007, respectively.

 

It is management’sintention to offset any settlement proceeds received from Aerojet, pursuant tothe settlement agreement, against the balance in the memorandum account, withthe exception of an $8.0 million payment guaranteed by Aerojet.  This payment, plus interest on the unpaidbalance, is scheduled to be paid by Aerojet in installments over five yearsbeginning in 2009.  Aerojet has alsoagreed to reimburse GSWC an additional $17.5 million, plus interestaccruing from January 1, 2004, for GSWC’s past legal and expert costs. Therecovery of the $17.5 million is contingent upon the issuance of land useapprovals for development in a defined area within Aerojet property in EasternSacramento County and the receipt of certain fees in connection with suchdevelopment.

 

***Santa Maria Adjudication Memorandum Accounts:***

 

As more fully discussedin Note 7, GSWC has incurred costs of approximately $7.0 million as of September 30,2008, including legal and expert witness fees, in defending its rights to thegroundwater supply in the Santa Maria Basin for use by its customers in SantaBarbara and San Luis Obispo Counties. Such costs had been recorded in utilityplant for future rate recovery. In February 2006, GSWC filed anapplication with the CPUC for recovery of $5.5 million of these costs,representing the amount of the costs that had been incurred as of December 31,2005. In February 2007, GSWC reached a settlement with the CPUC’s Divisionof Ratepayer Advocates (“DRA”) authorizing recovery of the $5.5 millionrequested in GSWC’s application. The settlement deferred review of theremaining legal costs pending final resolution of the lawsuit. In May 2007,the CPUC issued a decision that approved the settlement with the DRA. Pursuantto the decision, GSWC was authorized to place in rate base $2.7 million ofthe $5.5 million of previously incurred litigation costs in the SantaMaria groundwater basin adjudication.

 

17

----

Tableof Contents

 

GSWC was also authorizedto amortize, with interest, the remaining $2.8 million of the$5.5 million in rates over a ten-year period. This amount has beentransferred into a separate memorandum account included within regulatoryassets and a surcharge has been implemented in the third quarter of 2007 forrecovery of these costs. A rate surcharge generating approximately $113,000 and$79,000 was billed to customers during the three months ended September 30, 2008 and 2007, respectively, and $247,000 and $79,000 was billed tocustomers during the nine months ended September 30, 2008 and 2007,respectively.  All litigation costs,including interest, that have been incurred since December 31, 2005,totaling approximately $1.5 million, have also been transferred from ratebase to a separate new memorandum account, subject to a reasonableness reviewby the CPUC in a subsequent phase of this proceeding or in a newproceeding.  In April 2008, theAdministrative Law Judge closed the proceeding without ruling on thestipulation or authorizing recovery of the remaining costs. The ruling directedGSWC to file a new application. In accordance with this ruling, GSWC intends tofile a new application.  Managementbelieves that these additional costs will be approved and that recovery ofthese costs through rates is probable.

 

***General Rate Case Memorandum Accounts:***

 

For GSWC’s Region IIIrate case approved by the CPUC on January 12, 2006, the CPUC also approvedthe second year increases for Region III in an estimated amount ofapproximately $2.3 million, effective January 1, 2007. Based oncertain corrections to the rate calculation, GSWC also filed an Application forRehearing to request additional revenues in connection with the January 2006decision.  On July 31, 2008, theCPUC adopted a stipulation jointly filed by GSWC and DRA.  The stipulation addressed all of the pendingissues including proposing a 12-month surcharge enabling GSWC to recoverrevenues of approximately $541,000 for the period January 1, 2006 through May of2008.  As a result of the CPUC’s approval, a regulatory asset of $541,000was recorded in July 2008 with a corresponding increase to income.  GSWC expects to recover this regulatoryasset  through the 12-month surcharge.

 

***Other Regulatory Matters:***

 

On February 15,2007, the CPUC issued a subpoena to GSWC in connection with an investigation ofcertain work orders and charges paid to a specific contractor used by GSWC fornumerous construction projects. The CPUC’s investigation focuses on whetherthese charges were approved in customer rates and whether they were just andreasonable. In June 2007, GSWC received notification from the CPUC that itwas instituting an audit. The purpose of the audit was to examine for theperiod 1994 to the present, GSWC’s policies, procedures, and practicesthroughout all of its Regions regarding the granting or awarding ofconstruction contracts or jobs.  GSWC iscurrently responding to data requests submitted by the CPUC.  Management cannot predict the outcome of theinvestigation or audit at this time.

 

GSWC’s BVES division hasbeen regularly filing compliance reports with the CPUC regarding its purchasesof energy from renewable energy resources. The filings indicated that BVES hadnot achieved interim target purchase levels of renewable energy resources andthus, on its face, might be subject to a potential penalty. GSWC has formallycontested the potential penalty reflected in the compliance report. The CPUChas been considering the future timing and applicability of renewable energyresource requirements as they apply to smaller energy utilities like BVES.   On May 30, 2008, the CPUC issued itsfinal decision regarding the renewable responsibilities of small utilities(including BVES).  The final decisionaffirmed the renewable obligation targets for the small utilities but alsoallowed for the small utilities to defer compliance under the CPUC’s flexiblecompliance rules.  BVES is continuing itsefforts to procure renewable resources each year going forward, and where thatmay prove difficult because the market for such resources is very constrained,then BVES will be required to describe in detail the problems that warrantfurther deferral, in accordance with the CPUC’s flexible compliance rules.Because the final decision deferred BVES’ interim target purchase levels forthe years 2004 through 2007, management believes that the CPUC’s decisioneffectively forecloses any exposure to financial penalties for the year 2007and earlier.  For the 2008 year, BVES isnot expecting to meet the interim targets and expects  that the CPUC will waive any potential finesin accordance with the flexible compliance rules.  Accordingly, no provisionfor loss has been recorded in the financial statements as of September 30,2008.

 

18

----

Tableof Contents

 

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

 

Registrantcomputes earnings per share (“EPS”) in accordance with EITF No. 03-06, *“Participating Securities and the Two-Class Method under FASBStatement No. 128”. *EITFNo. 03-06 provides the accounting guidance for the effect of participatingsecurities on EPS calculations and the use of the “two-class” method. Theguidance 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 hasparticipating securities related to stock options and restricted stock unitsthat earn dividend equivalents on an equal basis with common shares that havebeen issued under AWR’s 2000 Stock Incentive Plan, 2008 Stock Incentive Planand 2003 Non-Employee Directors Stock Plan. In applying the “two-class” method, undistributed earnings are allocatedto both common shares and participating securities. The following is areconciliation of Registrant’s net income and weighted average common sharesoutstanding for calculating basic net income per share:

 
| **Basic**                                                                                                                                    | ** ** | **For The Three Months**Ended September 30, | ** ** | **For The Nine Months**Ended September 30, | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)**                                                                        | ** ** | **2008**                                                             | ** ** | **2007**                                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                                                                                                                   |       | $                                                                    | 4,552      |                                                                | $          | 7,629 |   | $ | 19,139 |   | $ | 21,935 |   |
| Less: (a)   Distributed earnings to common shareholders                                                                                 |       | 4,317                                                                |       | 4,041                                                               |       | 12,939 |   | 12,049 |   |
|                 Distributed earnings to  participating securities |       | 24                                                                   |       | 61                                                                  |       | 67 |   | 179 |   |
| Undistributed  earnings                                                                                                                      |       | 211                                                                  |       | 3,527                                                               |       | 6,133 |   | 9,707 |   |
|                                                                                                                                         |       |                                                                 |       |                                                                |       |   |   |   |   |
| (b)   Undistributed earnings allocated to common shareholders                                                                           |       | 210                                                                  |       | 3,475                                                               |       | 6,102 |   | 9,565 |   |
|        Undistributed earnings allocated to  participating securities                                           |       | 1                                                                    |       | 52                                                                  |       | 31 |   | 142 |   |
|                                                                                                                                         |       |                                                                 |       |                                                                |       |   |   |   |   |
| Total income  available to common shareholders, basic (a)+(b)                                                                                |       | $                                                                    | 4,527      |                                                                | $          | 7,516 |   | $ | 19,041 |   | $ | 21,614 |   |
|                                                                                                                                         |       |                                                                 |       |                                                                |       |   |   |   |   |
| Weighted average  Common Shares outstanding, basic                                                                                           |       | 17,268                                                               |       | 17,197                                                              |       | 17,252 |   | 17,091 |   |
| **Basic earnings per Common Share**                                                                                                          |       | $                                                                    | 0.26       |                                                                | $          | 0.44 |   | $ | 1.10 |   | $ | 1.26 |   |

 

DilutedEPS is based upon the weighted average number of common shares, including bothoutstanding shares and shares potentially issuable in connection with stockoptions and restricted stock units granted under Registrant’s 2000 StockIncentive Plan, 2008 Stock Incentive Plan and 2003 Non-Employee Directors StockPlan, and net income. At September 30, 2008 and 2007, there were 544,778and 499,145 stock options outstanding, respectively, under these Plans. At September 30,2008 and 2007, there were also approximately 76,809 and 62,007 restricted stockunits outstanding, respectively.

 

The following is a reconciliation of Registrant’s netincome and weighted average common shares outstanding for calculating dilutednet income per share:

 
| **Diluted**                                                           | ** ** | **For The Three Months  Ended September 30,** | ** ** | **For The Nine Months  Ended September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2008**                                                               | ** ** | **2007**                                                              | ** ** | **2008** | ** ** | **2007** | ** ** |
| Common  shareholders earnings, basic                                  |       | $                                                                      | 4,527      |                                                                  | $          | 7,516 |   | $ | 19,041 |   | $ | 21,614 |   |
| Undistributed  earnings for dilutive stock options (1)                |       | 1                                                                      |       | —                                                                |       | 31 |   | — |   |
| Total common  shareholders earnings, diluted                          |       | $                                                                      | 4,528      |                                                                  | $          | 7,516 |   | 19,072 |   | $ | 21,614 |   |
|                                                                  |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Weighted average  common shares outstanding, basic                    |       | 17,268                                                                 |       | 17,197                                                                |       | 17,252 |   | 17,091 |   |
| Stock-based  compensation (2)                                         |       | 136                                                                    |       | 42                                                                    |       | 126 |   | 41 |   |
| Weighted average  common shares outstanding, diluted                  |       | 17,404                                                                 |       | 17,239                                                                |       | 17,378 |   | 17,132 |   |
| **Diluted earnings per Common  Share**                                |       | $                                                                      | 0.26       |                                                                  | $          | 0.44 |   | $ | 1.10 |   | $ | 1.26 |   |

 

----

(1)          Undistributedearnings allocated to participating securities were not included as of September 30,2007 due to their antidilutive effect on diluted earnings per share.

(2)          Inapplying the treasury stock method of reflecting the dilutive effect ofoutstanding stock-based compensation in the calculation of diluted EPS, 544,778and 210,971 stock options at September 30, 2008 and 2007, respectively,were deemed to be outstanding in accordance with SFAS No. 128, *“Earnings Per Share.”* All of the 76,809 restricted stock units at September 30, 2008 wereincluded in the calculation of diluted EPS for the three and nine months ended September 30,2008.

 

19

----

Tableof Contents

 

Stockoptions of 89,843 were outstanding at September 30, 2007, but not includedin the computation of diluted EPS because the related option exercise price wasgreater than the average market price of AWR’s common shares for the ninemonths ended September 30, 2007. Stock options of 198,331 were outstanding at September 30,2007,  but not included in thecomputation of diluted EPS because they were antidilutive. Also not included inthe calculation of EPS were 62,007 restricted stock units at September 30,2007 because they were antidilutive.

 

 During the nine months ended September 30,2008 and 2007, Registrant issued 27,382 and 18,516 common shares, forapproximately $708,000 and $690,000, respectively, under the Registrant’sCommon Share Purchase and Dividend Reinvestment Plan, and the 401(k) Plan.  In addition, during the nine months ended September 30,2008 and 2007, Registrant issued 27,192 and 128,381 common shares forapproximately $666,000 and $3,097,000, respectively, as a result of theexercise of stock options under the Company’s stock incentive plans.  No cash proceeds received by AWR as a resultof the exercise of these stock options have been distributed to anysubsidiaries of AWR.

 

Registrantpurchased 2,729 and 1,104 common shares on the open market during the threemonths ended September 30, 2008 and 2007, respectively, under theRegistrant’s Common Share Purchase and Dividend Reinvestment Plan and 401(k) Plan.  The common shares purchased by Registrantwere used to satisfy the requirements of these plans.  During the nine months ended September 30,2008 and 2007, Registrant purchased 27,566 and 4,657 respectively, commonshares on the open market under these plans for the same purpose.

 

Duringthe three months ended September 30, 2008 and 2007, AWR paid quarterlydividends to shareholders of approximately $4.3 million, or $0.250 per share,and $4.0 million, or $0.235 per share, respectively.  During the nine months ended September 30,2008 and 2007, AWR paid quarterly dividends to shareholders of approximately$12.9 million, or $0.750 per share, and $12.0 million, or $0.705 per share,respectively.

 

On August 21,2008, the Board of Directors approved the issuance of 12 additional GSWC CommonShares to AWR for $30.0 million. GSWC used the proceeds to pay down debt owedto AWR.

 

**Note 4 — Derivative Instruments:**

 

Registrant has certainblock-forward purchase power contracts that are subject to SFAS No. 133, *“Accounting for Derivative Instruments and Hedging Activities,”*as amended by SFAS Nos. 138 and 149. A derivative financial instrument or othercontract derives its value from another investment or designated benchmark.SFAS No. 133 requires companies to record derivatives on the balance sheetas assets and liabilities, and to measure those instruments at their fairvalue. During 2002, GSWC became a party to block-forward purchase powercontracts that qualified as derivative instruments under SFAS No. 133.Contracts with Pinnacle West Capital Corporation (“PWCC”) which becameeffective in November 2002 have not been designated as normal purchasesand normal sales.  In June 2007,PWCC sold the contracts between PWCC and GSWC to Morgan Stanley Capital Group, Inc.(“MSCG”) effective November 1, 2007.  Settlement ofthese contracts occurred on a cash or net basis through 2006 and occurs byphysical delivery thereafter through the expiration of the contracts on December 31,2008. Registranthas no other derivative financial instruments.

 

As a result of thecontracts with MSCG, on a monthly basis, the related asset or liability isadjusted to reflect the fair market value at the end of the month.  Registrant adopted SFAS No. 157effective January 1, 2008 for financial assets and liabilities measured ona recurring basis.  SFAS No. 157applies to all financial assets and financial liabilities that are beingmeasured and reported on a fair value basis. There was no impact in theadoption of SFAS No. 157 to the consolidated financial statements.However, SFAS No. 157 requires disclosure that establishes a framework formeasuring fair value and expands disclosure about fair value measurements. Thestatement requires fair value measurements to be classified and disclosed inone of the following three categories:

* *

*Level 1*:Unadjusted quoted prices in active markets that are accessible at themeasurement date for identical, unrestricted assets or liabilities;

*Level 2*:Quoted prices in markets that are not active, or inputs which are observable,either directly or indirectly, for substantially the full term of the asset orliability, or

*Level 3*:Prices or valuation techniques that require inputs that are both significant tothe fair value measurement and unobservable (i.e., supported by little or nomarket activity).

 

Registrant’s valuationmodel utilizes various inputs that include quoted market prices for energy overthe duration of the contracts. The market prices used to determine the fairvalue for this derivative instrument were estimated based on independentsources such as broker quotes and publications that are not observable in or

 

20

----

Tableof Contents

 

corroborated by the market. When such inputshave a significant impact on the measurement of fair value, the instrument iscategorized in Level 3.  Accordingly, thevaluation of the derivative on Registrant’s purchased power contract with MSCGhas been classified as Level 3.

 

The following tablepresents changes in the fair value of the derivative for the three months endedSeptember 30, 2008.

 
| **(dollars in thousands)**                                                            | ** ** | **Gains (Losses)** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Balance,  June 30, 2008                                                                    |       | $                       | 2,953      |   |
|     Unrealized loss on purchased power  contracts included in operating expenses |       | (3,741                  | )          |
| Balance, September 30, 2008                                                                |       | $                       | (788       | ) |

 

The following tablepresents changes in the fair value of the derivative for the nine months ended September 30,2008.

 
| **(dollars in thousands)**                                                            | ** ** | **Gains (Losses)** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Balance,  December 31, 2007                                                                |       | $                       | (1,554     | ) |
|     Unrealized gain on purchased power  contracts included in operating expenses |       | 766                     |       |
| Balance, September 30, 2008                                                                |       | $                       | (788       | ) |

 

As these contracts aresettled, the realized gains or losses are recorded in power purchased forresale, and the previously recorded unrealized gains or losses are reversed.The fair market value of $788,000 cumulative loss recognized on the balancesheet in current assets as of September 30, 2008 is expected to berecognized as an increase to income during the fourth quarter of 2008 as thecontracts will expire on December 31, 2008.

 

In October 2008,  GSWC executed a new purchased powercontract  that will provide power to BVESeffective January 1, 2009 at a fixed cost over a five year term. The newcontract is subject to CPUC approval. Once the contract is approved, BVES intends to file a separate application to incorporate the new costs,including energy purchases and delivery costs, into rates.  The new contract will also be subject to SFASNo. 133 and will require mark-to-market derivative accounting.  BVES expects to make another separate filingrequesting the CPUC to authorize the establishment of regulatory asset andliability accounts to offset the entries required by SFAS No. 133.  All unrealized gains and losses generatedfrom the new purchased power contract would be deferred on a monthly basis intothe non-interest bearing regulatory accounts that would track the changes infair value of the derivative throughout the term of the contract.   Upon approval of the new contract by theCPUC, changes in the fair value of the derivative throughout the term of thenew contract will be included in the regulatory accounts established and would,as a result, no longer affect GSWC’s earnings.

 

**Note 5 —Income Taxes:**

 

As aregulated utility, GSWC treats certain temporary differences asflow-through adjustments in computing its income tax provisionconsistent with the income tax approach approved by the CPUC for ratemakingpurposes. Flow-through adjustments increase or decrease tax expensein one period, with an offsetting increase or decrease occurring inanother period. Giving effect to these temporary differences as flow-throughadjustments typically results in a greater variance between theeffective tax rate (“ETR”) and the statutory federal income tax rate in anygiven period than would otherwise exist if GSWC were not requiredto account for its income taxes as a regulated enterprise.

 

During the second quarterof 2008, the Internal Revenue Service (“IRS”) issued a Revenue Agent’s Report (“RAR”)in connection with its examination of the 2002 tax year which resulted inRegistrant recognizing certain tax benefits in accordance with FIN 48. Consequently, Registrant’s total unrecognized tax benefit decreased by $1,265,000from $5,113,000 at December 31, 2007 to $3,848,000 at September 30,2008.  The amount of the unrecognized taxbenefits that, if recognized, would affect the effective tax ratedecreased  from $118,000 at December 31,2007 to zero at September 30, 2008.  Associated with these changes,Registrant recognized $480,000 of interest income in the second quarter of2008, with a corresponding increase in an interest receivable included innoncurrent assets.  Upon receiving theRAR, Registrant filed a protest with the IRS’s Office of Appeals in which itrequested a conference to address Registrant’s disagreement with certain of theAgent’s adjustments.

 

Registrant’s policy is toclassify interest on income tax over/underpayments in interest income/expenseand penalties in “other operating expenses.”

 

21

----

Tableof Contents

 

**Note 6 —Employee Benefit Plans:**

 

Thecomponents of net periodic benefit costs, before allocation to the overheadpool, for Registrant’s pension plan, postretirement plan, and SupplementalExecutive Retirement Plan (“SERP”) for the three and nine months ended September 30,2008 and 2007 are as follows:

 
| ** **                                     | ** ** | **For The Three Months Ended September 30,** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | **Other Postretirement** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Pension Benefits**                                                  | ** ** | **Benefits** | ** ** | **SERP** | ** ** |
| **(dollars in thousands)**           | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Components  of Net Periodic Benefits Cost:** | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                   |       | $                                                                          | 896        |   | $ | 940 |   | $ | 86 |   | $ | 105 |   | $ | 60 |   | $ | 106 |   |
| Interest cost                                  |       | 1,350                                                                      |       | 1,243 |   | 161 |   | 168 |   | 63 |   | 41 |   |
| Expected return  on plan assets                |       | (1,235                                                                     | )          | (1,133 | ) | (63 | ) | (57 | ) | — |   | — |   |
| Amortization of  transition                    |       | —                                                                     |       | — |   | 105 |   | 105 |   | — |   | — |   |
| Amortization of  prior service cost            |       | 30                                                                         |       | 41 |   | (50 | ) | (50 | ) | 230 |   | 40 |   |
| Amortization of  actuarial (gain) loss         |       | —                                                                     |       | 154 |   | — |   | 25 |   | (14 | ) | (6 | ) |
| Net periodic  pension cost                     |       | $                                                                          | 1,041      |   | $ | 1,245 |   | $ | 239 |   | $ | 296 |   | $ | 339 |   | $ | 181 |   |

 
| ** **                                     | ** ** | **For The Nine Months Ended September 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | ** **                                                                | ** ** | ** ** | ** ** | **Other Postretirement** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Pension Benefits**                                                 | ** ** | **Benefits** | ** ** | **SERP** | ** ** |
| **(dollars in thousands)**           | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Components  of Net Periodic Benefits Cost:** | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                   |       | $                                                                         | 2,688      |   | $ | 2,820 |   | $ | 258 |   | $ | 315 |   | $ | 180 |   | $ | 318 |   |
| Interest cost                                  |       | 4,050                                                                     |       | 3,729 |   | 483 |   | 504 |   | 189 |   | 123 |   |
| Expected return  on plan assets                |       | (3,705                                                                    | )          | (3,399 | ) | (189 | ) | (171 | ) | — |   | — |   |
| Amortization of  transition                    |       | —                                                                    |       | — |   | 315 |   | 315 |   | — |   | — |   |
| Amortization of  prior service cost            |       | 90                                                                        |       | 123 |   | (150 | ) | (150 | ) | 690 |   | 120 |   |
| Amortization of  actuarial (gain) loss         |       | —                                                                    |       | 462 |   | — |   | 75 |   | (42 | ) | (18 | ) |
| Net periodic  pension cost                     |       | $                                                                         | 3,123      |   | $ | 3,735 |   | $ | 717 |   | $ | 888 |   | $ | 1,017 |   | $ | 543 |   |

 

Registrant made its annual contribution of $4,166,000 tothe pension plan during the third quarter of 2008.   No contributions were made to thepostretirement medical plan during the nine months ended September 30,2008.  Registrant expects to contributeapproximately $509,000 to the medical plan in the fourth quarter of 2008.

 

Due to recent market events, the fair value of the planassets for the pension and postretirement plans have declined since December 31,2007.   Lower plan asset values will: (i) resultin an increase in Registrant’s underfunded positions on the balance sheet witha corresponding increase in  regulatoryassets for pensions and other postretirement obligations at year-end; (ii) potentiallyincrease pension and postretirement expense in the next fiscal year, to theextent the effects are not offset by the effects of a change in the discountrate, and (iii) potentially require greater cash contributions in 2009. Registrant will also review theappropriateness of its expected long-term rate of return on plan assets to beused at the next measurement date (December 31, 2008) to determine theexpected return on assets component of expense for 2009.

 

**Note 7 — Contingencies:**

 

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

 

Perchlorate and/orVolatile Organic Compounds (“VOC”) have been detected in five wells servicingGSWC’s South San Gabriel System. GSWC filed suit in federal court, along withtwo other affected water purveyors and the San Gabriel Basin Water QualityAuthority (“WQA”), against some of those allegedly responsible for thecontamination of two of these wells. Some of the other potential defendantssettled with GSWC, other water purveyors and the WQA (the “Water Entities”), onVOC related issues prior to the filing of the lawsuit. In response to thefiling of the lawsuit, the Potentially Responsible Party (“PRP”) defendantsfiled motions to dismiss the suit or strike certain portions of the suit. Thejudge issued a ruling on April 1, 2003 granting in part and denying inpart the PRP’s motions. A key ruling of the court was that the water purveyors,including GSWC, by virtue of their 

 

22

----

Tableof Contents

 

ownership of wellscontaminated with hazardous chemicals are themselves PRPs under theComprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”).

 

GSWC has, pursuant topermission of the court, amended its suit to claim certain affirmative defensesas an “innocent” party under CERCLA. Registrant is presently unable to predictthe outcome of this ruling on its ability to fully recover from the PRPs futurecosts associated with the treatment of these wells. In this same suit, the PRPshave filed cross-complaints against the Water Entities, the Metropolitan WaterDistrict (“MWD”), the Main San Gabriel Basin Watermaster and others on thetheory that they arranged for and did transport contaminated water into theMain San Gabriel Basin for use by GSWC and the other two affected waterpurveyors and for other related claims.

 

On August 29, 2003,the US Environmental Protection Agency (“EPA”) issued Unilateral AdministrativeOrders (“UAO”) against 41 parties deemed responsible for polluting thegroundwater in that portion of the San Gabriel Valley from which two of GSWC’simpacted wells draw water. GSWC was not named as a party to the UAO. The UAOrequires that these parties remediate the contamination. The judge in thelawsuit has appointed a special master to oversee mandatory settlementdiscussions between the PRPs and the Water Entities. EPA is also conductingsettlement discussions with several PRPs regarding the UAO. The Water Entitiesand EPA are working to coordinate their settlement discussions under thespecial master in order to arrive at a complete resolution of all issuesaffecting the lawsuit and the UAO. Settlements with a number of the PRPs arebeing finalized; however, Registrant is presently unable to predict theultimate outcome of these settlement discussions.

 

Registrant is unable topredict an estimate of the loss, if any, resulting from any pending suits oradministrative proceedings.

 

***Condemnation of Properties:***

 

The laws of the State ofCalifornia and the State of Arizona provide for the acquisition of publicutility property by governmental agencies through their power of eminentdomain, also known as condemnation, where doing so is necessary and in thepublic interest. In addition, however, the laws of California provide: (i) thatthe owner of utility property may contest whether the condemnation is actuallynecessary and in the public interest, and (ii) that the owner is entitledto receive the fair market value of its property if the property is ultimatelytaken.

 

Although the City ofClaremont, California (the “City”) located in GSWC’s Region III, has notinitiated the formal condemnation process pursuant to California law, the Cityhas expressed various concerns to GSWC about the rates charged by GSWC and theeffectiveness of the CPUC’s rate-setting procedures. The City hired a consultantto perform an appraisal of the value of GSWC’s water system serving the City.The value was estimated in 2004 by the City’s consultant at$40—$45 million. GSWC disagrees with the consultant’s valuationassessment. As of September 30, 2008, management believes that the fairmarket value of the Claremont water system exceeds the $37.8 million recordednet book value and also exceeds the consultant’s estimates of its value. TheClaremont City Council held a project priorities workshop in April 2007.The council members agreed that the acquisition of GSWC’s water system was toremain a priority and authorized staff to obtain updated appraisals for thevalue of the water systems. Requests for proposals have been sent to consultingfirms by the City.  In  meetings held in February and June of2008, the Claremont City Council stated that they had decided to authorizeadditional studies of the acquisition of GSWC’s water system and plans to moveforward on this matter.

 

The Town of Apple Valleyabandoned its activities related to a potential condemnation of GSWC’s watersystem serving the Town in 2007.  Exceptfor the City of Claremont and the Town of Apple Valley, Registrant has notbeen, within the last three years, involved in activities related to thepotential condemnation of any of its water customer service areas or in itsBVES customer service area. No formal condemnation proceedings have been filedagainst any of the Registrant’s service areas during the past three years.

 

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

 

In1997, the Santa Maria Valley Water Conservation District (“plaintiff”) filed alawsuit against multiple defendants, including GSWC, the City of Santa Maria,and several other public water purveyors. The plaintiff’s lawsuit sought anadjudication of the Santa Maria Groundwater Basin (the “Basin”). A stipulatedsettlement of the lawsuit has been reached, subject to CPUC approval.  The settlement, among other things, ifapproved by the CPUC, would preserve GSWC’s historical pumping rights and securesupplemental water rights for use in case of drought or other reductions in thenatural yield of the Basin. GSWC, under the stipulation, has a right to 10,000acre-feet of 

 

23

----

Tableof Contents

 

groundwaterreplenishment provided by the Twitchell Project, a storage and flood controlreservoir project operated by the Santa Maria Valley ConservationDistrict.  A monitoring and annual reporting program has been establishedto allow the parties to responsibly manage the Basin and to respond to shortageconditions.  If severe water shortage conditions are found over a periodof five years, the management area engineer will make findings andrecommendations to alleviate such shortages.  In the unlikely casethat the Basin experiences severe shortage conditions, the court has theauthority to limit GSWC’s groundwater production to 10,248acre-feet per year, based on developed water in the Basin.

 

OnFebruary 11, 2008, the court issued its final judgment, which approves andincorporates the stipulation.  The judgment awards GSWC prescriptiverights to groundwater against the non-stipulating parties.  In addition,the judgment grants GSWC the right to use the Basin for temporary storage andto recapture 45 percent of the return flows that are generated from itsimportation of State Water Project water.  Pursuant to this judgment, thecourt retains jurisdiction over all of the parties to make supplemental ordersor to amend the judgment as necessary. On March 20, 2008, the non-stipulating parties filed notices ofappeal.  Registrant is unable to predictthe outcome of the appeal.

 

***Air Quality Management District:***

 

In 1998, the South CoastAir Quality Management District (“AQMD”) issued a permit to GSWC for theinstallation and use of air stripping equipment at one of GSWC’s groundwatertreatment systems in its Region II service area. In 2005, the AQMD conducted aninspection of this facility (“Watson Well”) and issued a Notice of Violation (“NOV”)for exceeding the amount of groundwater permitted to be treated by thetreatment system during calendar year 2004. Since receiving the NOV, changes inGSWC’s procedures have helped to avoid additional violations at the facility.The AQMD could have assessed penalties associated with an NOV; however, GSWCfinalized a settlement of the NOV with the AQMD in June 2007.  As part of the settlement, GSWC agreed toinstall and operate granular activated carbon (“GAC”) filters at the facility.Installation of the filters will eliminate the use of the air strippingequipment at the facilities involved with the NOV and thus improve air quality.The AQMD accepted  this agreement andassessed a nominal penalty of $25,000. During 2007, GSWC paid the penalty of$25,000. It is estimated that the total capital cost of the  installation of the GAC filters will beapproximately $1.8 million with a required estimated completion date of April 30,2009. Upon timely  installation of thefilters, GSWC will be released from any and all claims or penalties arisingfrom the NOV. Management believes that GSWC will be able to  complete installation of the filters and nofurther penalties are expected to be assessed. Management also believes it isprobable that the capital costs of the installation of the filters will be approved in rate base by the CPUC.GSWC has  begun  installation of the filters and has spentapproximately $933,000 as of September 30, 2008.

 

In January 2008,GSWC removed the air stripper from the Watson Plant.  An AQMD inspector visited the Watson Plantand confirmed the removal of the air stripping equipment.  GSWC submitted a request to deactivate theair quality permit in February 2008. GSWC has installed a temporary GAC treatment system.  The temporary treatment system was put inservice in March 2008.  GSWC expectsthat the return to service of the Watson Well will improve local groundwatersupply reliability.

 

***Environmental Clean-Up and Remediation:***

 

Chadron Plant:GSWC has been involved in environmental remediation and clean-up at a plantsite (“Chadron Plant”) that contained an underground storage tank which wasused to store gasoline for its vehicles. This tank was removed from the groundin July 1990 along with the dispenser and ancillary piping. As required atthe time, a tank removal report was submitted to the Los Angeles Department ofPublic Works (“DPW”). At the request of DPW, soil samples were collectedbeneath the tank and the results indicated gasoline impacted soil in thenorthern portion of the former tank pit. Quarterly monitoring began in July 1994.Between July 1994 and November 1995, additional monitoring wells wereinstalled and pilot remediation tests were conducted. A site assessment reportwas completed in April 1996.

 

In January 1998, aplan for the underground storage tank site remediation and closure wasprepared. The remediation system plan was installed and fully operational by October 1998with an estimated two years thereafter for site closure. This plan was approved by the Los Angeles RegionalWater Quality Control Board of the California Environmental Protection Agency (“LARWQCB”).In November 2002, the LARWQCB commented on the methodology selected forcleanup of dissolved contaminants in the shallow groundwater. Data fromoperation of the 

 

24

----

Tableof Contents

 

technology implemented atthe subject site has indicated that the technology did not work as expected.Other remedial alternatives have been considered and evaluated to mitigatedissolved contaminants in the groundwater at the site.  In October 2007, an interim remedialaction plan was approved by the LARWQCB and all appropriate permits have beenacquired to begin remediation.  In March 2008,construction began on Phase 1 of the new remediation system.

 

Based on recentestimates, the total project may take 3-5 more years and cost approximately$1.2 million. Remediation should be completed in two more years, followedby at least one year of monitoring and reporting. The estimate also includesquarterly monitoring and reporting costs. As of September 30, 2008, thetotal amount spent to clean-up and remediate GSWC’s plant facility isapproximately $2.8 million, of which $1.5 million has been paid bythe State of California Underground Storage Tank Fund (the “Fund”).  Amounts paid by GSWC not reimbursed from theFund have been included in rate-base and approved by the CPUC for recovery.During the nine months ended September 30, 2008, GSWC spent approximately$411,000 to clean-up and remediate this site and as of September 30, 2008,GSWC has an accrued liability of $828,000 for the estimated additional cost tocomplete the clean-up at the site. The ultimate cost may vary as there are manyunknowns in remediation of underground gasoline spills and this is an estimatebased on currently available information. Management also believes it isprobable that the estimated additional costs will be approved in rate-base bythe CPUC. Therefore, GSWC has recorded the additional estimated cost as aregulatory asset as of September 30, 2008 and December 31, 2007.

 

Ballona Plant:During the first quarter of 2008, hydrocarbon contaminated soil was found at aplant site (“Ballona Plant”)  located inGSWC’s Southwest customer service area where an abandoned water tank wasdemolished.  The contamination appears tobe shallow and is believed likely to be the result of past corrosion controlpractices. An initial investigation and characterization of the contaminatedarea has been conducted. However, at this time, GSWC is unable to reasonably estimate the cost of clean-up.  Historically, the cost for this type ofclean-up has been included in rates as approved by the CPUC.

 

***Contracted Services:***

 

On March 4, 2008,ASUS received a letter from the U.S. Army demanding payment of approximately$7.5 million in liquidated damages for alleged failure at FBWS to make a goodfaith effort to achieve its small business subcontracting goals. FBWS has fileda Notice of Appeal stating its disagreement with the position taken by the U.S.Army.  The U.S. Army has responded to theappeal and has disagreed with all of FBWS’ assertions.  The parties have each served writtendiscovery on the opposing party and responses have been provided to eachrespective party. On July 15, 2008, the government filed a motion forpartial summary judgment.  The motion asks the Armed Services Board ofContract Appeals (the “Appeals Board”) to rule that the liquidated damagesassessed against FBWS are not barred by cases finding that liquidated damageswhich far exceed actual damages are a “penalty” and, therefore, areunenforceable.   At this time,management believes that the probability of loss is remote and therefore, noprovision for loss has been recorded.

 

On October 15, 2008,the Appeals Board judge conducted a status conference with the parties at whichthey were asked to consider alternate dispute resolution (“ADR”). Each partyindicated  that they were willing toengage in ADR. ADR is scheduled for February 3 - 5, 2009.  If ADR is not successful or if either partydecides to not engage in ADR, both parties have indicated that they intend tofile a motion for summary judgment.  Inthis case, it is expected that  hearingswould likely commence in the third quarter of 2009. The U.S. Army has the rightto offset the claimed damages against amounts owed to this subsidiary, but hasnot exercised this right and has continued to make payments on outstandinginvoices.

 

***Other Litigation:***

 

Two former officers ofGSWC filed a lawsuit against both AWR and GSWC alleging among other things,wrongful termination and retaliation against the former officers. Managementbelieves that the allegations are without merit and intends to vigorouslydefend against them. Based on management’s understanding of all the claims,management does not believe that the ultimate resolution of this matter willhave a material adverse effect on AWR’s and GSWC’s financial position, resultsof operations, or cash flows.

 

Registrant is alsosubject to other ordinary routine litigation incidental to its business.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.

 

25

----

Tableof Contents

 

**Note 8 — Business Segments:**

 

AWR has three reportablesegments, water, electric and contracted services, whereas GSWC has twosegments, water and electric. Within the segments, AWR has three principalbusiness units: water and electric service utility operations conducted throughGSWC, a water-service utility operation conducted through CCWC, and acontracted services unit conducted through ASUS and its subsidiaries. Allactivities of GSWC are geographically located within California. All activitiesof CCWC are located in the state of Arizona. Activities of ASUS and itssubsidiaries have been conducted in California, Maryland, New Mexico, NorthCarolina, South Carolina, Texas and Virginia. Both GSWC and CCWC are rate-regulated utilities.  ASUS’ wholly-owned subsidiaries are regulatedby the state in which the subsidiary conducts water and/or wastewateroperations.  Rates are based upon theterms of the contracts with the U.S. government which have been filed with the commissionsin the states in which ASUS’ subsidiaries operate.  On a stand-alone basis, AWR has no materialassets other than its investments in its subsidiaries. The tables below setforth information relating to GSWC’s operating segments, CCWC, ASUS and itssubsidiaries, and other matters. 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 September ** 30, 2008 | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                                            | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                                           | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                                   | 67,316     |   | $ | 6,743 |   | $ | 2,049 |   | $ | 9,153 |   | $ | — |   | $ | 85,261 |   |
| Operating income  (loss)               |       | 18,060                                                                                                              |       | (4,011 | )(1) | 524 |   | (1,418 | ) | (12 | ) | 13,143 |   |
| Interest  expense, net                 |       | 4,101                                                                                                               |       | 633 |   | 96 |   | 204 |   | 101 |   | 5,135 |   |
| Identifiable  assets                   |       | 730,849                                                                                                             |       | 37,803 |   | 44,468 |   | 2,339 |   | — |   | 815,459 |   |
| Depreciation and  amortization expense |       | 6,700                                                                                                               |       | 552 |   | 461 |   | 169 |   | — |   | 7,882 |   |
| Capital additions                      |       | 19,279                                                                                                              |       | 172 |   | 904 |   | — |   | — |   | 20,355 |   |
|                                        |            |                                                                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)  Includes$3,741,000 unrealized loss on purchased power contracts.

 
|                                        | ** ** | **As Of And For The Three Months Ended September 30, 2007** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                                      | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                                     | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                             | 63,180     |   | $ | 6,289 |   | $ | 2,265 |   | $ | 4,108 |   | $ | — |   | $ | 75,842 |   |
| Operating income  (loss)               |       | 18,062                                                                                                        |       | (901 | )(2) | 476 |   | (60 | ) | (52 | ) | 17,525 |   |
| Interest  expense, net                 |       | 4,068                                                                                                         |       | 357 |   | 107 |   | 245 |   | (20 | ) | 4,757 |   |
| Identifiable  assets                   |       | 679,723                                                                                                       |       | 39,455 |   | 42,122 |   | 750 |   | — |   | 762,050 |   |
| Depreciation and  amortization expense |       | 6,361                                                                                                         |       | 564 |   | 466 |   | 48 |   | — |   | 7,439 |   |
| Capital additions                      |       | 12,166                                                                                                        |       | 638 |   | 414 |   | — |   | — |   | 13,218 |   |
|                                        |            |                                                                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(2)  Includes$896,000 unrealized loss on purchased power contracts.

 
|                                        | ** ** | **As Of And For The Nine Months Ended September **30, 2008 | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                                     | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                                    | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                            | 181,235    |   | $ | 21,754 |   | $ | 5,589 |   | $ | 25,938 |   | $ | — |   | $ | 234,516 |   |
| Operating income  (loss)               |       | 47,971                                                                                                       |       | 1,073 | (3) | 837 |   | (2,567 | ) | (128 | ) | 47,186 |   |
| Interest  expense, net                 |       | 12,174                                                                                                       |       | 1,491 |   | 330 |   | 639 |   | 37 |   | 14,671 |   |
| Identifiable  assets                   |       | 730,849                                                                                                      |       | 37,803 |   | 44,468 |   | 2,339 |   | — |   | 815,459 |   |
| Depreciation and  amortization expense |       | 20,089                                                                                                       |       | 1,657 |   | 1,382 |   | 357 |   | — |   | 23,485 |   |
| Capital additions                      |       | 54,734                                                                                                       |       | 721 |   | 2,322 |   | 1,210 |   | — |   | 58,987 |   |
|                                        |            |                                                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(3)  Includes$766,000 unrealized gain on purchased power contracts.

 

26

----

Tableof Contents

 
|                                        | ** ** | **As Of And For The Nine Months Ended September 30, 2007** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                                     | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                                    | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                            | 170,762    |   | $ | 21,413 |   | $ | 5,836 |   | $ | 29,347 |   | $ | — |   | $ | 227,358 |   |
| Operating income  (loss)               |       | 44,853                                                                                                       |       | 2,711 | (4) | 796 |   | 3,631 |   | (158 | ) | 51,833 |   |
| Interest expense,  net                 |       | 12,490                                                                                                       |       | 1,075 |   | 322 |   | 802 |   | (18 | ) | 14,671 |   |
| Identifiable  assets                   |       | 679,723                                                                                                      |       | 39,455 |   | 42,122 |   | 750 |   | — |   | 762,050 |   |
| Depreciation and  amortization expense |       | 18,583                                                                                                       |       | 1,631 |   | 1,258 |   | 144 |   | — |   | 21,616 |   |
| Capital additions                      |       | 29,668                                                                                                       |       | 1,833 |   | 1,253 |   | 78 |   | — |   | 32,832 |   |
|                                        |            |                                                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(4)  Includes$1,578,000 unrealized gain on purchased power contracts.

 

**Note 9 — Business Acquisition:**

 

ASUS, through itswholly-owned subsidiaries, entered into agreements with the U.S. government tooperate and maintain the water and/or wastewater systems at various militarybases pursuant to 50-year firm, fixed price contracts with prospective priceredeterminations.  ASUS, through itswholly-owned subsidiaries, entered into subcontracts with a single subcontractor pursuant to which thesubcontractor agreed to provide wastewater services to ASUS’ subsidiaries atbases in Maryland, New Mexico, Texas and Virginia.  On January 31, 2008, ASUS and itssubsidiaries agreed to buy out all rights which this subcontractor had toprovide wastewater services at these bases and any future rights that thesubcontractor or any of its affiliates might have to provide wastewaterservices as a subcontractor to ASUS or any of its subsidiaries at any otherbases for an aggregate purchase price of approximately $2.5 million, including acharge to income of $213,000 during the first quarter of 2008 for settlement ofthe preexisting relationship with the subcontractor.  The purchase also included the acquisition ofsubstantially all assets used by the subcontractor in providing the wastewaterservices, including most vehicles, tools, supplies, equipment and books andrecords totaling approximately $611,000.  The acquisition alsoresulted in the recording of approximately $1.1 million of goodwill and$571,000 of identifiable intangible assets subject to amortization.   This acquisition was not material toRegistrant’s financial position or results of operations.  

 

27

----

Tableof Contents

 

**Item 2. Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

# **General**

 

AWR isthe parent company of GSWC, CCWC and ASUS and its subsidiaries, Fort BlissWater Services Company (“FBWS”), Terrapin Utility Services, Inc. (“TUS”),Old Dominion Utility Services, Inc. (“ODUS”), Palmetto State UtilityServices, Inc. (“PSUS”) and Old North Utility Services, Inc. (“ONUS”).AWR was incorporated as a California corporation in 1998 as a holdingcompany.  AWR has three reportablesegments: water, electric and contracted services. Within the segments, AWR hasthree principal business units: water and electric service utility operationsconducted through GSWC, a water-service utility operation conducted throughCCWC, and a contracted services unit conducted through ASUS and itssubsidiaries.

 

GSWCis a California public utility company engaged principally in the purchase,production and distribution of water. GSWC also distributes electricity in onecustomer service area. GSWC is regulated by the California Public UtilitiesCommission (“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 (“BVES”) division.

 

GSWC served 254,689 water customers and 23,091electric customers at September 30, 2008, or a total of 277,780 customers,compared with 254,830 water customers and 23,273 electric customers, or a totalof 278,103 customers at September 30, 2007. GSWC’s utility operationsexhibit seasonal trends. Although GSWC’s water utility operations have adiversified customer base, residential and commercial customers account for themajority of GSWC’s water sales and revenues. Revenues derived from commercialand residential water customers accounted for approximately 91.0% and 90.8% of total water revenues for thethree months ended September 30, 2008 and 2007, respectively, and 87.7%and 87.9% for the nine months ended September 30, 2008 and 2007,respectively.

 

CCWCis an Arizona public utility company engaged principally in the purchase,production and distribution of water.  CCWCserved 13,437 customers as of September 30, 2008, compared with 13,474customers at September 30, 2007. Located in the town of Fountain Hills,Arizona and a portion of the City of Scottsdale, Arizona, the majority of CCWC’scustomers are residential. The Arizona Corporation Commission (“ACC”) regulatesCCWC.

 

ASUS,through its wholly-owned subsidiaries, has contracted with the U.S. governmentto provide water and/or wastewater services, including the operation andmaintenance of water and wastewater systems pursuant to 50-year fixed pricecontracts, which are subject to periodic prospective price redeterminations andmodifications for changes in circumstances. During the first quarter of 2008,ASUS commenced operations at three bases located in North Carolina and SouthCarolina.  All of the contracts with theU.S. government may be terminated, in whole or in part, prior to the end of the50-year term for convenience of the U.S. government or as a result of default ornonperformance by the subsidiary performing the contract. In either event, theASUS subsidiary is entitled to recover the remaining amount of its capitalinvestment pursuant to the terms of a termination settlement with the U.S.government at the time of termination as provided in each of the contracts. Thecontract price for each of these contracts is subject to redetermination twoyears after commencement of operations and every three years thereafter. Pricesare subject to equitable adjustment based upon changes in circumstances andchanges in wages and fringe benefits to the extent provided in each of thecontracts.

 

ASUS and GSWC have beenpursuing an opportunity to provide retail water services within the servicearea of the Natomas Central Mutual Water Company (“Natomas”).  Natomas is a California mutual water companywhich currently provides water service to its shareholders, primarily foragricultural irrigation in portions of Sacramento and Sutter counties innorthern California. In August 2004, Natomas and ASUS entered into acontract under which ASUS acts as the exclusive agent for marketing water thathas become temporarily surplus to the internal needs of Natomas, to thirdparties outside the Natomas service area, and that arises under water rightspermits and contracts owned or controlled by Natomas. On January 31, 2006,ASUS and Natomas entered into a water purchase and sale agreement under whichASUS will acquire 5,000 acre-feet of permanent Sacramento River water diversionrights from Natomas. Pursuant to the terms of this agreement, Natomas willsell, transfer and convey 

 

28

----

Tableof Contents

 

to ASUS, in perpetuity,water rights and entitlements to divert from the Sacramento River up to 5,000acre-feet of water per year for consumptive use, 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 achievement ofspecific milestones and events over a 10-year period. After first determiningwhether a need for the water exists in Sutter County, ASUS may use the waterrights acquired from Natomas to serve existing GSWC’s customers, to re-sell toother beneficial users, or to pursue and serve expanded service territories.

 

Pursuant to the marketingservices agreement described above, ASUS will attempt to arrange for the saleand transfer of Natomas’ temporarily surplus water for beneficial use beyond theNatomas service area.  Natomas will payto ASUS a commission of 16% of the lease or sale price for any such watersuccessfully marketed by ASUS. At the same time that the water purchaseagreement was completed, Natomas and ASUS also entered into a settlementagreement that released Natomas from previously established reimbursementobligations under prior agreements.  Inaccordance with the marketing agreement, Natomas shareholders voted in December 2007to approve the sale of 8,000 to 10,000 acre-feet of Natomas’ Central ValleyProject water to the City of Folsom, subject to certain regulatory andenvironmental approvals. The base price to be paid by Folsom is $4,000 peracre-foot.

 

GSWC and Natomas havealso entered into an agreement under which GSWC agreed to purchase and Natomasagreed to sell up to 30,000 acre-feet per year of water to be used exclusivelyby GSWC to serve customers in Sutter County, California. GSWC filed for aCertificate of Public Convenience and Necessity (“CPCN”) with the CPUC on May 31,2006 to provide retail water service in a portion of Sutter County, Californiawithin the Natomas service area. CPUC review of the application was deferredpending completion of an environmental assessment for the proposed new waterservice territory.  On September 29,2008, GSWC filed an amended application which included the ProponentsEnvironmental Assessment. On October 3, 2008 the County of Sutter and theCPUC’s Division of Rate Payer Advocates protested the application. On October 14,2008, GSWC submitted comments on the protests. The CPUC Administrative Law Judge has yet to set a date for a prehearingconference to determine the scope and procedural schedule. All of theagreements with Natomas are subject to receipt of various regulatory approvalsrequired for their full implementation.

 

**Overview**

 

Registrant’s revenues,operating income, and cash flows are earned primarily through deliveringpotable water to homes and businesses through approximately 2,900 miles ofwater distribution pipelines. Rates charged to customers of GSWC and CCWC aredetermined by the CPUC and ACC, respectively. These rates are intended to allowrecovery of operating costs and a fair rate of return on capital. Factorsrecently affecting financial performance include the process and timing ofsetting rates charged to customers; the ability to recover, and the process forrecovering in rates, the costs of distributing water and electricity; weather;effects of conservation; the impact of increased water quality standards on thecost of operations and capital expenditures; demands on water supply caused bypopulation growth, more stringent water quality standards, deterioration insource water quality, climate change and restrictions on the delivery ofpurchased water affecting deliveries of water from the Colorado River and theState Water Project; capital expenditures needed to upgrade water systems andincreased costs and risks associated with litigation relating to water qualityand water supply, including suits initiated by Registrant to protect its watersupply; delays in receiving payments from the U.S. government and receivingredetermination of prices and equitable adjustment of prices under contractswith the U.S. government, and potential assessments for failure to comply withthe terms of contracts with the U.S. government.

 

Registrant plans tocontinue to seek additional rate increases in future years to recover operatingand supply costs and receive fair returns on invested capital. Capitalexpenditures in future years are expected to remain at much higher levels thandepreciation expense. Cash solely from operations is not expected to besufficient to fund Registrant’s needs for capital expenditures, dividends,investments in Registrant’s contract business and other cash requirements.Registrant expects to fund a portion of these needs through a combination ofdebt and common  share offerings in theensuing years.  Registrant is planning onissuing common  shares over the nexttwelve months depending on market conditions.  On August 25, 2008, AWR amended its $85 million syndicated creditfacility, to increase the aggregate bank commitments by $30 million to $115million.

 

Operating revenues andincome from contracted services at ASUS and its subsidiaries are earned primarilyfrom the operation and maintenance and periodic replacement of system assets ofthe water and/or wastewater systems for the U.S. government at various militarybases. All of the operations and maintenance contracts with the 

 

29

----

Tableof Contents

 

U.S. government are50-year firm, fixed-price contracts with prospective price redeterminations.ASUS also may generate revenues from the construction of additionalinfrastructure improvements at these bases pursuant to the terms of these50-year contracts or pursuant to modifications to the contracts. ASUS plans tocontinue seeking contracts for the operation and maintenance of water and/orwastewater services at military bases.

 

Derivative accounting isrequired for the purchased power contracts at GSWC’s BVES division.  Unrealized gains and losses on purchasedpower contracts have been impacting GSWC’s earnings since 2002 when GSWC enteredinto certain purchased power contracts. These contracts qualified as derivative instruments under SFAS No. 133,*“Accounting for Derivative Instruments and HedgingActivities.”* The powerpurchased under the contract is only used to service electric customers’ demandand Registrant does not engage in trading of purchased power.   Althoughthe unrealized gains and losses result in significant fluctuations to theincome statement, there is no effect on Registrant’s cash flows. When analyzingthe financial performance of AWR, Registrant excludes the effect of unrealizedderivative gains or losses, as they are not reflective of day-to-dayoperations.  The unrealized derivative gains and losses are reflective ofchanges in future electricity costs that are outside of management’scontrol.  Due to decreasing energyprices, during the three months ended September 30, 2008, Registrantrecorded a pretax unrealized loss on purchased power of $3.7 million, or $0.13per share, as compared to an unrealized loss of $896,000, or $0.03 per share,during the three months ended September 30, 2007, a net decrease of $0.10per share.  During the nine months ended September 30,2008, Registrant recorded a pretax unrealized gain of $766,000, or $0.03 pershare, as compared to a gain of $1.6 million, or $0.05 per share, for the sameperiod in 2007, a net decrease of $0.02 per share.

 

**SummaryResults by Segment**

 

AWR has three reportablesegments: water, electric and contracts operation. Within the segments, AWR hasthree principal business units: water and electric service utility operationsconducted through GSWC, a water-service utility operation conducted throughCCWC, and a contracted services unit through ASUS and its subsidiaries.

 

*Third Quarter Results*

 

The tables below setforth summaries of the results by segment (amounts in thousands) for the threemonths ended September 30, 2008 and 2007:

 
| ** **             | ** ** | **Operating Revenues** | ** ** | **Pretax Operating Income** | ** ** |
|------------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| ** **             | ** ** | **3 Months**           | ** ** | **3 Months**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Ended**                   | ** ** | **Ended**                             | ** ** | **$** | ** ** | **%** | ** ** | **Ended** | ** ** | **Ended** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **             | ** ** | **9/30/2008**               | ** ** | **9/30/2007**                         | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** | **9/30/2008** | ** ** | **9/30/2007** | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
|                   |       |                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Water                  |       | $                           | 69,365     |                                  | $          | 65,445 |   | $ | 3,920 |   | 6.0 | % | $ | 18,584 |   | $ | 18,538 |   | $ | 46 |   | 0.2 | % |
| Electric               |       | 6,743                       |       | 6,289                                 |       | 454 |   | 7.2 | % | (4,011 | ) | (901 | ) | (3,110 | ) | -345.2 | % |
| Contracted  services   |       | 9,153                       |       | 4,108                                 |       | 5,045 |   | 122.8 | % | (1,418 | ) | (60 | ) | (1,358 | ) | -2263.3 | % |
| AWR parent             |       | —                      |       | —                                |       | — |   | — |   | (12 | ) | (52 | ) | 40 |   | 76.9 | % |
| Totals from  operation |       | $                           | 85,261     |                                  | $          | 75,842 |   | $ | 9,419 |   | 12.4 | % | $ | 13,143 |   | $ | 17,525 |   | $ | (4,382 | ) | -25.0 | % |

 

***Water-***For the three months ended September 30, 2008,pretax operating income for water increased slightly by $46,000, or 0.2%.  The dollar water margin increased $2.5million as compared to the same period of 2007 caused by higher water ratesapproved by the CPUC subsequent to September 30, 2007, offset by lowerwater  consumption.  A 6.8% decrease in water consumption duringthe three months ended September 30, 2008 resulted in a $2.9 milliondecrease in water revenues, or $0.07 per share. Although precipitation was overall lower in the three months ended September 30,2008 compared to same period 2007, the 2008 water revenues appear to have beenimpacted by the effects of state-wide customer conservation efforts.Differences in temperature and rainfall in Registrant’s service areas as wellas the effects of conservation, has impacted consumption of water by customers causing fluctuations in Registrant’srevenues and earnings between comparable periods.  In August 2008, the CPUC issued a finaldecision regarding conservation rate design that allows for the establishment and implementation of a Water RevenueAdjustment Mechanism (“WRAM”) to decouple sales from revenues.  GSWC intends to implement the WRAM  in November 2008 prospectively.  This should help mitigate fluctuations in Registrant’s future revenues andearnings due to changes in water consumption. In addition,  the CPUC alsoapproved an advice letter filed by GSWC to allow GSWC to create and implement aWater Conservation Memorandum Account (“WCMA”) 

 

30

----

Tableof Contents

 

to track theextraordinary expenses and revenue shortfall associated with  conservation measures in conjunction with thedeclared drought in California.  Seefurther discussion on conservation included in the *“RegulatoryMatters”* section.  Higheroperating expenses, as more fully described later, decreased pretax operatingincome by $2.5 million.

 

***Electric-***For the three months ended September 30, 2008,pretax operating income from electric operations decreased by $3.1 million dueprimarily to a $2.8 million increase in the unrealized loss on purchased powercontracts.   The unrealized loss onpurchased power contracts decreased operating income by approximately $3.7million for the three months ended September 30, 2008, or $0.13 per share,as compared to $896,000, or $0.03 per share, for the same period in 2007.  In addition, other operating expenses increasedby $514,000 compared to the same period in 2007 primarily caused by a $381,000increase in allocation of costs from the corporate headquarters’ to BVES.  Offsetting these decreases in pretaxoperating income was a slight increase in the dollar electric margin of$249,000 caused by the initial recording in the third quarter of 2007 of aregulatory liability totaling $442,000 for probable refunds to customersrelated to an overcollection of the total costs associated with the 8.4MWnatural gas-fueled generation plant.  In April 2005,new customer rates went into effect related to this generation plant, whichresulted in an increase of approximately $2.3 million in annual revenue basedon an estimated total capital-related cost of $13 million. The rates aresubject to refund pending the CPUC’s final cost review, which is scheduled tooccur as part of  BVES’ general rate casethat was recently filed. The CPUC also ordered GSWC to establish a memorandumaccount to track the capital-related costs of the generation plant. If actualrecorded costs in the memorandum account are less than the costs authorized bythe CPUC of $13 million, the revenue requirement for the difference is tobe refunded to customers. During the third quarter of 2007, GSWC received vendorcredits of approximately $851,000, which reduced the actual recorded costs ofthe generation plant to approximately $12.5 million.   During the third quarter of 2008,approximately $23,000 of additional regulatory liability for probable refundswas recorded.

 

***Contracted Services -***For the three months ended September 30,2008, the pretax operating loss for contracted services increased by $1.4million.  This was primarily due tolosses incurred at military bases under two new contracts.  ASUS began operating and maintaining thewater and wastewater systems under two new contracts in North Carolina andSouth Carolina during the first quarter of 2008.  Pretax operating losses at these two baseswere $1.6 million for the three months ended September 30, 2008, including$72,000 for emergency construction at PSUS to address pre-existing conditionsnot anticipated in the contract and for which ASUS is pursuing recovery fromthe U.S. government and $339,000 in anticipated losses associated with certaininitial capital upgrade projects.  Based on current estimates of constructioncosts, ASUS expects to incur  losseson  these initial capital upgrade projects at PSUS.   In September 2008, PSUS submitted aRequest for Equitable Adjustment (“REA”) for the water and wastewater systemsat Fort Jackson, South Carolina requesting a contract modification for theseinitial capital upgrades and emergency construction costs.  The aggregate value of the REA relating toconstruction work is approximately $1.6 million. The REA has not yet beenapproved by the U.S. government, and therefore, the anticipated losses on theseprojects and the pre-contract costs have been recorded during the third quarterof 2008 in construction expense.   Higherthan anticipated transition costs, increases in nonincome tax assessments andother operating expenses, including $488,000 of allocations from ASUS’and corporate headquarters,also contributed to the losses at these two new bases.

 

The other military baseshave generated a slight profit or slight loss during the three months ended September 30,2008.  The timely receipt of priceredeterminations is critical in order for ASUS to recover  increasing costs for operating andmaintaining the water and wastewater systems at the military bases.  In addition, higher allocations of corporateheadquarters’ expenses to ASUS and its wholly-owned subsidiaries by theCPUC  were not contemplated at the timethe contracts with the U.S. government were negotiated and need to be addressedin future price redeterminations. As a result of the CPUC decision, expenseallocations to ASUS increased by approximately $164,000 during the three monthsended September 30, 2008.

 

The contract price foreach of these military contracts is subject to price redetermination two yearsafter commencement of operations and every three years thereafter.  Redeterminations have been submitted and areunder review by the U.S. government for ASUS’ ODUS and TUS operations inVirginia and Maryland, respectively.  The price redeterminations  areexpected to be completed in 2009. Pending redetermination of prices, ASUS has received  interim inflation adjustments to the managementfees  for operating and maintaining thewater and wastewater systems at Fort Eustis, Fort Story and Fort Monroe inVirginia, and the wastewater system at Fort Lee

 

31

----

Tableof Contents

 

also in Virginiaeffective on the second anniversary of the date when ASUS began operating thesebases (February 23, 2006 for Fort Lee and April 3, 2006 for the otherthree bases).   In addition,  ASUSplans to submit an REA for the water and wastewater systems at Fort Bragg/PopeAir Force Base in North Carolina upon completion of the U.S. government’sreview of the Joint Inventory Report filed by ASUS in August 2008. The Joint Inventory Report indicates the quantity of the Fort Bragg/Pope AirForce Base infrastructure to be 20-30% greater than what was assumed under theoriginal 50-year contract.

 

ASUS has experienceddelays in the redetermination of prices at Fort Bliss following completion ofthe first two years of operation in October 2006.  At Fort Bliss, management fees for operationand maintenance of the water and wastewater systems are based on cost levelsprevailing in 2003 when the contract with the U.S. government was bid.   Further, the contract pricing was also basedon assumptions about the size and age of the infrastructure to be operated andmaintained over the 50-year contract.  Arequest for equitable adjustment has been filed as a claim with the U.S.government to adequately reflect the amount of assets included in theinfrastructure at Fort Bliss, which is substantially more than originally estimatedby the U.S. government as part of its solicitation for this contract.   Requests for equitable adjustments provideopportunity for both retrospective and prospective adjustments to revenues andare subject to the terms of the contract and regulations. With the filing ofthis claim, ASUS is also preparing the price redetermination for Fort Bliss andexpects to file  this request upon finalresolution of the request for equitable adjustment.  These price redeterminations, which includeadjustments to reflect changes in operating conditions and infrastructurelevels from that assumed at the time of the execution of the contracts as wellas inflation in costs, are expected to provide added revenues prospectively tohelp offset increased costs and provide Registrant the opportunity to generatepositive operating income from operating activities.  As of September 30, 2008, ASUS has $1.1million of goodwill which may be at risk for potential impairment if requestedprice redeterminations and equitable adjustments are not achieved.

 

*Year-to-Date Results*

 

Thetables below set forth summaries of the results by segment (amounts inthousands) for the nine months ended September 30, 2008 and 2007:

 
| ** **             | ** ** | **Operating Revenues** | ** ** | **Pretax Operating Income** | ** ** |
|------------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| ** **             | ** ** | **9 Months**           | ** ** | **9 Months**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Ended**                   | ** ** | **Ended**                             | ** ** | **$** | ** ** | **%** | ** ** | **Ended** | ** ** | **Ended** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **             | ** ** | **9/30/2008**               | ** ** | **9/30/2007**                         | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** | **9/30/2008** | ** ** | **9/30/2007** | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
|                   |       |                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Water                  |       | $                           | 186,824    |                                  | $          | 176,598 |   | $ | 10,226 |   | 5.8 | % | $ | 48,808 |   | $ | 45,649 |   | $ | 3,159 |   | 6.9 | % |
| Electric               |       | 21,754                      |       | 21,413                                |       | 341 |   | 1.6 | % | 1,073 |   | 2,711 |   | (1,638 | ) | -60.4 | % |
| Contracted  services   |       | 25,938                      |       | 29,347                                |       | (3,409 | ) | -11.6 | % | (2,567 | ) | 3,631 |   | (6,198 | ) | -170.7 | % |
| AWR parent             |       | —                      |       | —                                |       | — |   | — |   | (128 | ) | (158 | ) | 30 |   | 19.0 | % |
| Totals from  operation |       | $                           | 234,516    |                                  | $          | 227,358 |   | $ | 7,158 |   | 3.1 | % | $ | 47,186 |   | $ | 51,833 |   | $ | (4,647 | ) | -9.0 | % |

 

***Water -***For the nine months ended September 30,2008, pretax operating income for water increased by $3.2 million, or 6.9%,primarily due to an $8.2 million increase in the dollar water margin ascompared to the same period of 2007 caused by higher water rates approved bythe CPUC subsequent to September 30, 2007 and a favorable change in thewater supply mix, partially offset by lower water consumption.  There was an approximately 6% decrease inwater  consumption during the nine monthsended September 30, 2008 compared to the same period in 2007.  The 2007 results benefited from lower thanaverage precipitation, while in 2008 water revenues were impacted by theeffects of state-wide customer conservation efforts. Due to the decrease inusage, Registrant’s water revenues were lower by approximately $6.5 million, orapproximately $0.16 per share. Differences in temperature and rainfall in Registrant’s service areas aswell as the effects of conservation, have impacted  consumption of water by customers causingfluctuations in Registrant’s revenues and earnings between comparable periods.**  See furtherdiscussion on conservation included in the *“Regulatory Matters”*section.  Higher operating expenses, asmore fully described later, also decreased pretax operating income byapproximately $5 million.

 

***Electric-***For the nine months ended September 30, 2008,pretax operating income from electric operations decreased by $1.6 million or60.4% due in large part to a decrease of $812,000 in the pretax unrealized gainon BVES’ purchased power contracts during the nine months ended September 30,2008 as compared to the same period of 2007. The unrealized gain for the ninemonths ended September 30, 2008 increased operating income byapproximately $766,000 as compared to $1.6 million in the same period in2007.  Without the effects of the 

 

32

----

Tableof Contents

 

derivative, pretaxelectric operating income decreased by $826,000 during the nine months ended September 30,2008 due primarily to an increase of $807,000 in allocation of costs from thecorporate headquarters’ to BVES.

 

***Contracted Services -***For the nine months ended September 30,2008, pretax operating income for contracted services decreased by $6.2million. This was primarily due to a $20.6 million wastewater expansionconstruction project in 2007 with the U.S. government that generatedapproximately $4.9 million in pretax operating income during the nine monthsended September 30, 2007. The project was completed in August 2007.  While ASUS’ subsidiaries did undertakesimilar construction activity in 2008, they were on a smaller scale and therewas no singularly significant project during the nine months ended September 30,2008. Earnings and cash flows from amendments and modifications to the original50-year contracts with the U.S. government are sporadic and may or may notcontinue in the future periods.

 

Also contributing to thedecrease in pretax operating income were the losses incurred at military basesunder the two new contracts in North Carolina and South Carolina, previouslydiscussed.  Pretax operating losses atthese two bases were $2.8 million for the nine months ended September 30,2008 including $385,000 for emergency construction at PSUS to addresspre-existing conditions not anticipated in the contract and for which ASUS ispursuing recovery from the U.S. government and $397,000 in anticipated lossesassociated with certain initial capital upgrade projects, as previouslydiscussed.  Higher than anticipated transition costs,increases in nonincome tax assessments and other operating expenses, including$1.7 million of allocations from ASUS’ and corporate headquarters, also contributed to thelosses at these two new bases.

 

Overall, higheradministrative and general expenses in the first nine months of 2008 alsocontributed to the decrease in ASUS’ pretax operating income primarily due tothe commencement of the operation of water and wastewater services at militarybases in North and South Carolina, described above, and an increase in outsideservices for legal and consulting work. Higher outside services were incurred during the first nine months of2008 partly in connection with the acquisition of a subcontractor’s businessthat provided wastewater services to ASUS’ subsidiaries at the various militarybases.  On January 31, 2008, ASUSand its subsidiaries agreed to buy out all rights which this subcontractor hadto provide wastewater services at these bases and any future rights that thesubcontractor or any of its affiliates might have to provide wastewaterservices as a subcontractor to ASUS or any of its subsidiaries at any otherbases for an aggregate purchase price of approximately $2.5 million.  The purchase also included the acquisition ofsubstantially all assets used by the subcontractor in providing the wastewaterservices, including most vehicles, tools, supplies, equipment and books andrecords.  As a result of thistransaction, ASUS also recorded a charge of $213,000 during the first quarter of 2008 forsettlement of the preexisting relationship with the subcontractor.

 

Furthermore, final decisionson the general rate case for GSWC’s Region II and the application to recovergeneral office expenses at the corporate headquarters allocated to Regions IIand III were approved on November 16, 2007.  The decisions also imposed an increasedallocation of corporate headquarters’ expenses to ASUS and its wholly-ownedsubsidiaries, which caused a decrease in contracted services’ pretax operatingincome during the nine months ended September 30, 2008.  As a result of the CPUC decision, expenseallocations to ASUS increased by approximately $485,000 during the nine monthsended September 30, 2008.  Thishigher allocation of expenses was not contemplated at the time the contractswith the U.S. government were negotiated. As previously discussed in the quarterly results, the timely receipt ofprice redeterminations is critical in order to cover ASUS’ increasing costs foroperating and maintaining the water and wastewater systems at the militarybases.

 

Thefollowing discussion and analysis for the three and nine months ended September 30,2008 and 2007 provides information on AWR’s consolidated operations and assetsand where necessary, includes specific references to AWR’s individual segmentsand/or other subsidiaries: GSWC, CCWC, ASUS and its subsidiaries.

 

33

----

Tableof Contents

 

***ConsolidatedResults of Operations — Three Months Ended September 30, 2008 and 2007(amounts in thousands):***

 
| ** **                                        | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                        | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                        | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| OPERATING  REVENUES                               |       |              |       |              |       |       |       |       |       |
| Water                                             |       | $                 | 69,365     |              | $          | 65,445     |       | $          | 3,920      |   | 6.0 | % |
| Electric                                          |       | 6,743             |       | 6,289             |       | 454        |       | 7.2        | %          |
| Contracted  services                              |       | 9,153             |       | 4,108             |       | 5,045      |       | 122.8      | %          |
| Total operating  revenues                         |       | 85,261            |       | 75,842            |       | 9,419      |       | 12.4       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OPERATING  EXPENSES                               |       |              |       |              |       |       |       |       |       |
| Water purchased                                   |       | 15,087            |       | 14,740            |       | 347        |       | 2.4        | %          |
| Power purchased  for pumping                      |       | 3,484             |       | 3,517             |       | (33        | )          | -0.9       | %          |
| Groundwater  production assessment                |       | 2,791             |       | 2,666             |       | 125        |       | 4.7        | %          |
| Power purchased  for resale                       |       | 3,345             |       | 3,176             |       | 169        |       | 5.3        | %          |
| Unrealized loss  on purchased power contracts     |       | 3,741             |       | 896               |       | 2,845      |       | 317.5      | %          |
| Supply cost  balancing accounts                   |       | (490              | )          | (1,541            | )          | 1,051      |       | -68.2      | %          |
| Other operating  expenses                         |       | 7,366             |       | 7,004             |       | 362        |       | 5.2        | %          |
| Administrative  and general expenses              |       | 16,307            |       | 11,789            |       | 4,518      |       | 38.3       | %          |
| Depreciation and  amortization                    |       | 7,882             |       | 7,439             |       | 443        |       | 6.0        | %          |
| Maintenance                                       |       | 4,027             |       | 3,897             |       | 130        |       | 3.3        | %          |
| Property and  other taxes                         |       | 3,461             |       | 2,820             |       | 641        |       | 22.7       | %          |
| ASUS  construction expenses                       |       | 5,117             |       | 1,903             |       | 3,214      |       | 168.9      | %          |
| Net loss on sale  of property                     |       | —            |       | 11                |       | (11        | )          | -100.0     | %          |
| Total operating  expenses                         |       | 72,118            |       | 58,317            |       | 13,801     |       | 23.7       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OPERATING INCOME                                  |       | 13,143            |       | 17,525            |       | (4,382     | )          | -25.0      | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OTHER INCOME AND  EXPENSES                        |       |              |       |              |       |       |       |       |       |
| Interest expense                                  |       | (5,428            | )          | (5,347            | )          | (81        | )          | 1.5        | %          |
| Interest income                                   |       | 293               |       | 590               |       | (297       | )          | -50.3      | %          |
| Other                                             |       | (30               | )          | 102               |       | (132       | )          | -129.4     | %          |
|                                              |       | (5,165            | )          | (4,655            | )          | (510       | )          | 11.0       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| INCOME FROM  OPERATIONS BEFORE INCOME TAX EXPENSE |       | 7,978             |       | 12,870            |       | (4,892     | )          | -38.0      | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| Income tax  expense                               |       | 3,426             |       | 5,241             |       | (1,815     | )          | -34.6      | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| NET INCOME                                        |       | $                 | 4,552      |              | $          | 7,629      |       | $          | (3,077     | ) | -40.3 | % |

 

Net income for the threemonths ended September 30, 2008 was $4.6 million, equivalent to $0.26 percommon share on a basic and fully diluted basis, compared to $7.6 million or$0.44 per basic and fully diluted common share for the three months ended September 30,2007. Impacting the comparability in the results of the two periods on a fullydiluted per share basis are the following significant items:

 

·                  An unrealized loss on purchased powercontracts which decreased pretax income during the third quarter 2008 by $3.7million, or $0.13 per share, as compared to an unrealized loss which decreasedpretax income by $896,000, or $0.03 per share, for the same period in 2007, anet decrease of $0.10 per share.

 

·                  The dollar watermargin increased by $2.5 million, or $0.08 per share, during the third quarter2008 due to increased water rates approved by the CPUC subsequent to September 30,2007, partially offset by lower water consumption.  Increased water rates partially offset byhigher water supply costs contributed $0.15 per share to earnings, while a 6.8%decrease in water usage during the three months ended September 30, 2008resulted in a $2.9 million decrease in water revenues, or $0.07 per share.  Although precipitation was overall lower inthe three months ended September 30, 2008 compared to

 

34

----

Tableof Contents

 

the same period2007, the 2008 water revenues appear to have been impacted by the effects ofstate-wide customer conservation efforts.

 

·                  Pretax operatingincome for contracted services declined by $1.4 million, or $0.05 per share,during the third quarter of 2008 due primarily to losses incurred at newbases.  ASUS commenced operation of water and wastewater systems atmilitary bases in North Carolina and South Carolina during the first quarter of2008 and has incurred higher than anticipated transition and emergencyconstruction costs as well as projected losses on certain constructioncontracts.  Current estimates ofconstruction costs compared to contract revenues indicate losses on certaininitial capital upgrade projects.  Modifications or change orders have not yet been approved by the U.S.government, and therefore, the anticipated losses on these projects andpre-contract costs have been recorded in construction expenses during the thirdquarter of 2008.

 

·                  Higher otherexpenses at GSWC in 2008 primarily consisting of administrative and general,and depreciation expenses as described below, as well as a higher effective taxrate, contributed to an overall decrease of $0.11 per diluted share to theresults of operations.

 

***Operating Revenues***

 

*Water*

 

For the three monthsended September 30, 2008, revenues from water operations increased by 6%to $69.4 million, compared to $65.4 million for the three months ended September 30,2007. Contributing to this increase were rate increases approved by the CPUCsubsequent to September 30, 2007, which added approximately $6.3 millionin the third quarter of 2008 to water revenues. In addition, during the third quarter of 2008, GSWC recorded $541,000 ofadditional revenues in connection with Region III’s rehearing.  For GSWC’s Region III rate case approved bythe CPUC on January 12, 2006, the CPUC also approved the second yearincreases for Region III in an estimated amount of approximately$2.3 million, effective January 1, 2007. Based on certain correctionsto the rate calculation, GSWC had filed an Application for Rehearing to requestadditional revenues in connection with the January 2006 decision.  On July 31, 2008, the CPUC adopted astipulation jointly filed by GSWC and DRA. The stipulation addressed all of the pending issues including proposinga 12-month surcharge enabling GSWC to recover revenues of approximately$541,000 for the period January 1, 2006 through May of 2008.  Asa result of the CPUC’s approval, a regulatory asset of $541,000 was recorded inJuly 2008 with a corresponding increase to water revenues.  This regulatory asset will be recoveredthrough the 12-month surcharge.

 

The increases in revenueswere partially offset by a decrease of approximately 6.8% in waterconsumption  that resulted in a $2.9million decrease in water revenues primarily from the effects of conservation.Differences in temperature and rainfall in Registrant’s service areas as wellas conservation efforts impact consumption of water by customers, causing fluctuations in Registrant’srevenues and earnings between comparable periods.   In August 2008, the CPUC issued a finaldecision regarding conservation rate design that  allows for the establishment andimplementation of a WRAM to decouple sales from revenues.  GSWC intends to implement the WRAM  in November 2008 prospectively.  This should help mitigate fluctuations in Registrant’s future revenues andearnings due to changes in water consumption. In addition,  the CPUC alsoapproved an advice letter filed to allow GSWC to create and implement a watercost memorandum account to track the extraordinary expenses and revenueshortfall associated with the conservation measures in conjunction with thedeclared drought in California.  See furtherdiscussion on conservation included in the *“Regulatory Matters”*section.

 

*Electric*

 

For the three monthsended September 30, 2008, revenues from electric operations increased by7.2% to $6.7 million compared to $6.3 million for the three months ended September 30,2007 due primarily to higher electric usage. Electric usage increased by 2.1%. In addition, electric revenues in 2007 were lower due to the initialrecording in the third quarter of 2007 of a regulatory liability totaling$442,000 for probable refunds to customers related to an overcollection of thetotal costs associated with the 8.4MW natural gas-fueled generation plant.  These increases were partially offset bylower connections and reconnection fees.

 

Registrant relies uponrate approvals by state regulatory agencies in California and Arizona toprovide for a return on invested and borrowed capital used to fund utilityplant  in order to recover operatingexpenses and profit

 

35

----

Tableof Contents

 

margin. If adequate raterelief  is not granted in a timelymanner, operating revenues and earnings can be negatively impacted.

 

*ContractedServices*

 

Revenues from contracted servicesare composed of construction revenues and management fees for operating andmaintaining the water and/or wastewater systems at military bases. For thethree months ended September 30, 2008, revenues from contracted servicesincreased by $5.0 million, to $9.2 million compared to $4.1 million for thethree months ended September 30, 2007 primarily due to additional revenuesof $2.9 million during the third quarter of 2008 generated from operating andmaintaining the water and wastewater systems under the two new contracts inNorth Carolina and South Carolina, both of which began during the first quarterof 2008.  There was also an increase inconstruction revenues at the ODUS bases in Virginia pursuant to 50-yearfirm-fixed price contracts, as well as other construction revenues at the othermilitary bases, during the three months ended September 30, 2008.

 

Registrant reliesupon  price redeterminations andequitable adjustments by the U.S. government in order to recover operatingexpenses and profit margin. If adequate price redeterminations and adjustments are not granted in a timelymanner, operating revenues and earnings can be negatively impacted.

 

***Operating Expenses:***

 

***Supply Costs***

 

Supply costs for thewater segment consist of purchased water, purchased power for pumping,groundwater production assessment and water supply cost balancing accounts.Supply costs for the electric segment consist of  power purchased for resale (including thecost of natural gas) and the electric supply cost balancing accounts*.* Water and electric margins are computed by taking totalrevenues, less total supply costs. Registrant uses these margins and relatedpercentages as an important measure in evaluating its operating results.Registrant believes this measure is a useful internal benchmark in evaluatingthe utility business performance within its water and electric segments.Registrant reviews these measurements regularly and compares them to historicalperiods and to the operating budget as approved. However, this measure, whichis not presented in accordance with generally accepted accounting principles, or GAAP, may not be comparableto similarly titled measures used by other entities and should not beconsidered as an alternative to operating income, which is determined inaccordance with GAAP, as an indicator of operating performance.

 

Total supply costscomprise the largest segment of total operating expenses. Supply costsaccounted for approximately 33.6% and 38.7% of total operating expenses for thethree months ended September 30, 2008 and 2007, respectively. The tablebelow provides the amount of increases (decreases), percent changes in supplycosts, and margins during the three months ended September 30, 2008 and 2007(amounts in thousands):

 

36

----

Tableof Contents

 
| ** **                                       | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                       | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| WATER OPERATING  REVENUES **(1)**                |       | $                 | 69,365     |              | $          | 65,445     |       | $          | 3,920      |   | 6.0 | % |
| WATER SUPPLY  COSTS:                             |       |              |       |              |       |       |       |       |       |
| Water purchased **(1)**                          |       | $                 | 15,087     |              | $          | 14,740     |       | $          | 347        |   | 2.4 | % |
| Power purchased  for pumping **(1)**             |       | 3,484             |       | 3,517             |       | (33        | )          | -0.9       | %          |
| Groundwater  production assessment **(1)**       |       | 2,791             |       | 2,666             |       | 125        |       | 4.7        | %          |
| Water supply  cost balancing accounts **(1)**    |       | (907              | )          | (1,922            | )          | 1,015      |       | -52.8      | %          |
| TOTAL WATER  SUPPLY COSTS                        |       | $                 | 20,455     |              | $          | 19,001     |       | $          | 1,454      |   | 7.7 | % |
| WATER MARGIN **(2)**                             |       | $                 | 48,910     |              | $          | 46,444     |       | $          | 2,466      |   | 5.3 | % |
| PERCENT MARGIN -  WATER                          |       | 70.5              | %          | 71.0              | %          |       |       |       |       |
|                                             |       |              |       |              |       |       |       |       |       |
| ELECTRIC  OPERATING REVENUES **(1)**             |       | $                 | 6,743      |              | $          | 6,289      |       | $          | 454        |   | 7.2 | % |
| ELECTRIC SUPPLY  COSTS:                          |       |              |       |              |       |       |       |       |       |
| Power purchased  for resale **(1)**              |       | $                 | 3,345      |              | $          | 3,176      |       | $          | 169        |   | 5.3 | % |
| Electric supply  cost balancing accounts **(1)** |       | 417               |       | 381               |       | 36         |       | 9.4        | %          |
| TOTAL ELECTRIC  SUPPLY COSTS                     |       | $                 | 3,762      |              | $          | 3,557      |       | $          | 205        |   | 5.8 | % |
| ELECTRIC MARGIN **(2)**                          |       | $                 | 2,981      |              | $          | 2,732      |       | $          | 249        |   | 9.1 | % |
| PERCENT MARGIN -  ELECTRIC                       |       | 44.2              | %          | 43.4              | %          |       |       |       |       |
|                                                  |            |                   |            |                   |            |            |            |            |            |  |  |  |  |

 

----

| (1)    |   | As reported on AWR’s Consolidated Statements of Income, except for  supply cost balancing accounts. The sum of water and electric supply cost  balancing accounts in the table above are shown on AWR’s Consolidated  Statements of Income and totaled ($490,000) and ($1,541,000) for the three  months ended September 30, 2008 and 2007, respectively. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                     |
| (2)    |   | Water and electric margins do not include any depreciation and  amortization, maintenance expense, unrealized gains and losses on purchased  power contracts, or other operating expenses.                                                                                                                                                                               |

 

Two of the principalfactors affecting water supply costs and gross margin are the amount of waterproduced and the source of the water. Generally, the variable cost of producingwater from wells is less than the cost of water purchased from wholesalesuppliers. In addition, GSWC is authorized to establish water and electricsupply cost balancing accounts for increases and/or decreases in costs due tochanges in rates charged by its suppliers which provide purchased water andpurchased power, and by agencies assessing groundwater related pump taxes forwater service areas in California. Higher or lower actual costs as compared tocosts authorized by the CPUC will either be recovered from or refunded tocustomers in the future. However, changes in the water resource mix betweenwater supplied from purchased sources and that supplied from Registrant’s  wells can increase/decrease actualsupply-related costs relative to the mix approved for recovery through rates,thereby impacting earnings either negatively or positively.

 

On August 21, 2008,the CPUC issued a final decision which approved the establishment of a modifiedcost balancing account that allows recovery of supply costs for changes inwater supply mix.  GSWC  intends to implement the modified costbalancing account in November 2008 prospectively in connection with thenew conservation rate design and the implementation of a WRAM to decouple salesfrom revenues.

 

37

----

Tableof Contents

 

For the three monthsended September 30, 2008, GSWC’s water supply mix was approximately 44%purchased water as compared to 45% for the same period in 2007.  Purchased water costs for the three monthsended September 30, 2008 increased by 2.4% to $15.1 million compared to$14.7 million for the three months ended September 30, 2007 due primarilyto higher water rates charged  bywholesale suppliers.  Average rates fromwholesale suppliers increased in Regions I, II and III by approximately8%, 6% and 5%, respectively.  In general,the supply cost balancing account as discussed above allows GSWC to trackincremental rate changes from suppliers for future recovery in waterrates.  The increase in water rates fromour wholesale suppliers was partially offset by lower customer consumption anda favorable change in the water supply mix, discussed above.

 

For the three monthsended September 30, 2008, the slight decrease of 0.9% in power purchasedfor pumping was principally due to lower customer demand.  Groundwater production assessments werehigher by 4.7% due to increases in assessment rates (pump tax rates) leviedagainst groundwater production, effective July 2008.  Average pump tax rates increased in Region IIand III by approximately 3% and 6%, respectively, between the third quarters of2007 and 2008.  There was also anincrease in groundwater production assessments due to the favorable change inthe water supply mix.  These increases ingroundwater production assessments were partially offset by lower customerdemand.  Again, the supply cost balancingaccount tracks the increases in pump tax rates for future recovery in waterrates.

 

The supply cost balancingaccount tracks differences between the current cost for supply items (water,power, and pump taxes) charged by GSWC’s suppliers and the cost for those itemsincorporated into GSWC’s rates. Over-collections occur when the current cost ofthese items is less than the amount in rates which has the effect of increasingthe supply cost balancing account in the Statements of Income.Under-collections occur when the current cost exceeds the amount in rates forthese items and, conversely, will have the effect of decreasing the supply costbalancing account in the Statements of Income. Typically, over-collections orunder-collections, when they occur, are tracked in the supply cost balancingaccounts for future refund or recovery through a surcredit (in the event of anover-collection) or surcharge (in the event of an under-collection) oncustomers’ bills. Once in rates, the amortization of surcharges that are inplace to recover under-collections from customers have the effect of increasingthe supply cost balancing account and increasing revenues in the Statements ofIncome, resulting in no earnings impact. Conversely, the amortization ofsurcredits that are in rates to refund over-collections to customers have theeffect of decreasing the supply cost balancing account and decreasing revenues,also resulting in no earnings impact.

 

An increase of $1.0million in the water supply cost balancing account provision during the threemonths ended September 30, 2008 as compared to the same period in 2007 wasprimarily caused by a $1.1 million increase in the amortization of the watersupply cost balancing accounts for surcharges currently in effect.

 

For the three monthsended September 30, 2008, the cost of power purchased for resale tocustomers in GSWC’s BVES division increased by 5.3% to $3.3 million compared to$3.2 million for the three months ended September 30, 2007 reflecting an increase incustomer demand during the third quarter of 2008.

 

***Unrealized (Gain) Loss on Purchased Power Contracts***

 

Unrealized (gain) andloss on purchased power contracts represent gains and losses recorded for GSWC’spurchased power agreements with Morgan Stanley Capital Group, Inc. The$3.7 million pretax unrealized loss on purchased power contracts for the threemonths ended September 30, 2008 is due to a decrease in the currentforward market prices since June 30, 2008. There was an $896,000 pretax unrealizedloss on purchased power contracts for the three months ended September 30,2007. Unrealized gains and losses at BVES will continue to impact earningsduring the remaining life of the contract, which terminates at the end of2008.  As of September 30, 2008,there is a cumulative unrealized loss of $788,000 which will be recognized asan increase to income by December 31, 2008.

 

***Other Operating Expenses***

 

The primary components ofother operating expenses include payroll, materials and supplies, chemicals andwater treatment, and outside service costs of operating the regulated watersystems, including the costs associated with water transmission anddistribution, pumping, water quality, meter reading, billing, and operations ofdistrict offices.  Registrant’s electricand contracted services operations incur many of the same types of costs aswell.  For the three months ended September 30,2008 and 2007, other operating expenses by segment consisted of the following(amounts in thousands):

 

38

----

Tableof Contents

 
| ** **                      | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                      | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                  |       | $                 | 5,656      |              | $          | 5,553      |       | $          | 103        |   | 1.9 | % |
| Electric  Services              |       | 580               |       | 553               |       | 27         |       | 4.9        | %          |
| Contracted  Services            |       | 1,130             |       | 898               |       | 232        |       | 25.8       | %          |
| Total other  operating expenses |       | $                 | 7,366      |              | $          | 7,004      |       | $          | 362        |   | 5.2 | % |

 

For the three months ended September 30, 2008,other operating expenses for water and electric services increased by $130,000due primarily to an increase in labor costs of $161,000 due to higher wages.

 

Contracted services experienced increases in otheroperating expenses of $232,000 primarily due to the commencement of the operationof water and wastewater systems at military bases in North Carolina and SouthCarolina that began during the first quarter of 2008.  As a result of these new bases, otheroperating expenses increased by approximately $792,000 during the third quarterof 2008.  These increases werepartially offset by decreases at the other military bases during the thirdquarter of 2008 resulting from lower outside services of $426,000 primarilypaid to the subcontractor that  providedwastewater services to certain of ASUS’ subsidiaries. On January 31, 2008,ASUS and its subsidiaries agreed to buy out all current and future rights whichthis subcontractor had to provide wastewater services at any bases owned andoperated by ASUS and any of its present and/or future subsidiaries.  Forthe three months ended September 30, 2008, most of these services wereperformed internally at lower cost some of which is recorded in labor costswithin maintenance expense . There was also a decrease of $136,000 in baddebt expense.

 

***Administrative and General Expenses***

 

Administrative andgeneral expenses include payroll related to administrative and generalfunctions, all employee benefits charged to expense accounts, insuranceexpenses, outside legal and consulting fees, regulatory utility commissionexpenses, expenses associated with being a public company and general corporateexpenses. For the three months ended September 30, 2008 and 2007,administrative and general expenses by segment consisted of the following(amounts in thousands):

 
| ** **                                 | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                 | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                             |       | $                 | 11,783     |              | $          | 9,431      |       | $          | 2,352      |   | 24.9 | % |
| Electric  Services                         |       | 1,674             |       | 1,132             |       | 542        |       | 47.9       | %          |
| Contracted  Services                       |       | 2,850             |       | 1,226             |       | 1,624      |       | 132.5      | %          |
| Total  administrative and general expenses |       | $                 | 16,307     |              | $          | 11,789     |       | $          | 4,518      |   | 38.3 | % |

 

For thethree months ended September 30, 2008, administrative and general expenses increased by$2.4 million in water services compared to the three months ended September 30, 2007 due primarily to anincrease of $1.3 million in labor costs due to higher wages largely related toRegistrant’s annual performance-based salary review program and an overallincrease in  employees.   There was also: (i) an increase of$736,000 in outside services relating to tax, legal and consulting services,and (ii) $585,000 of additional compensation expense relating to theresignation of a GSWC officer effective September 26, 2008 in connectionwith a Resignation Agreement and General Release of Claims. These increaseswere partially offset by decreases in various other administrative and generalexpenses.

 

39

----

Table of Contents

 

For thethree months ended September 30, 2008, administrative and general expensesincreased by $542,000 in electric services compared to the three months ended September 30,2007 due primarily to: (i) an increase of $381,000 in allocation of costsfrom the corporate headquarters’ to BVES; (ii) an increase of $69,000 inlabor costs and related employee benefits, and (iii) an increase of$125,000 in outside consulting and legal services.

 

There was an increase of$1.6 million in contracted services administrative and general expenses dueprimarily to the commencement of the operation of water and wastewater systems atmilitary bases in North Carolina and South Carolina that began during the firstquarter of 2008.   As a result of thesenew bases, administrative and general expenses increased by $1.2 million duringthe third quarter of 2008 including $682,000 of allocations from ASUS’headquarters and the General Office.  There were also increases at the othermilitary bases due to higher wages and related benefits.

*** ***

***Depreciation and Amortization***

 

For the three monthsended September 30, 2008 and 2007, depreciation and amortization bysegment consisted of the following (amounts in thousands):

 
| ** **                           | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                           | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                       |       | $                 | 7,161      |              | $          | 6,827      |       | $          | 334        |   | 4.9 | % |
| Electric  Services                   |       | 552               |       | 564               |       | (12        | )          | -2.1       | %          |
| Contracted  Services                 |       | 169               |       | 48                |       | 121        |       | 252.1      | %          |
| Total  depreciation and amortization |       | $                 | 7,882      |              | $          | 7,439      |       | $          | 443        |   | 6.0 | % |

 

For the three monthsended September 30, 2008, depreciation and amortization expense for waterand electric services increased by $322,000 to $7.7 million compared to $7.4million for the three months ended September 30, 2007 reflecting, amongother things, the effects of  completingapproximately $55.2 million of additions to utility plant during 2007,depreciation on which began in January 2008.  There were also changes to the compositedepreciation rates approved by the CPUC. Registrant anticipates thatdepreciation expense will continue to increase due to Registrant’s on-goingconstruction program at its regulated subsidiaries. Registrant believes thatdepreciation expense related to property additions approved by the appropriateregulatory agency will be recovered through water and electric rates.

 

There was also anincrease in depreciation and amortization expense for contracted services due to the commencement ofthe operation of water and wastewater systems at military bases in NorthCarolina and South Carolina that began during the first quarter of 2008.  As a result of these new bases, depreciationand amortization expense increased by $74,000 during the third quarter of 2008.  There were also increases at the othermilitary bases due to the addition of fixed assets.

 

***Maintenance***

 

For the three monthsended September 30, 2008 and 2007, maintenance expense by segmentconsisted of the following (amounts in thousands):

 

40

----

Tableof Contents

 
| ** **           | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **           | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services       |       | $                 | 3,096      |              | $          | 3,532      |       | $          | (436       | ) | -12.3 | % |
| Electric  Services   |       | 261               |       | 295               |       | (34        | )          | -11.5      | %          |
| Contracted  Services |       | 670               |       | 70                |       | 600        |       | 857.1      | %          |
| Total  maintenance   |       | $                 | 4,027      |              | $          | 3,897      |       | $          | 130        |   | 3.3 | % |

 

For the three months ended September 30, 2008,maintenance expense for water services decreased by $436,000 to $3.1 millioncompared to $3.5 million for the three months ended September 30, 2007 dueprincipally to a decrease in emergency maintenance on GSWC’s wells and watersupply sources in its Region II service area. Region II’s maintenance expense decreased by $325,000.  There was also a decrease of $148,000 in GSWC’sRegion III maintenance expense.

 

There was an increase of$600,000 in contracted services maintenance expense due primarily to thecommencement ofthe operation of water and wastewater systems at military bases in NorthCarolina and South Carolina that began during the first quarter of 2008, whichadded $437,000 in maintenance expense. The level of maintenance costs also reflects the age and condition of the infrastructure at thesebases.  There was also increasedmaintenance expense of $162,000 at the other bases due primarily to higherinternal labor costs which substituted for the subcontractor that providedwastewater services to these ASUS subsidiaries. As previously mentioned, in January 2008, ASUS and itssubsidiaries agreed to buy out all current and future rights which thissubcontractor had to provide wastewater services at any bases owned andoperated by ASUS.

 

***Property and Other Taxes***

 

For the three monthsended September 30, 2008 and 2007, property and other taxes by segmentconsisted of the following (amounts in thousands):

 
| ** **                      | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                      | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                  |       | $                 | 2,635      |              | $          | 2,600      |       | $          | 35         |   | 1.3 | % |
| Electric  Services              |       | 183               |       | 198               |       | (15        | )          | -7.6       | %          |
| Contracted  Services            |       | 643               |       | 22                |       | 621        |       | 2822.7     | %          |
| Total property  and other taxes |       | $                 | 3,461      |              | $          | 2,820      |       | $          | 641        |   | 22.7 | % |

 

For the three monthsended September 30, 2008, overall property and other taxes remainedrelatively unchanged for water and electric services.  Additional property taxes resulting fromhigher assessed values and increases in payroll taxes based on increased laborcosts, were offset by lower franchise fees at BVES.

 

Property and other taxeswere higher in contracted services due to the commencement of the operation of water and wastewatersystems at military bases in North Carolina and South Carolina that beganduring the first quarter of 2008.  As aresult of these new bases, property and other taxes increased by $214,000during the third quarter of 2008. There was also an increase of $371,000 innonincome taxes primarily related to the ODUS military bases in Virginia due inpart to an increase in gross revenues.

 

***Construction Expenses***

 

For the three monthsended September 30, 2008, ASUS construction expenses increased by $3.2million to $5.1 million compared to $1.9 million for the same period in 2007reflecting thecommencement of the operation of water and wastewater systems at military basesin North Carolina and South Carolina that began during the first

 

41

----

Table of Contents

 

quarter of 2008.  Asa result of these new bases, construction expenses increased by $1.8 millionduring the third quarter of 2008, including $72,000 for emergencyconstruction at PSUS to address pre-existing conditions not anticipated in thecontract and for which ASUS is pursuing recovery from the U.S. government and$339,000 in anticipated losses associated with certain initial capital upgradeprojects.  There was also an increase in constructionexpenses of $1.4 million at the other bases pursuant to the 50-year contracts.

 

There are no comparableconstruction expenses for the water and electric services segments.

 

***Net Loss on Sale of Property***

 

For the three months ended September 30, 2007, water servicesrecorded a pretax loss of $11,000.

 

***Interest Expense***

 

For the three monthsended September 30, 2008 and 2007, interest expense by segment consistedof the following (amounts in thousands):

 
| ** **                   | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 5,223      |              | $          | 5,100      |       | $          | 123        |   | 2.4 | % |
| Contracted  Services         |       | 205               |       | 247               |       | (42        | )          | -17.0      | %          |
| Total interest  expense      |       | $                 | 5,428      |              | $          | 5,347      |       | $          | 81         |   | 1.5 | % |

 

For the three monthsended September 30, 2008, overall interest expense increased by 1.5% to$5.4 million compared to $5.3 million for the three months ended September 30,2007 primarily reflecting an increase in short-term borrowings. Average bankloan balances outstanding under an AWR credit facility for the three monthsended September 30, 2008 were approximately $60.2 million, as compared toan average of $26.9 million during the same period of 2007. This was partiallyoffset by lower short-term interest rates. The average interest rates on short-term borrowings for the three monthsended September 30, 2008 was 3.2%, as compared to an average of 6.1%during the same period of 2007.

 

***Interest Income***

 

For the three monthsended September 30, 2008 and 2007, interest income by segment consisted ofthe following (amounts in thousands):

 
| ** **                   | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 292        |              | $          | 588        |       | $          | (296       | ) | -50.3 | % |
| Contracted  Services         |       | 1                 |       | 2                 |       | (1         | )          | -50.0      | %          |
| Total interest  income       |       | $                 | 293        |              | $          | 590        |       | $          | (297       | ) | -50.3 | % |

 

Interest income for waterand electric services decreased by $296,000 for the three months ended September 30,2008 due primarily to less interest earned on short-term cash surplus and adecrease of $162,000 in interest accrued on the uncollected balance of theAerojet litigation memorandum account authorized by the CPUC due to lowerinterest rates.

 

***Other***

 

For the three months ended September 30, 2008, water servicesrecorded other loss of $30,000 as compared to other income of $102,000 allrelating to a non-operating equity investment.

 

42

----

Tableof Contents

 

***Income Tax Expense***

 

For the three monthsended September 30, 2008 and 2007, income tax expense by segment consistedof the following (amounts in thousands):

 
| ** **                   | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 4,062      |              | $          | 5,389      |       | $          | (1,327     | ) | -24.6 | % |
| Contracted  Services         |       | (636              | )          | (148              | )          | (488       | )          | 329.7      | %          |
| Total income tax  expense    |       | $                 | 3,426      |              | $          | 5,241      |       | $          | (1,815     | ) | -34.6 | % |

 

For the three monthsended September 30, 2008, income tax expense for water and electricservices decreased by 24.6% to $4.1 million compared to $5.4 million for thethree months ended September 30, 2007 due primarily to a decrease inpretax income.  The effective tax rate (“ETR”)for water and electric services for the three months ended September 30,2008 was 42.3% as compared to a 40.9% ETR applicable to the three months ended September 30,2007.  The ETR increased primarily due tochanges between book and taxable income that are treated as flow-throughadjustments in accordance with regulatory requirements (principallycompensatory-related in nature including incremental compensation costs inconnection with the resignation of a GSWC officer effective September 26,2008, discussed elsewhere). Flow-through adjustments increase or decrease taxexpense in one period, with an offsetting increase or decrease occurring inanother period.

 

Income tax benefit forcontracted services increased to $636,000 compared to $148,000 for the threemonths ended September 30, 2007 due primarily to a decrease in pretaxincome.  The ETR for contracted servicesfor the three months ended September 30, 2008 was 39.2% as compared to a48.4% ETR applicable to the three months ended September 30, 2007.

 

43

----

Tableof Contents

 

***ConsolidatedResults of Operations — Nine Months Ended September 30, 2008 and 2007(amounts in thousands):***

 
| ** **                                        | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                        | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                        | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| OPERATING  REVENUES                               |       |              |       |              |       |       |       |       |       |
| Water                                             |       | $                 | 186,824    |              | $          | 176,598    |       | $          | 10,226     |   | 5.8 | % |
| Electric                                          |       | 21,754            |       | 21,413            |       | 341        |       | 1.6        | %          |
| Contracted  services                              |       | 25,938            |       | 29,347            |       | (3,409     | )          | -11.6      | %          |
| Total operating  revenues                         |       | 234,516           |       | 227,358           |       | 7,158      |       | 3.1        | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OPERATING  EXPENSES                               |       |              |       |              |       |       |       |       |       |
| Water purchased                                   |       | 36,119            |       | 35,690            |       | 429        |       | 1.2        | %          |
| Power purchased  for pumping                      |       | 7,819             |       | 8,308             |       | (489       | )          | -5.9       | %          |
| Groundwater  production assessment                |       | 8,056             |       | 7,494             |       | 562        |       | 7.5        | %          |
| Power purchased  for resale                       |       | 10,179            |       | 10,372            |       | (193       | )          | -1.9       | %          |
| Unrealized gain  on purchased power contracts     |       | (766              | )          | (1,578            | )          | 812        |       | -51.5      | %          |
| Supply cost  balancing accounts                   |       | (1,269            | )          | (3,451            | )          | 2,182      |       | -63.2      | %          |
| Other operating  expenses                         |       | 22,415            |       | 20,160            |       | 2,255      |       | 11.2       | %          |
| Administrative  and general expenses              |       | 46,077            |       | 38,460            |       | 7,617      |       | 19.8       | %          |
| Depreciation and  amortization                    |       | 23,485            |       | 21,616            |       | 1,869      |       | 8.6        | %          |
| Maintenance                                       |       | 12,569            |       | 11,223            |       | 1,346      |       | 12.0       | %          |
| Property and  other taxes                         |       | 9,220             |       | 8,593             |       | 627        |       | 7.3        | %          |
| ASUS  construction expenses                       |       | 13,426            |       | 19,232            |       | (5,806     | )          | -30.2      | %          |
| Net gain on sale  of property                     |       | —            |       | (594              | )          | 594        |       | -100.0     | %          |
| Total operating  expenses                         |       | 187,330           |       | 175,525           |       | 11,805     |       | 6.7        | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OPERATING INCOME                                  |       | 47,186            |       | 51,833            |       | (4,647     | )          | -9.0       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OTHER INCOME AND  EXPENSES                        |       |              |       |              |       |       |       |       |       |
| Interest expense                                  |       | (16,100           | )          | (16,413           | )          | 313        |       | -1.9       | %          |
| Interest income                                   |       | 1,429             |       | 1,742             |       | (313       | )          | -18.0      | %          |
| Other                                             |       | 91                |       | 234               |       | (143       | )          | -61.1      | %          |
|                                              |       | (14,580           | )          | (14,437           | )          | (143       | )          | 1.0        | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| INCOME FROM  OPERATIONS BEFORE INCOME TAX EXPENSE |       | 32,606            |       | 37,396            |       | (4,790     | )          | -12.8      | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| Income tax  expense                               |       | 13,467            |       | 15,461            |       | (1,994     | )          | -12.9      | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| NET INCOME                                        |       | $                 | 19,139     |              | $          | 21,935     |       | $          | (2,796     | ) | -12.7 | % |

 

Net income for the ninemonths ended September 30, 2008 was $19.1 million, equivalent to $1.10 percommon share on a basic and fully diluted basis, compared to $21.9 million or$1.26 per basic and fully diluted common share for the nine months ended September 30,2007, respectively. Impacting the comparability in the results of the twoperiods on a fully diluted per share basis are the following significant items:

 

44

----

Tableof Contents

 

·                  An unrealized gain on purchased powercontracts which increased pretax income during the nine months ended September 30,2008 by $766,000, or $0.03 per share, as compared to $1.6 million, or $0.05 pershare, for the same period in 2007, a net decrease of $0.02 per share.

 

·                  The dollar water margin increased by$8.2 million, or $0.28 per share, during the nine months ended September 30,2008 due to increased water rates approved by the CPUC subsequent to September 30,2007 and a favorable supply mix change. However, this increase was partially offset by a decrease in waterconsumption. Increased water rates partially offset by higher water supplycosts contributed $0.44 per share to earnings while an approximately 6%decrease in water usage during the nine months ended September 30, 2008resulted in a $6.5 million decrease in water revenues, or $0.16 per share. The2007 results benefited from lower than average precipitation, while the 2008water revenues were impacted by the effects of state-wide customer conservationefforts.

 

·                  Pretax operatingincome for contracted services declined by $6.2 million, or $0.21 per share,during the nine months ended September 30, 2008 due primarily to a  $20.6 million wastewater  expansion project in 2007 at Fort Bliss.  ASUS recognized pretax operating income of$4.9 million from the wastewater expansion project during the nine months endedSeptember 30, 2007.  There was nosimilar significant project during the nine months ended September 30,2008.  Higher administrative and generalexpenses as well as contract losses also contributed to the decrease in ASUS’pretax operating income.

 

·                  GSWC recorded anet gain on sale of property of $594,000, or $0.02 per share, during the ninemonths ended September 30, 2007. There was no similar gain in the same period of 2008.

 

·                  GSWC recorded $480,000 in interest income,or $0.02 per share, during the second quarter of 2008 in connection with the IRS’sexamination of the 2002 income tax return.

 

·                  Higher otherexpenses at GSWC in 2008 primarily consisting of administrative,  general and depreciation expenses asdescribed below, contributed to an overall decrease of $0.21 per diluted shareto the results of operations.

 

***Operating Revenues***

 

*Water*

 

For the nine months endedSeptember 30, 2008, revenues from water operations increased by 5.8% to$186.8 million, compared to $176.6 million for the nine months ended September 30, 2007. Contributingto this increase were rate increases approved by the CPUC subsequent to September 30,2007, which added approximately $16.1 million to water revenues during the ninemonths ended September 30, 2008.  Inaddition, during the third quarter of 2008, GSWC recorded $541,000 ofadditional revenues in connection with Region III’s rehearing, previouslydiscussed. These increases were partially offset by a decrease of approximately6% in water consumption due to conservation during 2008 which caused waterrevenues to be lower by approximately $6.5 million.  Differences in temperature and rainfall inRegistrant’s service areas as well as the effects of state-wide customerconservation efforts , impact  the volumeof water sold to customers causing fluctuations in Registrant’s revenues andearnings between comparable periods.

 

*Electric*

 

For the nine months endedSeptember 30, 2008, revenues from electric operations increased by 1.6% to$21.8 million compared to $21.4 million for the nine months ended September 30,2007 due to an increase of 0.6% in electric usage.   In addition, electric revenues in 2007 werelower due to the initial recording in the third quarter of 2007 of a regulatoryliability totaling $442,000 for probable refunds to customers related to anovercollection of the total costs associated with the 8.4MW natural gas-fueledgeneration plant.  These increases werepartially offset by lower connections and reconnection fees.

 

45

----

Tableof Contents

 

*ContractedServices*

 

Revenues from contractedservices are composed of construction revenues and management fees foroperating and maintaining the water and/or wastewater systems at militarybases. For the nine months ended September 30, 2008, revenues fromcontracted services decreased by $3.4 million, or 11.6%, to $25.9 millioncompared to $29.3 million for the nine months ended September 30, 2007primarily due to revenues in 2007 related to the wastewater expansion projectat Fort Bliss, previously discussed. This special project, which began in early 2007, generated $20.6 millionof construction revenues for the nine months ended September 30,2007.  The project was completed in August 2007.Earnings and cash flows from amendments and modifications to the original50-year contracts with the U.S. government are sporadic and may or may notcontinue in future periods. The year over year revenue decrease resulting fromthis special project was partially offset by an increase of $4.8 million inconstruction revenues at Fort Lee in Virginia due to a modification and specialproject at that base.  There were alsoadditional revenues totaling $6.7 million during 2008 generated from operatingand maintaining the water and wastewater systems under the two new contracts inNorth Carolina and South Carolina, both of which began during the first quarterof 2008.  Finally, there was an increasein construction revenues of $5.2 million at the other military bases pursuantto the 50-year firm-fixed price contracts at these bases during the nine monthsended September 30, 2008.

 

***Operating Expenses:***

 

***Supply Costs***

 

Supply costs for thewater segment consist of purchased water, purchased power for pumping,groundwater production assessment and water supply cost balancing accounts.Supply costs for the electric segment consist of power purchased for resale(including the cost of natural gas) and the electric supply cost balancing accounts*.* Water and electric margins are computed by taking totalrevenues, less total supply costs. Registrant uses these margins and relatedpercentages as an important measure in evaluating its operating results.Registrant believes this measure is a useful internal benchmark in evaluatingthe utility business performance within its water and electric segments.Registrant reviews these measurements regularly and compares them to historicalperiods and to its operating budget as approved. However, this measure, whichis not presented in accordance with GAAP may not be comparable to similarlytitled measures used by other entities and should not be considered as analternative to operating income, which is determined in accordance with GAAP,as an indicator of operating performance.

 

Total supply costscomprise the largest segment of total operating expenses. Supply costsaccounted for approximately 32.5% and 33.3% of total operating expenses for thenine months ended September 30, 2008 and 2007, respectively. The tablebelow provides the amount of increases (decreases), percent changes in supplycosts, and margins during the nine months ended September 30, 2008 and2007 (amounts in thousands):

 

46

----

Tableof Contents

 
| ** **                                       | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                       | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| WATER OPERATING  REVENUES **(1)**                |       | $                 | 186,824    |              | $          | 176,598    |       | $          | 10,226     |   | 5.8 | % |
| WATER SUPPLY COSTS:                              |       |              |       |              |       |       |       |       |       |
| Water purchased **(1)**                          |       | $                 | 36,119     |              | $          | 35,690     |       | $          | 429        |   | 1.2 | % |
| Power purchased  for pumping **(1)**             |       | 7,819             |       | 8,308             |       | (489       | )          | -5.9       | %          |
| Groundwater  production assessment **(1)**       |       | 8,056             |       | 7,494             |       | 562        |       | 7.5        | %          |
| Water supply  cost balancing accounts **(1)**    |       | (3,510            | )          | (5,079            | )          | 1,569      |       | -30.9      | %          |
| TOTAL WATER  SUPPLY COSTS                        |       | $                 | 48,484     |              | $          | 46,413     |       | $          | 2,071      |   | 4.5 | % |
| WATER MARGIN **(2)**                             |       | $                 | 138,340    |              | $          | 130,185    |       | $          | 8,155      |   | 6.3 | % |
| PERCENT MARGIN -  WATER                          |       | 74.0              | %          | 73.7              | %          |       |       |       |       |
|                                             |       |              |       |              |       |       |       |       |       |
| ELECTRIC  OPERATING REVENUES **(1)**             |       | $                 | 21,754     |              | $          | 21,413     |       | $          | 341        |   | 1.6 | % |
| ELECTRIC SUPPLY  COSTS:                          |       |              |       |              |       |       |       |       |       |
| Power purchased  for resale **(1)**              |       | $                 | 10,179     |              | $          | 10,372     |       | $          | (193       | ) | -1.9 | % |
| Electric supply  cost balancing accounts **(1)** |       | 2,241             |       | 1,628             |       | 613        |       | 37.7       | %          |
| TOTAL ELECTRIC  SUPPLY COSTS                     |       | $                 | 12,420     |              | $          | 12,000     |       | $          | 420        |   | 3.5 | % |
| ELECTRIC MARGIN **(2)**                          |       | $                 | 9,334      |              | $          | 9,413      |       | $          | (79        | ) | -0.8 | % |
| PERCENT MARGIN -  ELECTRIC                       |       | 42.9              | %          | 44.0              | %          |       |       |       |       |

 

----

| (1)    |   | As reported on AWR’s Consolidated Statements of Income, except for  supply cost balancing accounts. The sum of water and electric supply cost  balancing accounts in the table above are shown on AWR’s Consolidated  Statements of Income and totaled ($1,269,000) and ($3,451,000) for the nine  months ended September 30, 2008 and 2007, respectively. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                      |
| (2)    |   | Water and electric margins do not include any depreciation and  amortization, maintenance expense, unrealized gains and losses on purchased  power contracts or other operating expenses.                                                                                                                                                                                 |

 

For the nine months endedSeptember 30, 2008, 41.6% of  GSWC’swater supply mix was purchased as compared to 42.4% purchased for the ninemonths ended September 30, 2007. Because the cost of water purchased isgenerally higher than pumped water from GSWC’s wells, this change in mixresulted in a slight improvement in water’s percent margin in 2008 compared tothe same period in 2007.

 

Purchased water costs forthe nine months ended September 30, 2008 increased slightly by 1.2%.  The increase in purchased water due to higherwater rates charged from wholesale suppliers was offset by lower customer usageand the slight favorable change in the supply mix discussed above.   In general, the supply cost balancingaccount as discussed above allows GSWC to track incremental rate changes fromsuppliers for future recovery in water rates. The favorable change in the supply mix allowed GSWC to serve a portionof the increased customer demand from groundwater production rather thanwholesale purchases, primarily because of the return to service or replacementof wells which had been removed from service as a result of water qualityissues and mechanical problems.

 

For the nine months endedSeptember 30, 2008, the decrease of 5.9% in power purchased for pumpingwas principally due to lower customer demand, partially offset by a favorablechange in the supply mix, as discussed above. Groundwater production assessments were higher by 7.5% due to afavorable change in supply mix and increases in assessment rates (pump taxrates) levied against groundwater production, effective July 2007 and2008.  Average pump tax rates increasedin Regions II and III by approximately 3% and 6%, respectively, between the twoperiods.  These increases in groundwaterproduction assessments were partially offset by lower customer demand.  Again, the supply cost balancing accounttracks the increases in pump tax rates for future recovery in water rates.

 

47

----

Tableof Contents

 

An increase of $1.6million in the water supply cost balancing account provision during the ninemonths ended September 30, 2008 as compared to the same period in 2007 wasprimarily caused by: (i) a $1.4 million increase in the amortization ofthe water supply cost balancing accounts; (ii) a net decrease totaling$114,000 of under-collections in 2008 compared to the same period in 2007caused by recent CPUC decisions that updated the authorized rates for supplycosts, therefore, lowering the level of under-collections being recorded, and (iii) a$257,000 decrease in interest earned on the supply cost balancingaccounts.  These increases to the watersupply cost balancing account provision were offset by the recording of a$181,000 net under-collection adjustment relating to Region III’s pre-2001 supplycosts which were approved by the CPUC in May of 2008.  Upon approval by the CPUC, a regulatory assetwas established for these previously incurred supply costs.

 

For the nine months endedSeptember 30, 2008, the cost of power purchased for resale to customers inGSWC’s BVES division decreased by 1.9% to $10.2 million compared to $10.4million for the nine months ended September 30, 2007 reflecting an increase insales of surplus power to the spot market at higher energy prices.   Income from the spot market sales for thenine months ended September 30, 2008 decreased the cost of power purchased for resaleand increased the electric supply cost balancing account provision,respectively, with no impact to the electric margin.

 

***Unrealized (Gain) Loss on Purchased Power Contracts***

 

Unrealized (gain) andloss on purchased power contracts represent gains and losses recorded for GSWC’spurchased power agreements with Morgan Stanley Capital Group, Inc. The$766,000 pretax unrealized gain on purchased power contracts for the ninemonths ended September 30, 2008 is due to an increase in the currentforward market prices since December 31, 2007. There was a $1.6 millionpretax unrealized gain on purchased power contracts for the nine months ended September 30,2007. Unrealized gains and losses at BVES will continue to impact earningsduring the remaining life of the contract, which terminates at the end of2008.  As of September 30, 2008,there is a cumulative unrealized loss of $788,000 which will be recognized asan increase to income by December 31, 2008.

 

***Other Operating Expenses***

 

The primary components ofother operating expenses include payroll, materials and supplies, chemicals andwater treatment, and outside service costs of operating the regulated watersystems, including the costs associated with water transmission anddistribution, pumping, water quality, meter reading, billing, and operations ofdistrict offices.  Registrant’s electricand contracted services operations incur many of the same types of costs aswell.  For the nine months ended September 30,2008 and 2007, other operating expenses by segment consisted of the following(amounts in thousands):

 
| ** **                      | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                      | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                  |       | $                 | 16,652     |              | $          | 16,381     |       | $          | 271        |   | 1.7 | % |
| Electric  Services              |       | 1,666             |       | 1,375             |       | 291        |       | 21.2       | %          |
| Contracted  Services            |       | 4,097             |       | 2,404             |       | 1,693      |       | 70.4       | %          |
| Total other  operating expenses |       | $                 | 22,415     |              | $          | 20,160     |       | $          | 2,255      |   | 11.2 | % |

 

For the nine months ended September 30, 2008,other operating expenses for water services increased by $271,000, or 1.7%, dueprimarily to an increase: (i) in labor costs of $588,000 due to higherwages and related benefits, and an overall increase in employees; (ii) of$167,000 in bad debt expense; and (iii) of $126,000 in outside consultingservices.   These increases werepartially offset by a decrease of $570,000 due to lower water treatment andchemical costs, including the removal of nitrate and perchlorate at variousgroundwater treatment plants that occurred in 2007.

 

There was an increase of $291,000 in other operatingexpenses for electric services primarily due to higher wages and relatedbenefits of $167,000, as well as an increase of $89,000 in bad debt expense.

 

48

----

Tableof Contents

 

Contracted services experienced increases in otheroperating expenses of $1.7 million primarily due to the commencement of theoperation of water and wastewater systems at military bases in North Carolinaand South Carolina that began during the first quarter of 2008.  As a result of these new bases, otheroperating expenses increased by $2.5 million during the nine months ended September 30,2008.  These increases werepartially offset by decreases at the other military bases during 2008 resultingfrom lower outside services of $817,000 primarily paid to the subcontractorthat  provided wastewater services to certainof ASUS’ subsidiaries. On January 31, 2008, ASUS and its subsidiariesagreed to buy out all current and future rights which this subcontractor had toprovide wastewater services at any bases owned and operated by ASUS and any ofits present and/or future subsidiaries.  For the nine months ended September 30,2008, most of these services were performed internally at lower cost some ofwhich is recorded in labor costs within maintenance expense.  There wasalso a decrease of $157,000 in bad debt expense.

 

***Administrative and General Expenses***

 

Administrative andgeneral expenses include payroll related to administrative and generalfunctions, all employee benefits charged to expense accounts, insuranceexpenses, outside legal and consulting fees, regulatory utility commission expenses,expenses associated with being a public company and general corporate expenses.For the nine months ended September 30, 2008 and 2007, administrative andgeneral expenses by segment consisted of the following (amounts in thousands):

 
| ** **                                 | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                 | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                             |       | $                 | 33,484     |              | $          | 30,789     |       | $          | 2,695      |   | 8.8 | % |
| Electric  Services                         |       | 4,753             |       | 4,104             |       | 649        |       | 15.8       | %          |
| Contracted  Services                       |       | 7,840             |       | 3,567             |       | 4,273      |       | 119.8      | %          |
| Total  administrative and general expenses |       | $                 | 46,077     |              | $          | 38,460     |       | $          | 7,617      |   | 19.8 | % |

 

For thenine months ended September 30, 2008, administrative and general expenses increased by$2.7 million in water services compared to the nine months ended September 30, 2007 due primarily to anincrease of $2.3 million in labor costs and other miscellaneous employeebenefits due to higher wages largely related to Registrant’s annualperformance-based salary review program and an increase in overall  employees. There was also $585,000 of additional compensation expense relating tothe resignation of a GSWC officer effective September 26, 2008.  These increases were partially offset bydecreases in various other administrative and general expenses.

 

For the nine months ended September 30, 2008, administrative andgeneral expenses increased by $649,000 in electric services compared to thenine months ended September 30, 2007 due primarily to an increase of $807,000 inallocation of costs from the corporate headquarters’ to BVES.  Labor costs and employee related benefitsalso increased by $161,000.  Theseincreases were partially offset by a decrease of $260,000 in outside consultingand legal services.

 

There was an increase of$4.3 million in contracted services administrative and general expenses dueprimarily to an increase of $2.8 million associated with the commencement of the operation of waterand wastewater systems at military bases in North Carolina and South Carolinathat began during the first quarter of 2008, including allocations from ASUS’headquarters and the General Office headquarters.  There were also increases at the other basesincluding: (i) an increase of approximately $365,000 in outsideservices for legal and consulting work, including costs incurred in connectionwith a business acquisition, discussed previously; (ii) an approximate$1.1 million increase in labor and employee benefit costs, and (iii) a charge of$213,000 relating to that business acquisition and the related settlement ofthe preexisting relationship between ASUS and its wastewater subcontractor.

 

49

----

Tableof Contents

 

***Depreciation and Amortization***

 

For the nine months endedSeptember 30, 2008 and 2007, depreciation and amortization by segmentconsisted of the following (amounts in thousands):

 
| ** **                           | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                           | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                       |       | $                 | 21,471     |              | $          | 19,841     |       | $          | 1,630      |   | 8.2 | % |
| Electric  Services                   |       | 1,657             |       | 1,631             |       | 26         |       | 1.6        | %          |
| Contracted  Services                 |       | 357               |       | 144               |       | 213        |       | 147.9      | %          |
| Total  depreciation and amortization |       | $                 | 23,485     |              | $          | 21,616     |       | $          | 1,869      |   | 8.6 | % |

 

For the nine months endedSeptember 30, 2008, depreciation and amortization expense for water andelectric services increased by $1.7 million to $23.1 million compared to $21.5million for the nine months ended September 30, 2007 reflecting, amongother things, the effects of closing approximately $55.2 million of additionsto utility plant during 2007, depreciation on which began in January 2008.  There were also changes to the compositedepreciation rates approved by the CPUC. Registrant anticipates thatdepreciation expense will continue to increase due to ongoing construction atits regulated subsidiaries. Registrant believes that depreciation expenserelated to property additions approved by the appropriate regulatory agencywill be recovered through water and electric rates.

 

There was also anincrease in depreciation and amortization expense for contracted services due to the commencement ofthe operation of water and wastewater systems at military bases in NorthCarolina and South Carolina that began during the first quarter of 2008.  As a result of these new bases, depreciationand amortization expense increased by $87,000 during the nine months ended September 30,2008.  There were also increases at theother military bases due to the addition of fixed assets.

 

***Maintenance***

 

For the nine months endedSeptember 30, 2008 and 2007, maintenance expense by segment consisted ofthe following (amounts in thousands):

 
| ** **           | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **           | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services       |       | $                 | 10,031     |              | $          | 10,462     |       | $          | (431       | ) | -4.1 | % |
| Electric  Services   |       | 590               |       | 474               |       | 116        |       | 24.5       | %          |
| Contracted  Services |       | 1,948             |       | 287               |       | 1,661      |       | 578.7      | %          |
| Total  maintenance   |       | $                 | 12,569     |              | $          | 11,223     |       | $          | 1,346      |   | 12.0 | % |

 

For the nine months ended September 30, 2008,maintenance expense for water services decreased by $431,000 to $10.0 millioncompared to $10.5 million for the nine months ended September 30, 2007 dueprincipally to a decrease in emergency maintenance on GSWC’s wells and watersupply sources in its Region II service area. Region II’s maintenance expense decreased by $832,000.  This decrease was partially offset by anincrease of $614,000 in maintenance expense at Regions I and III.

 

There was an increase of $116,000 in maintenance forelectric services related to the 8.4 MW natural gas-fueled generation plant.

 

50

----

Tableof Contents

 

There was an increase of$1.7 million in contracted services maintenance expense due primarily to thecommencement ofthe operation of water and wastewater systems at military bases in NorthCarolina and South Carolina that began during the first quarter of 2008, whichadded $1.3 million in maintenance expense for the nine months ended September 30,2008.  The level of maintenance costs at thesebases also reflects the age and condition of the  infrastructure at these bases.  There was also increased maintenance expenseof $343,000 at the other bases due primarily to higher internal labor costswhich substituted for the subcontractor that provided wastewater services tothese ASUS subsidiaries.  As previouslymentioned, in January 2008, ASUS and its subsidiaries agreed to buyout all current and future rights which this subcontractor had to providewastewater services at any bases owned and operated by ASUS.

 

***Property and Other Taxes***

 

For the nine months endedSeptember 30, 2008 and 2007, property and other taxes by segment consistedof the following (amounts in thousands):

 
| ** **                      | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                      | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                  |       | $                 | 8,021      |              | $          | 7,811      |       | $          | 210        |   | 2.7 | % |
| Electric  Services              |       | 361               |       | 701               |       | (340       | )          | -48.5      | %          |
| Contracted  Services            |       | 838               |       | 81                |       | 757        |       | 934.6      | %          |
| Total property  and other taxes |       | $                 | 9,220      |              | $          | 8,593      |       | $          | 627        |   | 7.3 | % |

 

For the nine months endedSeptember 30, 2008, overall property and other taxes for water andelectric services decreased by $130,000. Additional property taxes resulting from higher assessed values andincreases in payroll taxes based on increased labor costs, were partially offsetby lower franchise fees at BVES.

 

Property and other taxeswere higher in contracted services due to the commencement of the operation of water and wastewatersystems at military bases in North Carolina and South Carolina that beganduring the first quarter of 2008.  As aresult of these new bases, property and other taxes increased by $275,000during the nine months ended September 30, 2008. There was also anincrease of $364,000 in gross receipt taxes primarily related to the ODUSmilitary bases in Virginia due in part to an increase in gross revenues.

 

***Construction Expenses***

 

For the nine months endedSeptember 30, 2008, ASUS’ construction expenses decreased to $13.4 millioncompared to $19.2 million for the same period in 2007 reflecting primarily thecosts incurred in 2007 for the wastewater expansion project at Fort Bliss.   For the nine months ended September 30,2007, this project generated $15.7 million in construction expenses.  The project was completed in August 2007.The decrease in construction expenses because of this project was partiallyoffset by other smaller construction projects during the nine months ended September 30,2008.  There was also an increase inconstruction expenses dueto the commencement of the operation of water and wastewater systems atmilitary bases in North Carolina and South Carolina that began during the firstquarter of 2008.  As a result of thesenew bases, construction expenses increased by $2.4 million during the nine monthsended September 30, 2008, including $385,000 for emergencyconstruction at PSUS to address pre-existing conditions not anticipated in thecontract and for which ASUS is pursuing recovery from the U.S. government and$397,000 in anticipated losses associated with certain initial capital upgradeprojects.

 

***Net Gain on Sale of Property***

 

For the nine months ended September 30, 2007, waterservices recorded a net pretax gain of $594,000 on the sale of propertyprimarily related to a gain of $325,000 relating to GSWC’s sale of a parcel ofland to the Los Angeles Unified School District for the purpose of constructinga high school.  There was also a pretaxgain of $238,000 on the sale of property it owned in the City of Claremont.There were no similar gains in the same period of 2008.  Earnings and cash flows from thesetransactions are sporadic and may or may not continue in future periods.

 

51

----

Tableof Contents

 

***Interest Expense***

 

For the nine months endedSeptember 30,2008 and 2007, interest expense by segment consisted of the following (amountsin thousands):

 
| ** **                   | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 15,456     |              | $          | 15,592     |       | $          | (136       | ) | -0.9 | % |
| Contracted  Services         |       | 644               |       | 821               |       | (177       | )          | -21.6      | %          |
| Total interest  expense      |       | $                 | 16,100     |              | $          | 16,413     |       | $          | (313       | ) | -1.9 | % |

 

For the nine months endedSeptember 30, 2008, overall interest expense decreased by 1.9% to $16.1 millioncompared to $16.4 million for the nine months ended September 30, 2007primarily reflecting lower short-term interest rates.  The average interest rate on short-termborrowings for the nine months ended September 30, 2008 was 3.4%, ascompared to an average of 6.1% during the same period of 2007. This waspartially offset by an increase in short-term borrowings. Average bank loanbalances outstanding under an AWR credit facility for the nine months ended September 30,2008 were approximately $51.8 million, as compared to an average of $31.7million during the same period of 2007.

 

***Interest Income***

 

For the nine months endedSeptember 30, 2008 and 2007, interest income by segment consisted of thefollowing (amounts in thousands):

 
| ** **                   | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 1,424      |              | $          | 1,723      |       | $          | (299       | ) | -17.4 | % |
| Contracted  Services         |       | 5                 |       | 19                |       | (14        | )          | -73.7      | %          |
| Total interest  income       |       | $                 | 1,429      |              | $          | 1,742      |       | $          | (313       | ) | -18.0 | % |

 

Interest income for waterand electric services decreased by 17.4% due to less interest earned onshort-term cash surplus and a decrease of $460,000 in interest accrued on theuncollected balance of the Aerojet litigation memorandum account authorized bythe CPUC due to lower interest rates. These decreases were partially offset by the recording of $480,000 ininterest income during the second quarter of 2008 in connection with the IRS’sexamination of the 2002 income tax return.

 

***Other***

 

For the nine months ended September 30, 2008 and 2007, waterservices recorded other income of $91,000 and $234,000, respectively, as aresult of  a non-operating equityinvestment.

 

52

----

Table of Contents

 

***Income Tax Expense***

 

For the nine months endedSeptember 30,2008 and 2007, income tax expense by segment consisted of the following(amounts in thousands):

 
| ** **                   | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **9/30/2008**     | ** ** | **9/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 14,714     |              | $          | 14,423     |       | $          | 291        |   | 2.0 | % |
| Contracted  Services         |       | (1,247            | )          | 1,038             |       | (2,285     | )          | -220.1     | %          |
| Total income tax  expense    |       | $                 | 13,467     |              | $          | 15,461     |       | $          | (1,994     | ) | -12.9 | % |

 

For the nine months endedSeptember 30,2008, income tax expense for water and electric services increased by 2.0% to$14.7 million compared to $14.4 million for the nine months ended September 30,2007 due primarily to an increase in pretax income.  The ETR for water and electric services forthe nine months ended September 30, 2008 was 41.1% as compared to a 41.7%ETR applicable to the nine months ended September 30, 2007.  The ETR deviates from the federal  statutory rate primarily due to state taxesand the changes between book and taxable income that are treated asflow-through adjustments (principally plant, rate case and compensatory innature) in accordance with regulatory requirements.  Flow-throughadjustments increase or decrease tax expense in one period, with an offsettingincrease or decrease occurring in another period.

 

Income tax expense forcontracted services decreased to a tax benefit of $1.2 million compared to taxexpense of $1.0 million for the nine months ended September 30, 2007 dueprimarily to a decrease in pretax income. The ETR for contracted services for the nine months ended September 30,2008 was 38.9% as compared to a 36.7% ETR applicable to the nine months ended September 30,2007.

 

53

----

Tableof Contents

 

**CriticalAccounting Policies and Estimates**

 

Criticalaccounting policies and estimates are those that are important to the portrayalof AWR’s financial condition, results of operations and cash flows, and requirethe most difficult, subjective or complex judgments of AWR’s management. Theneed to make estimates about the effect of items that are uncertain is whatmakes these judgments difficult, subjective and/or complex. Management makessubjective judgments about the accounting and regulatory treatment of manyitems. These judgments are based on AWR’s historical experience, terms ofexisting contracts and AWR’s observance of trends in the industry, informationprovided by customers and information available from other outside sources, asappropriate. Actual results may differ from these estimates underdifferent assumptions or conditions.

 

The critical accounting policies used in the preparation of the Registrant’s financial statements that it believes affect the more significant judgments and estimates used in the preparation of its consolidated financial statements presented in this report are described in *“Management’s Discussion and Analysis of Financial Condition and Results of Operation”* included in Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007. There have been no material changes to the critical accounting policies.

 

**Liquidityand Capital Resources**

 

***AWR***

 

Registrant’s regulated business (primarily that ofGSWC), is capital intensive and requires considerable capital resources. Aportion of these capital resources are provided by internally generated cashflows from operations. When necessary, Registrant obtains funds from externalsources in the capital markets and through bank borrowings. Access to externalfinancing on reasonable terms depends on Registrant’s credit ratings andcurrent business conditions, including that of the water utility industry ingeneral as well as conditions in the debt or equity capital markets. If thesebusiness and market conditions deteriorate to the extent that AWR no longer hasaccess to the capital markets at reasonable terms, Registrant has access to arevolving credit facility that is currently utilized to support operations.  On August 25, 2008, AWR amended its $85million syndicated credit facility, to increase the aggregate bank commitmentsby $30 million to $115 million. Up to $20 million of this facility may be usedfor letters of credit. As of September 30, 2008, an aggregate of $65.5million in cash borrowings were included in current liabilities andapproximately $11.1 million of letters of credit were outstanding under thisfacility.  As of September 30, 2008,AWR has $38.4 million available to borrow under the credit facility.  AWR also has a Registration Statement on filewith the Securities and Exchange Commission for the sale from time to time ofdebt and equity securities. As of September 30, 2008, $156.5 million wasavailable for issuance under Registration Statements.  Of thisamount, $6.5 million is available under a registration statement that willexpire on November 30, 2008 and the remainder is available under aregistration statement that will expire in August 2009.  AWR is planning on issuing common  shares over the next twelve months dependingon market conditions.    Proceeds fromthe issuance of common  shares areexpected to be used to pay down short-term borrowings.

 

Theexpansion of the credit line allows time to explore other opportunities in thedebt and equity markets. Registrant believes that AWR’s sound capital structureand “A” stable credit rating, combined with its financial discipline, willenable AWR to access debt and/or equity markets. However, unpredictablefinancial market conditions in the future may limit its access or impact thetiming of when to access the market, in which case Registrant may choose totemporarily reduce its capital spending.

 

AWR funds itsoperating expenses and pays dividends on its outstanding common sharesprimarily through dividends from GSWC and through proceeds from equityissuances not invested in subsidiaries. The ability of GSWC to pay dividends to AWR is restricted by Californialaw. Under restrictions of the California tests, at September 30, 2008,approximately $127.3 million was available from the retained earnings of GSWCto pay dividends to AWR.  GSWC is alsosubject to contractual restrictions on its ability to pay dividends. GSWC’smaximum ability to pay dividends is restricted by certain Note Agreements tothe sum of $21 million plus 100% of consolidated net income from various datesplus the aggregate net cash proceeds received from capital stock offerings orother instruments convertible into capital stock from various dates. Under themost restrictive of the Note Agreements, $234.8 million was available to paydividends to AWR as of September 30, 2008. GSWC is also prohibited frompaying dividends if, after giving effect to the dividend, its totalindebtedness to capitalization ratio (as defined) would be more than 0.6667 to1.  Dividends in the amount of $8.8million were paid to AWR by GSWC during the nine months ended September 30,2008.  Dividends in the amount of $12.9million were paid to AWR by GSWC during the nine months ended September 30,2007.

 

AWR has paid common dividends for over 75 consecutive years.  On October 31, 2008, AWR declared a regular quarterly dividendof $0.250 per Common Share. The dividend, totaling approximately $4.3million, will be paid onDecember 1, 2008 to common shareholders of record at the close of businesson November 12, 2008.  During thenine months ended September 30, 2008 and 2007, AWR paid quarterlydividends to shareholders, 

 

54

----

Tableof Contents

 

totaling approximately $12.9 million or $0.750 pershare and $12.0 million or $0.705 per share, respectively.  AWR presently intends to continue payingquarterly cash dividends in the future, on March 1, June 1, September 1and December 1, subject to earnings and financial condition, regulatoryrequirements and such other factors as the Board of Directors may deemrelevant.

 

AWR anticipatesthat interest costs will increase in future periods due to the need foradditional external capital to fund its construction program, and potentialmarket interest rate increases. AWR believes that costs associated with capitalused to fund construction at its regulated subsidiaries will continue to berecovered in water and electric rates charged to customers.

 

Due to recent market events, the fair value of the planassets for the pension and postretirement plans have declined since December 31,2007.   Lower plan asset values will: (i) resultin an increase in AWR’s underfunded positions on the balance sheet with acorresponding increase in  regulatoryassets for pensions and other postretirement obligations at year-end; (ii) potentiallyincrease pension and postretirement expense in the next fiscal year, to theextent the effects are not offset by the effects of a change in the discountrate, and (iii)  may require greater cash contributions  in 2009.  AWR will also review the appropriateness of its expectedlong-term rate of return on plan assets to be used at the next measurement date(December 31, 2008) to determine the expected return on assets componentof expense for  2009.

 

In August 2008, Standard & Poor’sreaffirmed a rating of “A Stable” for both AWR and GSWC. S&P debt ratingsrange from AAA (highest rating possible) to D (obligation is in default).Securities ratings are not recommendations to buy, sell or hold a security andare subject to change or withdrawal at any time by the rating agency.

 

*CashFlows from Operating Activities*:

 

Registrant’s future cashflows from operating activities will be affected by utility regulation;infrastructure investment; maintenance expenses; inflation; compliance withenvironmental, health and safety standards; production costs; customer growth;per customer usage of water and electricity; weather and seasonality.  In addition, future cash flows fromnon-regulated subsidiaries will depend on new business activities, includingmilitary base operations and the construction of new and/or replacementinfrastructure at the different military bases, timely redetermination ofprices and requests for equitable adjustments of prices and timely collectionof payments from the U.S. government.

 

Cash flows fromnon-regulated subsidiaries would be adversely impacted if the U.S. governmentwere to exercise its offset rights for the $7.5 million penalty assessed by theU. S. Army for the alleged failure to meet small business subcontractor goalsat Fort Bliss.  FBWS has filed a Noticeof Appeal of this assessment stating its disagreement with the position takenby the U.S. Army.  The U.S. Army hasresponded to the appeal and has disagreed with all of FBWS’ assertions.  The parties have each served writtendiscovery on the opposing party and responses have been provided to eachrespective party. On July 15, 2008, the government filed a motion forpartial summary judgment.  The motion asks the Armed Services Board ofContract Appeals (the “Appeals Board”) to rule that the liquidated damagesassessed against FBWS are not barred by cases finding that liquidated damageswhich far exceed actual damages are a “penalty” and, therefore, areunenforceable.  On October 15, 2008, the Appeals Board judgeconducted a status conference with the parties at which they were asked toconsider alternative dispute resolution (“ADR”).  Both FBWS and the Government agreed toutilizing non-binding ADR to attempt to resolve this claim.  Dates for ADR have tentatively been set for February 3- 5, 2009.   Pending the results of ADR,the motion for summary judgment is on hold. Should ADR be unsuccessful, the Appeals Board judge has indicated that ahearing on the issues would likely be scheduled in the third quarter of 2009.

 

Cash flows from operatingactivities have generally been sufficient to meet operating requirements and aportion of capital expenditure requirements. As previously mentioned,  AWR amended its $85 million syndicated creditfacility, to increase the aggregate bank commitments by $30 million to $115million. Registrant will continue to seek access to debt and equity capitalmarkets to meet future operating requirements and capital expenditurerequirements.  There can be no assurancethat Registrant will be able to successfully access such markets on favorableterms or at all. Operating cash flows can be negatively affected by changes inthe regulatory environments.

 

Taking into account thefactors noted above, Registrant also obtains cash from non-operating sourcessuch as the proceeds from debt issuances, customer advances for andcontributions in aid of construction and equity offerings, discussed below infinancing activities.

 

55

----

Tableof Contents

 

Net cash provided byoperating activities was $43.3 million for the nine months ended September 30,2008 as compared to $42.2 million for the same period ended September 30,2007. The overall increase of $1.1 million was primarily attributable to thetiming of cash disbursements made to subcontractors used by ASUS whichcontributed to an overall increase in accounts payable of $4.9 million.  There was also an increase of $4.4 million inbillings in excess of costs and estimated earnings on uncompleted contractscollected during the nine months ended September 30, 2008 from the U.S.government, primarily at Fort Jackson and Fort Bragg. These increases wereoffset by a $5.2 million increase in ASUS’ costs and estimated earnings inexcess of billings on uncompleted contracts during the nine months ended September 30,2008.  This was caused primarily by anincrease in construction activities at Andrews Air Force Base that will bebilled and collected in future periods. The timing of cash receipts and disbursements related to other workingcapital items, including rate recovery from customers of  regulatory assets, also affected the changesin net cash provided by operating activities. Changes in cash flows from operating activities were generallyconsistent with changes in the results of operations as adjusted by changes inworking capital in the normal course of business.

 

*CashFlows from Investing Activities*:

 

Net cash used ininvesting activities, which consists primarily of construction expenditures atGSWC, increased to $61.3 million for the nine months ended September 30,2008 as compared to $32.2 million for the same period in 2007. This increasewas primarily due to higher construction expenditures totaling $26.2 millionconsistent with Registrant’s capital investment plan for 2008.  Also in 2008, ASUS completed the acquisitionof substantially all of the net assets of the subcontractor that provided thewastewater services to ASUS’ subsidiaries at military bases for an aggregatepurchase price of $2.3 million related to the net assets.  In 2007, cash used in investing activitiesalso included proceeds received on the sale of property.  There were no proceeds received on the saleof property during 2008.

 

Cash flows used in investingactivities are expected to rise during 2008 as construction expenditures areexpected to be approximately $65 million to $75 million during 2008. Registrantintends to invest capital prudently to provide essential services to itsregulated customer base, while working with its regulators to have theopportunity to earn a fair rate of return on investment. Registrant’sinfrastructure investment plan consists of both infrastructure renewalprograms, where  infrastructure isreplaced, as needed, and major capital investment projects, where  new water treatment and delivery facilitieswill be constructed.  Projected capitalexpenditures and other investments are subject to periodic review and revisionto reflect changes in economic conditions and other factors.

 

*CashFlows from Financing Activities*:

 

Registrant’s financingactivities include the issuance and repayments of long-term debt and notespayable to banks, primarily through its wholly owned subsidiary, GSWC, theissuance of common shares, proceeds from stock option exercises, and thepayment of dividends on common shares. In order to finance new infrastructure, Registrant also receivescustomer advances for and contributions in aid of construction (net of refunds).

 

Net cash provided byfinancing activities was $17.5 million for the nine months ended September 30,2008 as compared to net cash used of $9.6 million for the same period in 2007.The increase of $27.1 million in net cash provided by financing activities wasprimarily caused by an increase of $28.3 million in notes payable to banks tofund operations.  This increase waspartially offset by an increase of $894,000 in dividends paid to AWR’sshareholders and a decrease of $2.4 million in the proceeds from stock optionexercises.

 

***GSWC***

 

GSWC funds the majority of its operating expenses, payments on itsdebt, and dividends on its outstanding common shares and a portion of itsconstruction expenditures through internal sources. Internal sources of cashflow are provided primarily by retention of a portion of earnings fromoperating activities. Internal cash generation is influenced by factors such asweather patterns, environmental regulation, litigation, changes in supply costsand regulatory decisions affecting GSWC’s ability to recover these supplycosts, timing of rate relief, increases in maintenance expenses and capitalexpenditures.

 

As mentioned previously,GSWC relies on external sources, including equity investments and short-termborrowings from AWR, and long-term debt to help fund a portion of itsconstruction expenditures.  In addition,GSWC receives advances and contributions from customers, home builders and realestate developers to fund construction necessary to extend service to newareas. Advances for construction are refundable generally at rates ranging from10% to 22% of the revenues received from the installation for which funds wereadvanced or in equal 

 

56

----

Tableof Contents

 

annual installments overperiods of time ranging from 10 to 40 year periods.  Amounts which are no longer refundable arereclassified to contributions in aid of construction. Utility plant funded byadvances and contributions is excluded from rate base. Generally, GSWCdepreciates contributed property and amortizes contributions in aid ofconstruction at the composite rate of the related property.

 

GSWC also has aRegistration Statement on file with the SEC for issuance from time to time, ofup to $100 million of debt securities. As of September 30, 2008, $50million remained for issuance under this Registration Statement, which willexpire on November 30, 2008.  GSWCexpects to file a new shelf registration statement with the SEC prior to theend of the year.

 

*CashFlows from Operating Activities*:

 

Net cash provided byoperating activities was $45.0 million for the nine months ended September 30,2008 as compared to $38.5 million for the same period in 2007. The increase of$6.5 million is primarily attributable to the timing of cash receipts anddisbursements related to working capital items affecting the changes in netcash provided by operating activities, including rate recovery from customersof GSWC’s  regulatory assets.  Changes in cash flows from operatingactivities were generally consistent with changes in the results of operationsas adjusted by changes in working capital in the normal course of business.

 

*CashFlows from Investing Activities*:

 

Net cash used ininvesting activities increased to $55.5 million for the nine months ended September 30,2008 as compared to $30.9 million for the same period in 2007. This increasewas due to higher capital expenditures consistent with GSWC’s 2008 capitalimprovement plan. In 2007, cash used in investing activities also includedproceeds received on the sale of property. There were no proceeds received on the sale of property during 2008.

 

*CashFlows from Financing Activities*:

 

Net cash provided byfinancing activities was $9.6 million for the nine months ended September 30,2008 as compared to net cash used of $7.0 million for the same period in 2007.The increase in net cash provided by financing activities was primarily due tothe issuance of 12 additional GSWC Common Shares to AWR for $30.0 million.  GSWC used the proceeds to pay downintercompany debt owed to AWR. Accordingly, there was a $16.9 million decrease in the net change inintercompany borrowings.  There was alsoa $4.1 million decrease in dividends paid to AWR.

 

***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 constructionexpenditures.

 

***ASUS***

 

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

 

**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, 2007. See *“Managements’ Discussion and Analysis of Financial Condition and Results of Operation–Contractual Obligations, Commitments and Off Balance Sheet Arrangements”* of the Registrant’s Form 10-K for the year-ended December 31, 2007 for a detailed discussion of contractual obligations and other commitments.

 

57

----

Tableof Contents

 

**RegulatoryMatters**

 

GSWC is subject toregulation by the CPUC, which has broad powers with respect to service andfacilities, rates, classification of accounts, valuation of properties, thepurchase, disposition and mortgaging of properties necessary or useful inrendering public utility service, the issuance of securities, the granting ofcertificates of public convenience and necessity as to the extension ofservices and facilities and various other matters. CCWC is subject tocomparable regulation by the ACC.

 

Rates that GSWC and CCWCare authorized to charge are determined by the CPUC and the ACC, respectively,in general rate cases and are derived using rate base, cost of service and costof capital, as projected for a future test year in California and using ahistorical test year, as adjusted, in Arizona. Rates charged to customers varyaccording to customer class and rate jurisdiction and are generally set atlevels allowing for recovery of prudently incurred costs, including a fairreturn on rate base. Rate base generally consists of the original cost ofutility plant in service, plus certain other assets, such as working capitaland inventory, less accumulated depreciation on utility plant in service,deferred income tax liabilities and certain other deductions.

 

GSWCis required to file a general rate case (“GRC”) application every threeyears for each of its water rate-making areas according to a scheduleestablished by the CPUC. GRC’s typically include an increase in the first testyear with inflation rate adjustments for the second and third years of the GRCcycle. Rates are based on a forecast of expenses and capital costs for the testyear. According to the CPUC’s new water rate case plan adopted in May 2007,GSWC will migrate to a rate case schedule that brings all three Regions of GSWCwithin a single triennial rate case. Starting with the filing made on July 1, 2008, GSWC’s RegionsII and III plus the general office will undergo rate review in a single case.Region I’s most recent rate case was decided on January 31, 2008,  GSWC will file its next rate case  for Region I in January 2010, for ratesin years 2011 and 2012.  GSWC will thenfile for all three regions in July 2011 for years 2013, 2014, and 2015.According to the new rate case schedule, all Regions will then be reviewed in asingle case for the ensuing three-year cycle. The new consolidated GRC is expected to have an 18-month processingschedule. In California, rates may also be increased by offsets for certainexpense increases, including but not limited to supply cost offset andbalancing account amortization, advice letter filings related to certain plantadditions and other operating cost increases. Offset rate increases and adviceletter filings typically have a two- to four- month regulatory processing lag.

 

Underthe new rate case plan adopted by the CPUC in May 2007, GSWC filed aseparate application to review the rate of return authorized by the CPUC.  In prior years, the rate of return wasdetermined as part of the general rate case process along with all otheroperating costs.  This new procedure toseparate the rate of return from the general rate case is the same process thatthe CPUC utilizes to determine the rate of return for energy companies underCPUC jurisdiction.  GSWC filed its firstcost of capital application under the new rate case plan on May 1,2008.  The application requests the CPUCto adopt a new rate of return on rate-base (“RORB”) of 10% on average forcalendar years 2009, 2010, and 2011, based on a return on equity (“ROE”) of12.1%.  According to the rate case plan,the CPUC intends to process the cost of capital proceeding in six months, atwhich time, the rate of return authorized by the CPUC will be implemented intorates on a company-wide basis.  Ifapproved as filed, the new adopted ROE and RORB are expected to generateapproximately $12 million of additional annual revenue in 2009.   The scoping memo for this proceeding hasbeen bifurcated into two phases.  Phase Iwill establish ROE’s for the utilities in the case.  Phase II will address automatic adjustmentmechanisms for ROE/RORB between rate cases.

 

Neitherthe operations nor rates of AWR and ASUS are directly regulated by the CPUC orthe ACC. The CPUC and the ACC do, however, regulate certain transactionsbetween GSWC and its affiliates.  Inaddition, ASUS’ subsidiaries are regulated by their respective commissions inthe state in which they operate. However, the amounts charged by the subsidiaries of ASUS for water andwastewater services at military bases are based upon the terms of 50-yearcontracts with the U.S. government and supplemental fixed price constructioncontracts. The operations and maintenance contracts provide that prices will beredetermined at the end of two years after commencement of operations at eachmilitary base and every three years thereafter. In addition, prices may beequitably adjusted for changes in law, wage and benefit increases and othercircumstances.  ASUS has, however,experienced delays in the redetermination of rates.  For the supplemental construction contracts,prices may be changed through the change order process if significantunforeseen issues arise during the construction process.

 

58

----

Tableof Contents

 

***RecentChanges in Rates***

 

*Rate increases in 2008:*

 

In January 2008, the CPUC approved rate increasesfor the seven ratemaking areas in the Region I customer service area. Theauthorized rate increases will provide GSWC additional annual revenues ofapproximately $6.4 million in 2008 based on an authorized ROE of 10.2%. The newrates were effective January 1, 2008. On March 3, 2008, the Division of Ratepayer Advocates (“DRA”) filedan application for rehearing of the Region I GRC decision on various legalgrounds.  As permitted by the CPUC, GSWCfiled a response to DRA’s application. GSWC is not able to predict the outcome of this matter.  In September 2008, the CPUC granted alimited rehearing in order to consider whether it is reasonable to include inRegion I’s rate base approximately $3.7 million of costs incurred in connectionwith the La Serena Plant Improvement Project. The project is currently in rate base and the earnings have beenincluded in rates since January 1, 2008.  At this time, managementbelieves it is probable that the costs of this project will be allowed toremain in rate base.  The finalresolution of this issue is expected as part of the Region II and III currentgeneral rate case and  that is expectedto be decided in the fourth quarter of 2009.

 

In January 2008, the CPUC also approved attritionyear rate increases for Regions II and Region III customer service areaseffective January 1, 2008. The authorized rate increases  are expected to provide GSWC additionalannual revenues of approximately $3.6 million for Region II representing thesecond year of a three-year rate case increase approved by the CPUC in 2007.The increase of approximately $3.0 million for Region III is the third year ofa three-year rate increase approved in 2006.

 

The combined rate increases for Regions I, II andIII are designed to generate approximately $13.0 million annually, based uponnormalized sales levels approved by the CPUC, effective January 1, 2008.

 

*Rate increases in 2007:*

 

In February 2006, GSWC filed an application withthe CPUC for rate increases in Region II and to cover general office expensesat the Corporate Headquarters. The rate increases for the CorporateHeadquarters’ expenses would also increase Region III rates for 2007.  Due to delays in issuing a decision on theseapplications, the CPUC had previously approved interim rate increases totaling$1.2 million and $135,000 for Region II and Region III, respectively, thatbecame effective January 1, 2007. On November 16, 2007, the CPUCapproved the general rate increases for the Region II service area andadditional rate increases in Region II and III to recover general officeexpenses at the Corporate Headquarters.  Based on the decisions issued by the CPUC on November 16, 2007, theapproved revenue increases for 2007 were approximately $6.4 million for RegionII and approximately $3.0 million to recover Corporate Headquarters’ expensesallocated to Region III.  The rateincreases were retroactive to January 1, 2007.   Accordingly, during the fourth quarter of2007, GSWC recorded the revenue difference between the interim ratesimplemented on January 1, 2007 and the final rates authorized by the CPUCfor the period from January 1 to the implementation of the authorizedrates.  This resulted in the recording ofa $7.2 million regulatory asset and corresponding increase in revenues duringthe fourth quarter of 2007.  A surchargewas implemented in the first quarter of 2008 to begin recovering this amountfrom customers.

 

For GSWC’s Region IIIrate case approved by the CPUC on January 12, 2006, the CPUC also approvedthe second year increases for Region III in an estimated amount ofapproximately $2.3 million, effective January 1, 2007. Based oncertain corrections to the rate calculation, GSWC also filed an Application forRehearing to request additional revenues in connection with the January 2006decision.  On July 31, 2008, theCPUC adopted a stipulation jointly filed by GSWC and DRA.  The stipulation addressed all of the pendingissues including proposing a 12-month surcharge enabling GSWC to recoverrevenues of approximately $541,000 for the period January 1, 2006 through May of2008.  In addition, it was stipulated that tariffs in Region III should beadjusted for additional revenues generated from the date the stipulation wasapproved.  The adjustment  isexpected to result in an annual increase in revenues of approximately$226,000.   As a result of the CPUC’sapproval, a regulatory asset of $541,000 was established in July 2008 witha corresponding increase to income.  Thisregulatory asset will be recovered through the 12-month surcharge.

 

59

----

Table of Contents

 

***PendingRate Changes***

 

*GSWC*

 

According to the CPUC’snew water rate case plan adopted in May 2007 discussed above, GSWC filedits general rate case for Region II and III plus the general office on July 1,2008.  The new rates are to be effectivefor 2010, 2011 and 2012. GSWC filed for revenue increases and if approved asfiled, the rate increases for Region II are expected to generate approximately$20.3 million in annual revenues starting in 2010, $2.6 million in 2011 and$4.2 million in 2012, and increases of $30.0 million starting in 2010, $1.7million in 2011 and $3.7 million in 2012 for Region III.

 

In June 2008, GSWC’sBVES division filed its general rate case with the CPUC’s electricdivision.  The filing was the first fullgeneral rate case for BVES since 1996.  Costs incurred inconnection with the construction of the generating facility are expected to bereviewed by the CPUC as part of the 2008 general rate case.  The filing requests an overall annualrevenue increase of $6.8 million.  All of the increase is to the base rateportion of BVES’ rates.  The $6.8 million increase represents an overallincrease of approximately 23% over current rates.  BVES has included a request for a phased-inimplementation of the rate increase.  Theproposed phase in plan would recognize the full rate increase in the first yearfor financial reporting purposes, but defer the revenue recovery to asubsequent year.  In the application,BVES has requested an ROE of 11.7%.

 

During the third quarterof 2008, BVES filed a second application to address the revenue requirement forthe purchased power component of rates. DRA has protested the application.   In October 2008,  GSWC executed a new purchased powercontract  that will provide power to BVESeffective January 1, 2009 at a fixed cost over a five year term. The newcontract is subject to CPUC approval. Once the contract is approved, BVES intends to file a separate application to incorporate the new costs,including energy purchases and delivery costs, into rates.  The new contract will also be subject to SFASNo. 133 and will require mark-to-market derivative accounting.  BVES expects to make another separate filingrequesting the CPUC to authorize the establishment of regulatory asset andliability accounts to offset the entries required by SFAS No. 133.  All unrealized gains and losses generatedfrom the new purchased power contract would be deferred on a monthly basis intothe non-interest bearing regulatory accounts that would track the changes infair value of the derivative throughout the term of the contract.   Upon approval of the new contract by theCPUC, changes in the fair value of the derivative throughout the term of thenew contract will be included in the regulatory accounts established and would,as a result, no longer affect GSWC’s earnings.

 

*CCWC*

 

CCWC filed a rate casewith the ACC in August 2004 for its water system in Fountain Hills,Arizona. In September 2005, the ACC approved a rate increase for CCWC. Therate increase was effective on October 1, 2005 and generated additionalannual revenues of approximately $1.1 million, an 18% increase over 2004revenues. During this GRC, CCWC sought to have its rates determined using afair value rate base. The ACC elected not to use fair value in setting therates. CCWC appealed ACC’s use of only original cost less depreciation ratebase to determine the revenue requirement. Because CCWC’s fair value rate basewas higher, the use of original cost exclusively to determine the revenuerequirement deprived CCWC of a substantial amount of operating income.Following the approval of this rate case, CCWC filed an appeal with the ArizonaCourt of Appeals. On February 13, 2007, the Arizona Court of Appealsupheld CCWC’s challenge to the ACC’s failure to use fair value rate base in thedetermination of operating income. The process the ACC utilized resulted in alower revenue requirement and was found to be in violation of the ArizonaConstitution. However, the Court also held that the ACC’s determination of thereturn on equity, while not well-explained, was made based on the evidence, wasa matter within the agency’s substantial discretion and was lawful.  The ACC decided to not seek review, and thematter was returned to the ACC on remand for modification of the original ACCdecision consistent with the decision of the Court of Appeals. Testimony wasfiled by ACC staff and the Residential Utility Consumer Office.  The ACC conducted evidentiary hearings on theremanded case in January 2008.  TheACC rendered its final decision on July 17, 2008.  The decision reduced the ROE from the 9.3% inthe original decision by 200 basis points resulting in a return on fair valuerate base of 6.4%.  The net increase inCCWC rates  was $12,000.

 

During the course ofremand proceedings in the 2004 rate case, in the fourth quarter of 2007, CCWCfiled its new general rate case with the ACC. Unlike California, there is not a three-year cycle in Arizona.  The only filing requirement is that a utilitycannot have two applications pending at the same time, and the typical rule isthat rates should be in effect for one year before filing a new case.  In the 2007 filing, CCWC requested rateincreases 

 

60

----

Tableof Contents

 

which are expected togenerate approximately $3.1 million in additional annual revenues. Theprocessing of this case was expected to take approximately 18 months.  However, the ACC suspended processing of the2007 rate case until completion of the proceedings on remand of the 2004 ratecase.  As a result of the finaldetermination in the 2004 rate case, CCWC intends to pursue the 2007 case aspromptly as possible including a request for interim rates.  As of September 30, 2008, CCWC has $11.3million of goodwill which may be at risk for potential impairment if therequested  rate increases are not grantedby the ACC.

 

***Other Regulatory Matters***

 

**ConservationRate Design and Revenue Adjustment Mechanisms**

 

In February 2007,the CPUC opened an Order Instituting Investigation (“OII”) to Consider Policiesto Achieve Conservation Objectives (known as the “Conservation OII”). TheConservation OII’s primary considerations were: (i) the establishment of aWRAM to decouple sales from revenues; (ii) tiered rate design as a meansto encourage water conservation; (iii) a modified supply cost balancingaccount; and (iv) whether the adoption of a revenue adjustment mechanismshould affect the authorized ROE. The WRAM and the modified supply costbalancing account are intended to negate any impact on the Company’s earningsfrom customers’ conservation efforts.  OnAugust 21, 2008, CPUC issued a final decision which authorized GSWC toimplement an increasing block rate design in GSWC’s Regions II and III as ameans to encourage water conservation. It also directs GSWC to file a tieredrate design for Region I within 20 days of the decision.  GSWC filed the application for tiered ratesin Region I.  In addition, GSWC isauthorized to establish a WRAM to track revenue shortfalls for subsequentrecovery from customers, and a modified supply cost balancing account thatwould include recovery for changes in water supply mix. The decision furtherdefers to the upcoming cost of capital proceeding, the issue of whether theadoption of the WRAM should affect the water utilities’ ROE.

 

In accordance with theCPUC’s administrative processing rules, GSWC intends to implement two-tiered increasing block rates in November 2008.. During the interim, GSWC  has providedcustomers with conservation rate notices as a bill insert and  explained to customers the impact ofconservation rates on customers’ bills.

 

Furthermore, the CPUCalso approved an advice letter filing to allow GSWC to create and implement aWater Conservation Memorandum Account (“WCMA”) to track the extraordinaryexpenses and revenue shortfall associated with the conservation measures inconjunction with the declared drought in California.  The WCMA was effective August 18,2008.  As of September 30, 2008,approximately $2.2 million of net undercollection has been included in theWCMA.  If approved by the CPUC, GSWCwould establish a regulatory asset with a corresponding increase to income.

 

**WestboroughDevelopment, Sacramento County**

 

On April 7, 2006,GSWC filed an advice letter with the CPUC to incorporate the Westboroughdevelopment in Sacramento County into the Rancho Cordova service area and toprovide water service to that new development. The City of Folsom filed aprotest of GSWC’s advice letter on April 27, 2006. On January 30,2007, the CPUC rejected the advice letter without prejudice, and invited GSWCto re-file the advice letter once the City of Folsom protest was resolved, orfile an application for CPUC approval of the service territory expansion.

 

In June 2007, GSWCsigned an agreement with the City of Folsom and the City agreed not to contestGSWC’s providing water service to Westborough and relinquished all claimsconcerning GSWC’s providing water service to the area. As compensation to theCity of Folsom to resolve its claim, GSWC has agreed to pay the City of Folsom$550,000. Aerojet will reimburse GSWC for 50%, or $275,000, of the settlementpayment. As of September 30, 2008, GSWC has recorded an obligation of$550,000 to the City of Folsom and an additional receivable of $275,000 fromAerojet for the amount to be reimbursed.

 

During the third quarterof 2007, GSWC filed a second advice letter after resolving the issue with theCity of Folsom. That advice letter was subsequently protested by the SacramentoCounty Water Agency (“SCWA”).  During thesecond quarter of 2008, the objections raised by SCWA in their protest wereremoved.

 

GSWC intends to fileagain with the CPUC later in 2008 to incorporate the Westborough development inSacramento County into the Rancho Cordova service area and to provide waterservice to that new development.  The recoveryfrom Aerojet of the $17.5 million in legal and expert costs and accruedinterest from January 1, 2004 in the Aerojet litigation, previouslydiscussed, is contingent upon the issuance of land use approvals fordevelopment 

 

61

----

Tableof Contents

 

of Aerojet property whichincludes the Westborough development and the receipt of certain fees inconnection with that development.

 

**Supply CostMemorandum/Balancing Accounts**

 

As permitted by the CPUC,Registrant maintains water supply cost balancing accounts for GSWC to accountfor under-collections and over-collections of revenues designed to recover suchcosts.  The supply cost balancingaccounts track differences between the current cost for supply items (water,power, and pump taxes) charged by GSWC’s suppliers and the cost for those itemsincorporated into GSWC’s rates. Under-collections (recorded as regulatoryassets) occur when the current cost exceeds the amount in rates for these itemsand, conversely, over-collections (recorded as regulatory liabilities) occurwhen the current cost of these items is less than the amount in rates.  As of September 30, 2008, there isapproximately $12.0 million net under-collection in the water supply costbalancing accounts.  Of this amount,approximately $8.2 million relates to GSWC’s Region III customer servicearea.  In May 2008, the CPUCapproved a surcharge to begin recovering $7.0 million of this under-collectionover 24 months.   The remaining $1.2 million for Region III will beincluded in future filings for recovery. Further, the remaining $3.8 million net under-collections in the watersupply cost balancing accounts relate to GSWC’s Region I net under-collectionof $1.9 million and Region II’s net under-collection of $1.9 million.  Currently, there are surcharges in place inRegion I expiring in 2009 and 2010 to recover this under-collection. Asurcredit at Region II to refund a previous over-collection expired in August 2008.  During the fourth quarter of 2008, GSWCintends to file for supply expense offsets in Regions II and III to reduce thelevel of under-collections being accumulated.

 

**Santa Maria Groundwater Adjudication and MemorandumAccounts**

 

In1997, the Santa Maria Valley Water Conservation District (“plaintiff”) filed alawsuit against multiple defendants, including GSWC, the City of Santa Maria,and several other public water purveyors. The plaintiff’s lawsuit sought anadjudication of the Santa Maria Groundwater Basin (the “Basin”). A stipulatedsettlement of the lawsuit has been reached, subject to CPUC approval.  The settlement, among other things, ifapproved by the CPUC, would preserve GSWC’s historical pumping rights andsecure supplemental water rights for use in case of drought or other reductionsin the natural yield of the Basin. GSWC, under the stipulation, has a right to10,000 acre-feet of groundwater replenishment provided by the TwitchellProject, a storage and flood control reservoir project operated by the SantaMaria Valley Conservation District.  A monitoring and annual reportingprogram has been established to allow the parties to responsibly manage theBasin and to respond to shortage conditions.  If severe water shortageconditions are found over a period of five years, the management areaengineer will make findings and recommendations to alleviate suchshortages.  In the unlikely case that the Basin experiences severeshortage conditions, the court has the authority to limit GSWC’sgroundwater production to 10,248 acre-feet per year, based ondeveloped water in the Basin.

 

OnFebruary 11, 2008, the court issued its final judgment, which approves andincorporates the stipulation.  The judgment awards GSWC prescriptiverights to groundwater against the non-stipulating parties.  In addition,the judgment grants GSWC the right to use the Basin for temporary storage andto recapture 45 percent of the return flows that are generated from itsimportation of State Water Project water.  Pursuant to this judgment, thecourt retains jurisdiction over all of the parties to make supplemental ordersor to amend the judgment as necessary. On March 20, 2008, thenon-stipulating parties filed notices of appeal.  Registrant is unable to predict the outcomeof the appeal.

 

GSWC has incurred costsof approximately $7.0 million as of September 30, 2008, includinglegal and expert witness fees, in defending its groundwater supply in theBasin. Such costs had been recorded in utility plant for future rate recovery.In February 2006, GSWC filed an application with the CPUC for recovery of$5.5 million of these costs, representing the amount of the costs that hadbeen incurred as of December 31, 2005. In February 2007, GSWC reacheda settlement with the CPUC’s DRA authorizing recovery of the $5.5 millionrequested in GSWC’s application. The settlement deferred review of theremaining legal costs pending final resolution of the lawsuit. In May 2007,the CPUC issued a decision that approved the settlement with the DRA. Pursuant tothe decision, GSWC was authorized to place in rate base $2.7 million ofthe $5.5 million of previously incurred litigation costs. GSWC was alsoauthorized to amortize, with interest, the remaining $2.8 million of the$5.5 million in rates over a ten-year period. This amount has beentransferred into a separate memorandum account included within regulatoryassets and a surcharge was implemented in the third quarter of 2007 forrecovery of these costs.

 

62

----

Tableof Contents

 

All litigation costs,including interest, that have been incurred since December 31, 2005,totaling approximately $1.5 million, have also been transferred from ratebase to a separate new memorandum account, subject to a reasonableness reviewby the CPUC in a subsequent phase of this proceeding or in a newproceeding.  In April 2008, theAdministrative Law Judge closed the proceeding without ruling on thestipulation or authorizing recovery of the remaining costs.  The ruling directed GSWC to file a newapplication.  In accordance with thisruling, GSWC intends to file a new application. Management believes that these additional costs will be approved and therecovery of these costs through rates is probable.

 

**CPUCSubpoena**

 

On February 15,2007, the CPUC issued a subpoena to GSWC in connection with an investigation ofcertain work orders and charges paid to a specific contractor used by GSWC fornumerous construction projects. The CPUC’s investigation focuses on whetherthese charges were approved in customer rates and whether they were just andreasonable. In June 2007, GSWC received notification from the CPUC that itwas instituting an audit. The purpose of the audit was to examine for theperiod 1994 to the present, GSWC’s policies, procedures, and practicesthroughout all of its Regions regarding the granting or awarding ofconstruction contracts or jobs.  GSWC iscurrently responding to data requests submitted by the CPUC. Management cannotpredict the outcome of the investigation or audit at this time.

 

**Bear Valley Electric Service**

 

GSWC’s BVES division hasbeen filing compliance reports with the CPUC regarding its purchases of energyfrom renewable energy resources. The filings indicated that BVES had notachieved interim target purchase levels of renewable energy resources and thus,on its face, might be subject to a potential penalty. GSWC has formallycontested the potential penalty reflected in the compliance report. The CPUChas been considering the future timing and applicability of renewable energyresource requirements as they apply to smaller energy utilities like BVES.   On May 30, 2008, the CPUC issued itsfinal decision regarding the renewable responsibilities of small utilities(including BVES).  The final decisionaffirmed the renewable obligation targets for the small utilities but alsoallowed the small utilities to defer compliance under the CPUC’s flexiblecompliance rules.  BVES will need tocontinue its efforts to procure renewable resources each year going forward,and where that may prove difficult because the market for such resources isvery constrained, then BVES will be required to describe in detail the problemsthat warrant further deferral, in accordance with the CPUC’s flexiblecompliance rules.  Because the finaldecision deferred BVES’ interim target purchase levels for the years 2004through 2007, management believes that the CPUC’s decision effectivelyforecloses any exposure to financial penalties for the year 2007 and earlier.For the 2008 year, BVES is not expecting to meet the interim targets andexpects that the CPUC will waive any potential fines in accordance with theflexible compliance  rules.  Accordingly, no provision for loss has beenrecorded in the financial statements as of September 30, 2008.

 

**CustomerInformation/Customer Relationship Management System (CIS/CRM)**

 

In October 2008,GSWC filed an advice letter with the CPUC requesting authorization to enterinto a contract with a vendor to provide implementation services for a newCustomer Information/Customer Relationship Management System (CIS/CRM) and toexpend funds in excess of the amount authorized previously by the CPUC in2007.  The revised total cost of theproject under the contract is estimated at $11.6 million, before overhead.  At this time, management cannot predict theoutcome of this advice letter filing.

 

There have been no othermaterial changes to AWR’s other regulatory matters since December 31,2007. See *“Managements’ Discussion and Analysis of FinancialCondition and Results of Operation—Regulatory Matters”*section ofthe Registrant’s Form 10-K for the year-ended December 31, 2007 for adetailed discussion of other regulatory matters.

 

63

----

Tableof Contents

 

**Environmental Matters**

 

AWR’s 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.

 

*Drinking Water Standard:*

 

During the first quarterof 2008, one of GSWC’s water systems located in northern California violated adrinking water standard.  GSWC routinely monitors for the presence ofdrinking water contaminants including total trihalomethanes (“TTHM”).  TheTTHM samples taken in the first quarter of 2008 indicated that this watersystem exceeded the maximum contaminant level (“MCL”) for TTHM. During thefirst quarter, GSWC implemented various operational changes and conductedincreased monitoring over the quarter in an attempt to identify and control thefactors leading to the formation of TTHM in the distribution system.** **The results of these studiesindicate that source water quality is the predominate factor in this situation.Water imported from the Sacramento-San Joaquin Delta experienced saltwater intrusion and had high levels of organic compounds from agriculturaldrainage during the first quarter. These compounds form TTHM during thetreatment process.  GSWC has no control over the quality of the sourcewater that is purchased from the Contra Costa Canal.  To remedy thesituation,  GSWC increased the purchaseof chloraminated water from the Contra Costa Water District beginning in March 2008and throughout the second and third quarters of 2008.  Chloramination is an accepted and widely usedmethod to mitigate TTHM.  Based on theresults of recent compliance samples, GSWC is now in compliance of the TTHMMCL.  GSWC has filed an advice letterwith the CPUC to allow the establishment of a memorandum account to recoverfuture additional costs associated with the purchase of chloraminated water.

 

*Environmental Clean-Up andRemediation:*

 

During the firstquarter of 2008, hydrocarbon contaminated soil was found at a plant site (“BallonaPlant”)  located in GSWC’s Southwestcustomer service area where an abandoned water tank was demolished.  The contamination appears to be shallow andlikely the result of past corrosion control practices.  An initial investigation and characterizationof the contaminated area has been conducted. However, at this time, GSWC is unable to reasonably estimate the cost ofclean-up.  Historically, this type ofclean-up cost has been included in rates as approved by the CPUC.

 

Additionalinformation on these requirements and other significant environmental mattersis described in *“Management’s Discussion and Analysis of**Financial Condition and Results of Operation”*included in Registrant’s 2007 Annual Report on Form 10-K for the yearended December 31, 2007. There have been no other material changes in anyof the environmental matters discussed in the Form 10-K since December 31,2007.

 

**WaterSupply**

 

***State Water Project***

 

GSWCmanages a portfolio of water supplies, including groundwater production, use oftreated surface water and arrangements with water wholesalers to insure thereliability, quality and affordability of water.  For example, GSWC has contracts withvarious governmental entities, principally Metropolitan Water District’s memberagencies (“MWD”), and other parties to purchase water for distribution tocustomers.  The MWD is a publicagency organized and managed to provide a supplemental, imported supply ofwater to its member public agencies.  GSWChas connections to MWD’s water distribution facilities and those of memberagencies.  The Company purchases MWDwater through six separate member agencies aggregating more than 75,000acre-feet annually. MWD’s principal sources of water are the Colorado River andthe State Water Project (“SWP”) which conveys water from northern California.

 

Watersupplies available to MWD through the SWP have historically varied from year toyear based on weather, although MWD has generally been able to providesufficient quantities of water to satisfy the needs of its constituents.  However, a key link in the SWP is theSacramento/San Joaquin River Delta adjacent to the San Francisco Bay (“Delta”).  The fresh water pathway through the Delta issupported by earthen levees, and the reliability of those levees has beencalled into question based on post hurricane Katrina assessments by variousfederal, state and local agencies.  Asignificant failure of the Delta levee system would substantially interferewith water exports, thus potentially disrupting the water supply available toGSWC from northern California via MWD.  

 

64

----

Tableof Contents

 

In light of these risks,the state Department of Water Resources and the Governor have convened a seriesof interdisciplinary task forces to develop proposals to preserve theenvironmental viability of the Delta and safeguard the water supply.  GSWC continues to participate in and monitordevelopments related to the Delta and efforts to craft a workable solution tothe risks presented by reliance on the Delta for water supply conveyance tosouthern California.

 

TheSWP faces particular challenges to the operation of its pumping plant locatedat the southern end of the Delta which naturally drains to the Pacific Oceanthrough the San Francisco Bay. Because of its diversion of water for export tocentral, coastal and southern California through the pumping plant, the SWP issubject to a variety of operating limitations and permitting processesdesigned, collectively, to balance the need for water exports with the need torestore and protect the Delta environment.  In late 2007, a Federal judgeissued a decision in the case *NaturalResources Defense Council v. Kempthorne*, Case No. 05-CV-1207(U.S. Dist. Ct., E.D.) finding, among other things, that the Biological Opinion(“BiOp”) issued by the U.S. Fish and Wildlife Service (the “Service”) waslegally insufficient and failed to consider recent declines in delta smeltabundance.  A new BiOp, responsive to recent scientific findings and tothe judge’s order,  is expected to becompleted by December 15, 2008. The judge has imposed interim restrictions on pumping until the new BiOp iscompleted, including significant reductions in deliveries to contractualcustomers of the SWP, including MWD, of up to 37% of baseline deliveries. Actual curtailments will depend on weather conditions, fish and flow patternsin the Delta.

 

The current outlook forincreased deliveries on the SWP has not improved. SWP allocations during 2008have remained at 35% due to the Delta restrictions.  The allocations represent the maximum annualSWP contract portion available to each signatory of the SWP contract duringfull allocations.  Without the Deltarestrictions, DWR has indicated the allocation would have been approximately50%.  Due to declining storage levels inthe State’s reservoirs, current estimates of initial allocations on the SWP for2009 will be around 10 to 15%, which is the second lowest in history of the SWP.  In February 2008, MWD approved a “WaterSupply Allocation Plan.”  Under thisplan, the MWD Board can declare a water supply shortage and allocate water tothe MWD member agencies.  Depending onweather conditions during winter 2008, such a declaration could occur as earlyas January 2009.  However, under thecurrent approved plan, the Board would make a determination in April followedby implementation in July.  MWD hasindicated that a regional shortage of 10 to 25% or more is possible for 2009.

 

Approximately 55% ofGSWC’s water supply comes from its own groundwater production wells situatedthroughout its service areas. GSWC owns a total of approximately 118,000acre-feet of water rights, mostly groundwater, to help meet supplyrequirements. The Company purchases from the MWD and its member agencies, about45% of its total demand. In light of restrictions on imported water suppliesand drought conditions in southern California, GSWC has been engaging in acomprehensive and on-going assessment of its water rights and groundwaterstorage assets. In addition, the Company has begun to aggressively pursuevoluntary conservation measures among its customers and implement customereducation initiatives to help to deal with supply variability and the generalscarcity of water supplies.

 

***Weather***

 

Watersupply and revenues at GSWC and CCWC are significantly affected, both in theshort-run and long-run, by changes in weather and climate conditions.

 

In June, 2008, GovernorArnold Schwarzenegger issued an executive order declaring a statewide drought,which directed state agencies and departments to take immediate action toaddress the serious drought conditions and water delivery reductions that existin California.  In July 2008, theGovernor and Senator Dianne Feinstein proposed a compromise plan to thelegislature to update California’s water system that would put the state on thepath toward restoring the Sacramento-San Joaquin Delta, expanding watersupplies and promoting conservation efforts that will ensure a clear, reliablewater supply for California.

 

In September, 2008 theGovernor’s office issued the following statement reaffirming the severe droughtconditions as stated previously on the June 2008 press release: “California’sdrought is impacting our economy, our agriculture and our families, and an endto these dry conditions is nowhere in sight. We are facing the potential for another dry year in 2009, which is whythe Administration is actively planning for an ongoing drought and working toalleviate the effects of the state’s dry conditions.  The Water Bank program will be providingwater to communities who need it most.”

 

Theabove average precipitation level in early 2008 in California was offset by dryweather experienced since March of 2008. The precipitation level in the State for the three months ended September 30,2008 was 0.21 inches, which was lower than the 10-year average precipitation of0.51 inches for the same period.  Theprecipitation level for the month of September 2008 was only 0.01 inches,the driest such month on record for the past 113 years.  The U.S. Seasonal Drought Outlook’s October 2,2008 publication forecasted little rainfall across California and that droughtconditions would likely improve in the northwestern part of the State, while inother parts of the State the drought would continue to persist or intensify.

 

65

----

Tableof Contents

 

GSWCis investing in infrastructure improvements to protect water supplies fromsource to tap and encouraging its customers to conserve.  GSWC intends to implement an increasing blockrate design as a means to encourage water conservation.

 

Additionalinformation on water supply issues are described in *“Management’sDiscussion and Analysis of**Financial Condition andResults of Operation”* included in our 2007 Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

**NewAccounting Pronouncements**

 

Registrantis subject to newly issued requirements as well as changes in existingrequirements issued by the Financial Accounting Standards Board. Differences infinancial reporting between periods could occur unless and until the CPUC andthe ACC approve such changes for conformity through regulatory proceedings. See*Note 1**of UnauditedNotes to Consolidated Financial Statements.*

 

**Item 3. Quantitative and Qualitative DisclosuresAbout Market Risk**

 

Registrantis exposed to certain market risks, including fluctuations in interest rates,and commodity price risks 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 changesregarding Registrant’s market risk position from the information provided inits Annual Report on Form 10-K for the year ended December 31, 2007.The quantitative and qualitative disclosures about market risk are discussed in*Item 7A-Quantitative and Qualitative DisclosuresAbout Market Risk*, contained in Registrant’s Annual Report on Form 10-K.

 

**Item 4. Controls and Procedures**

 

**(a) Evaluationof Disclosure Controls and Procedures**

 

Asrequired by Rule 13a-15(b) under the Securities and Exchange Act of1934 (the “Exchange Act”), we have carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer (“CEO”) and our Chief Financial Officer (“CFO”), of theeffectiveness, as of the end of the fiscal quarter covered by this report, ofthe design and operation of our “disclosure controls and procedures” as definedin Rule 13a-15(e) and 15d-15(e) promulgated by the Securitiesand Exchange Commission (SEC) under the Exchange Act. Based upon thatevaluation, the CEO and the CFO concluded that disclosure controls andprocedures, as of the end of such fiscal quarter, were adequate and effectiveto ensure that information required to be disclosed by us in the reports thatwe file or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and formsand that such information is accumulated and communicated to our management,including our CEO and CFO, as appropriate to allow timely decisions regardingrequired disclosure.

 

**(b) Changesin Internal Controls over Financial Reporting**

 

Therehas been no change in our internal control over financial reporting during thequarter ended September 30, 2008, that has materially affected or isreasonably likely to materially affect our internal control over financialreporting.

 

**Item 4T. Controls and Procedures**

 

Notapplicable.

 

66

----

Tableof Contents

 

**PART II**

 

**Item 1. Legal Proceedings**

 

There have been no materialdevelopments in any of the legal proceedings described in our 2007 AnnualReport on Form 10-K.

 

Registrant is subject to ordinaryroutine litigation incidental to its business. Other than those disclosed inRegistrant’s Form 10-K for the year ended December 31, 2007, no otherlegal proceedings are pending, which are believed to be material. 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.

 

**Item 1A. Risk Factors**

 

There have been no significant changes in the risk factorsdisclosed in our 2007 Annual Report on Form 10-K.

 

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

 

The shareholders of AWR have approved the material featuresof all equity compensation plans under which AWR directly issues equitysecurities. AWR did not directly issue any unregistered equity securitiesduring the third quarter of 2008.  Thefollowing table provides information about repurchases of common shares by AWRduring the third quarter of 2008:

 
| **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** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1 - 31, 2008      |       | 146                                              |       | $                                                | 34.25      |                                                                                                                                      | —     |                                                                                                                                | NA         |   |
| August 1 - 31, 2008    |       | 41                                               |       | $                                                | 38.54      |                                                                                                                                      | —     |                                                                                                                                | NA         |   |
| September 1 - 30, 2008 |       | 2,542                                            |       | $                                                | 38.14      |                                                                                                                                      | —     |                                                                                                                                | NA         |   |
| Total                       |       | 2,729                                            | (2)        | $                                                | 37.93      |                                                                                                                                      | —     |                                                                                                                                | NA         | (3) |

 

----

| (1)    |   | None of the common shares were purchased pursuant  to any publicly announced stock repurchase program.                                                                                                                                                                                                   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                     |
| (2)    |   | Of this amount,  1,746 common shares were acquired on the open market for employees pursuant  to the Company’s 401(k) Plan. The remainder of the common shares were  acquired on the open market for participants in the Company’s Common Share  Purchase and Dividend Reinvestment Plan. |
|   |   |                                                                                                                                                                                                                                                                                                     |
| (3)    |   | None of these  plans contain a maximum number of common shares that may be purchased in  the open market under the plans.                                                                                                                                                                           |

 

**Item 3. Defaults Upon Senior Securities**

 

None

 

**Item 4. Submission of Matters toa Vote of Security Holders**

 

No items were submitted during thethird quarter of the 2008 fiscal year covered by this report to a vote ofsecurity holders through the solicitation of proxies or otherwise.

 

**Item 5. Other Information**

 

(a)          On October 31, 2008,the Board of Directors of AWR declared a regular quarterly dividend of $0.250per common share. The dividend will be paid December 1, 2008 toshareholders of record as of the close of business on November 12, 2008.

 

(b)         There have been no materialchanges during the third quarter of 2008 to the procedures by whichshareholders may nominate persons to the Board of Directors of AWR.

 

67

----

Tableof Contents

 

## **Item 6. Exhibits**

##  

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

 
| 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)          Filed concurrentlyherewith

 

(2)          Furnished concurrentlyherewith

 

68

----

Tableof Contents

 

#### **SIGNATURE**

####  

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized and as its principal financial officer.

 

 
|        |   |   | AMERICAN STATES WATER COMPANY |
|--------|--------|--------|-------------------------------|
|   |   |   | and its subsidiary            |
|   |   |   | GOLDEN STATE WATER COMPANY    |
|   |   |   |                          |
|   |   |   |                          |
|   |   |   | By:                           | /s/ Eva G. Tang |
|   |   |   |                          | Eva G. Tang |
|   |   |   |                          | Senior Vice President-Finance, Chief Financial |
|   |   |   |                          | Officer, Corporate Secretary and Treasurer |

 

 

Dated: November 7,2008

 

69

----