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 June 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”, “acceleratedfiler” and smaller reporting company” in Rule 12b-2 of the Exchange 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 August 6, 2008, the number of Common Shares outstanding, of AmericanStates Water Company was 17,253,910 shares.

 

Asof August 6, 2008, all of the 122 outstanding Common Shares of GoldenState Water Company were owned by American States Water Company.

 

 

 

----

Table of 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 June 30, 2008 and December 31, 2007           | 2          |
|             |                                                                                                                        |       |
|             | Consolidated Statements of Income of American States  Water Company for the Three Months Ended June 30, 2008 and 2007  | 4          |
|             |                                                                                                                        |       |
|             | Consolidated Statements of Income of American States  Water Company for the Six Months Ended June 30, 2008 and 2007    | 5          |
|             |                                                                                                                        |       |
|             | Consolidated Statements of Cash Flow of American  States Water Company for the Six Months Ended June 30, 2008 and 2007 | 6          |
|             |                                                                                                                        |       |
|             | Balance Sheets of Golden State Water Company as of  June 30, 2008 and December 31, 2007                           | 7          |
|             |                                                                                                                        |       |
|             | Statements of Income of Golden State Water Company for  the Three Months Ended June 30, 2008 and 2007                  | 9          |
|             |                                                                                                                        |       |
|             | Statements of Income of Golden State Water Company for  the Six Months Ended June 30, 2008 and 2007                    | 10         |
|             |                                                                                                                        |       |
|             | Statements of Cash Flow of Golden State Water Company  for the Six Months Ended June 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                                 | 27         |
|             |                                                                                                                        |       |
| Item 3:          | Quantitative  and Qualitative Disclosures About Market Risk                                                                 | 62         |
|             |                                                                                                                        |       |
| Item 4:          | Controls and  Procedures                                                                                                    | 62         |
|             |                                                                                                                        |       |
| Item 4T:         | Controls and  Procedures                                                                                                    | 62         |
|             |                                                                                                                        |       |
| **Part II** | **Other  Information**                                                                                                      |       |
| ** **       | ** **                                                                                                                  |       |
| Item 1:          | Legal Proceedings                                                                                                           | 63         |
|             |                                                                                                                        |       |
| Item 1A:         | Risk  Factors                                                                                                               | 63         |
|             |                                                                                                                        |       |
| Item 2:          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                | 63         |
|             |                                                                                                                        |       |
| Item 3:          | Defaults Upon  Senior Securities                                                                                            | 63         |
|             |                                                                                                                        |       |
| Item 4:          | Submission of  Matters to a Vote of Security Holders                                                                        | 63         |
|             |                                                                                                                        |       |
| Item 5:          | Other Information                                                                                                           | 64         |
|             |                                                                                                                        |       |
| Item 6:          | Exhibits                                                                                                                    | 64         |
|             |                                                                                                                        |       |
|             | Signatures                                                                                                                  | 65         |

 

----

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, including changesin customer demand and changes in water and energy supply costs; future weatherand climatic conditions; the effects of conservation due to increased customerawareness; delays in customer payments or price redeterminations on contractsexecuted by ASUS and its subsidiaries; and legislative, legal proceedings,regulatory and other circumstances affecting anticipated revenues and costs.

 

1

----

Table ofContents

 

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

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

 
| **(in thousands)**                                                                                       | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Utility  Plant, at cost**                                                                                   | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Water                                                                                                         |       | $                       | 1,005,495  |                        | $          | 982,708 |   |
| Electric                                                                                                      |       | 65,453                  |       | 65,078                      |       |
|                                                                                                          |       | 1,070,948               |       | 1,047,786                   |       |
| Less -  Accumulated depreciation                                                                              |       | (332,319                | )          | (316,038                    | )          |
|                                                                                                          |       | 738,629                 |       | 731,748                     |       |
| Construction work  in progress                                                                                |       | 62,822                  |       | 44,631                      |       |
| Net utility  plant                                                                                            |       | 801,451                 |       | 776,379                     |       |
|                                                                                                          |       |                    |       |                        |       |
| **Other  Property and Investments**                                                                           | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Goodwill                                                                                                      |       | 12,393                  |       | 11,354                      |       |
| Other property  and investments                                                                               |       | 10,813                  |       | 10,245                      |       |
| Total other  property and investments                                                                         |       | 23,206                  |       | 21,599                      |       |
|                                                                                                          |       |                    |       |                        |       |
| **Current  Assets**                                                                                           | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Cash and cash  equivalents                                                                                    |       | 371                     |       | 1,698                       |       |
| Accounts  receivable-customers (less allowance for doubtful accounts of $572 in 2008  and $539 in 2007)       |       | 17,552                  |       | 16,095                      |       |
| Unbilled revenue                                                                                              |       | 21,681                  |       | 16,035                      |       |
| Receivable from  the U.S. government (less allowance for doubtful accounts of $332 in 2008 and  $496 in 2007) |       | 5,015                   |       | 7,556                       |       |
| Other accounts  receivable (less allowance for doubtful accounts of $324 in 2008 and $629 in  2007)           |       | 3,566                   |       | 4,154                       |       |
| Income taxes  receivable                                                                                      |       | 1,538                   |       | 60                          |       |
| Materials and  supplies, at average cost                                                                      |       | 1,683                   |       | 1,576                       |       |
| Regulatory  assets – current                                                                             |       | 7,723                   |       | 5,187                       |       |
| Prepayments and  other current assets                                                                         |       | 2,042                   |       | 2,765                       |       |
| Unrealized gain  on purchased power contracts                                                                 |       | 2,953                   |       | —                      |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts                                  |       | 5,185                   |       | 3,842                       |       |
| Deferred income  taxes – current                                                                         |       | 675                     |       | 4,047                       |       |
| Total current  assets                                                                                         |       | 69,984                  |       | 63,015                      |       |
|                                                                                                          |       |                    |       |                        |       |
| **Regulatory  and Other Assets**                                                                              | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Regulatory  assets                                                                                            |       | 80,418                  |       | 82,539                      |       |
| Other accounts  receivable                                                                                    |       | 9,963                   |       | 9,723                       |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts                                  |       | 7,022                   |       | 2,284                       |       |
| Deferred income  taxes                                                                                        |       | 112                     |       | 28                          |       |
| Other                                                                                                         |       | 10,385                  |       | 8,331                       |       |
| Total regulatory  and other assets                                                                            |       | 107,900                 |       | 102,905                     |       |
|                                                                                                          |       |                    |       |                        |       |
| **Total  Assets**                                                                                             |       | $                       | 1,002,541  |                        | $          | 963,898 |   |

 

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

 

2

----

Table ofContents

 

**AMERICAN STATES WATER COMPANY****CONSOLIDATED BALANCE SHEETS****CAPITALIZATION AND LIABILITIES****(Unaudited)**

 
| **(in thousands)**                                                      | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Capitalization**                                                           | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Common shares,  no par value, no stated value                                |       | $                       | 182,922    |                        | $          | 181,796 |   |
| Earnings  reinvested in the business                                         |       | 126,259                 |       | 120,333                     |       |
| Total common  shareholders’ equity                                      |       | 309,181                 |       | 302,129                     |       |
| Long-term debt                                                               |       | 267,114                 |       | 267,226                     |       |
| Total  capitalization                                                        |       | 576,295                 |       | 569,355                     |       |
|                                                                         |       |                    |       |                        |       |
| **Current  Liabilities**                                                     | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Notes payable to  banks                                                      |       | 56,750                  |       | 37,200                      |       |
| Long-term debt –  current                                               |       | 523                     |       | 609                         |       |
| Accounts payable                                                             |       | 34,902                  |       | 29,091                      |       |
| Income taxes  payable                                                        |       | —                  |       | 398                         |       |
| Accrued employee  expenses                                                   |       | 7,321                   |       | 6,228                       |       |
| Accrued interest                                                             |       | 2,466                   |       | 2,467                       |       |
| Unrealized loss  on purchased power contracts                                |       | —                  |       | 1,554                       |       |
| Regulatory  liabilities – current                                       |       | —                  |       | 173                         |       |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | 4,405                   |       | 2,641                       |       |
| Deferred income  taxes – current                                        |       | 435                     |       | —                      |       |
| Other                                                                        |       | 12,489                  |       | 13,890                      |       |
| Total current  liabilities                                                   |       | 119,291                 |       | 94,251                      |       |
|                                                                         |       |                    |       |                        |       |
| **Other  Credits**                                                           | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Advances for  construction                                                   |       | 85,737                  |       | 84,479                      |       |
| Contributions in  aid of construction – net                             |       | 99,664                  |       | 98,657                      |       |
| Deferred income  taxes                                                       |       | 83,151                  |       | 82,480                      |       |
| Unamortized  investment tax credits                                          |       | 2,291                   |       | 2,336                       |       |
| Accrued pension  and other postretirement benefits                           |       | 23,480                  |       | 20,851                      |       |
| Regulatory  liabilities                                                      |       | 531                     |       | 557                         |       |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | 3,172                   |       | 2,037                       |       |
| Other                                                                        |       | 8,929                   |       | 8,895                       |       |
| Total other  credits                                                         |       | 306,955                 |       | 300,292                     |       |
|                                                                         |       |                    |       |                        |       |
| **Commitments  and Contingencies (Note 7)**                                  |       | —                  |       | —                      |       |
|                                                                         |       |                    |       |                        |       |
| **Total  Capitalization and Liabilities**                                    |       | $                       | 1,002,541  |                        | $          | 963,898 |   |

 

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

 

3

----

Table ofContents

 

**AMERICAN STATES WATER COMPANY****CONSOLIDATED STATEMENTS OF INCOME**

**FOR THE THREE MONTHS****ENDED JUNE 30, 2008 AND 2007****(Unaudited)**

 
| ** **                                                            | ** ** | **Three Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| **Operating  Revenues**                                               | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Water                                                                 |       | $                                               | 65,370     |   | $ | 60,826 |   |
| Electric                                                              |       | 6,208                                           |       | 6,255 |   |
| Contracted  services                                                  |       | 8,735                                           |       | 12,165 |   |
| Total operating  revenues                                             |       | 80,313                                          |       | 79,246 |   |
|                                                                  |       |                                            |       |   |   |
| **Operating  Expenses**                                               | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Water purchased                                                       |       | 13,079                                          |       | 12,077 |   |
| Power purchased  for pumping                                          |       | 2,655                                           |       | 2,673 |   |
| Groundwater  production assessment                                    |       | 2,890                                           |       | 2,549 |   |
| Power purchased  for resale                                           |       | 2,595                                           |       | 2,915 |   |
| Unrealized  (gain) loss on purchased power contracts                  |       | (1,664                                          | )          | 236 |   |
| Supply cost  balancing accounts                                       |       | (672                                            | )          | (1,190 | ) |
| Other operating  expenses                                             |       | 7,053                                           |       | 6,559 |   |
| Administrative  and general expenses                                  |       | 14,943                                          |       | 13,664 |   |
| Depreciation and  amortization                                        |       | 7,810                                           |       | 7,088 |   |
| Maintenance                                                           |       | 4,770                                           |       | 4,353 |   |
| Property and  other taxes                                             |       | 2,839                                           |       | 2,843 |   |
| ASUS  construction expenses                                           |       | 4,434                                           |       | 8,260 |   |
| Net gain on sale  of property                                         |       | —                                          |       | (238 | ) |
| Total operating  expenses                                             |       | 60,732                                          |       | 61,789 |   |
|                                                                  |       |                                            |       |   |   |
| **Operating  Income**                                                 |       | 19,581                                          |       | 17,457 |   |
|                                                                  |       |                                            |       |   |   |
| **Other  Income and Expenses**                                        | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Interest expense                                                      |       | (5,294                                          | )          | (5,570 | ) |
| Interest income                                                       |       | 775                                             |       | 586 |   |
| Other                                                                 |       | 7                                               |       | 63 |   |
| Total other  income and expenses                                      |       | (4,512                                          | )          | (4,921 | ) |
|                                                                  |       |                                            |       |   |   |
| **Income  from operations before income tax expense**                 |       | 15,069                                          |       | 12,536 |   |
|                                                                  |       |                                            |       |   |   |
| Income tax  expense                                                   |       | 5,786                                           |       | 5,214 |   |
|                                                                  |       |                                            |       |   |   |
| **Net  Income**                                                       |       | $                                               | 9,283      |   | $ | 7,322 |   |
|                                                                  |       |                                            |       |   |   |
| **Weighted  Average Number of Shares Outstanding**                    |       | 17,248                                          |       | 17,094 |   |
| **Basic  Earnings Per Common Share**                                  |       | $                                               | 0.54       |   | $ | 0.42 |   |
|                                                                  |       |                                            |       |   |   |
| **Weighted  Average Number of Diluted Shares**                        |       | 17,325                                          |       | 17,146 |   |
| **Fully  Diluted Earnings Per Share**                                 |       | $                                               | 0.53       |   | $ | 0.42 |   |
|                                                                  |       |                                            |       |   |   |
| **Dividends  Declared Per Common Share**                              |       | $                                               | 0.250      |   | $ | 0.235 |   |

 

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

 

4

----

Table ofContents

 

**AMERICAN STATES WATER COMPANY****CONSOLIDATED STATEMENTS OF INCOME**

**FOR THE SIX MONTHS****ENDED JUNE 30, 2008 AND 2007****(Unaudited)**

 
| ** **                                                            | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| **Operating  Revenues**                                               | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Water                                                                 |       | $                                             | 117,459    |   | $ | 111,153 |   |
| Electric                                                              |       | 15,011                                        |       | 15,124 |   |
| Contracted  services                                                  |       | 16,785                                        |       | 25,239 |   |
| Total operating  revenues                                             |       | 149,255                                       |       | 151,516 |   |
|                                                                  |       |                                          |       |   |   |
| **Operating  Expenses**                                               | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Water purchased                                                       |       | 21,032                                        |       | 20,950 |   |
| Power purchased  for pumping                                          |       | 4,335                                         |       | 4,791 |   |
| Groundwater  production assessment                                    |       | 5,265                                         |       | 4,828 |   |
| Power purchased  for resale                                           |       | 6,834                                         |       | 7,196 |   |
| Unrealized gain  on purchased power contracts                         |       | (4,507                                        | )          | (2,474 | ) |
| Supply cost  balancing accounts                                       |       | (779                                          | )          | (1,910 | ) |
| Other operating  expenses                                             |       | 15,049                                        |       | 13,156 |   |
| Administrative  and general expenses                                  |       | 29,770                                        |       | 26,671 |   |
| Depreciation and  amortization                                        |       | 15,603                                        |       | 14,177 |   |
| Maintenance                                                           |       | 8,542                                         |       | 7,326 |   |
| Property and  other taxes                                             |       | 5,759                                         |       | 5,773 |   |
| ASUS  construction expenses                                           |       | 8,309                                         |       | 17,329 |   |
| Net gain on sale  of property                                         |       | —                                        |       | (605 | ) |
| Total operating  expenses                                             |       | 115,212                                       |       | 117,208 |   |
|                                                                  |       |                                          |       |   |   |
| **Operating  Income**                                                 |       | 34,043                                        |       | 34,308 |   |
|                                                                  |       |                                          |       |   |   |
| **Other  Income and Expenses**                                        | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Interest expense                                                      |       | (10,672                                       | )          | (11,066 | ) |
| Interest income                                                       |       | 1,136                                         |       | 1,152 |   |
| Other                                                                 |       | 121                                           |       | 132 |   |
| Total other  income and expenses                                      |       | (9,415                                        | )          | (9,782 | ) |
|                                                                  |       |                                          |       |   |   |
| **Income  from operations before income tax expense**                 |       | 24,628                                        |       | 24,526 |   |
|                                                                  |       |                                          |       |   |   |
| Income tax  expense                                                   |       | 10,041                                        |       | 10,220 |   |
|                                                                  |       |                                          |       |   |   |
| **Net  Income**                                                       |       | $                                             | 14,587     |   | $ | 14,306 |   |
|                                                                  |       |                                          |       |   |   |
| **Weighted  Average Number of Shares Outstanding**                    |       | 17,243                                        |       | 17,066 |   |
| **Basic  Earnings Per Common Share**                                  |       | $                                             | 0.84       |   | $ | 0.83 |   |
|                                                                  |       |                                          |       |   |   |
| **Weighted  Average Number of Diluted Shares**                        |       | 17,362                                        |       | 17,121 |   |
| **Fully  Diluted Earnings Per Share**                                 |       | $                                             | 0.84       |   | $ | 0.82 |   |
|                                                                  |       |                                          |       |   |   |
| **Dividends  Declared Per Common Share**                              |       | $                                             | 0.500      |   | $ | 0.470 |   |

 

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

 

5

----

Table ofContents

 

**AMERICAN STATES WATER COMPANY****CONSOLIDATED STATEMENTS OF CASH FLOW**

**FOR THE SIX MONTHS ENDED JUNE 30, 2008 AND 2007****(Unaudited)**

 
| ** **                                                                   | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| **(in thousands)**                                                      | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| **Cash  Flows From Operating Activities:**                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net income                                                                   |       | $                                             | 14,587     |   | $ | 14,306 |   |
| Adjustments for  non-cash items:                                             |       |                                          |       |   |   |
| Depreciation and  amortization                                               |       | 15,603                                        |       | 14,177 |   |
| Provision for  doubtful accounts                                             |       | 406                                           |       | 194 |   |
| Deferred income  taxes and investment tax credits                            |       | 4,415                                         |       | 3,248 |   |
| Unrealized gain  on purchased power contracts                                |       | (4,507                                        | )          | (2,474 | ) |
| Stock-based  compensation expense                                            |       | 618                                           |       | 530 |   |
| Net gain on sale  of property                                                |       | —                                        |       | (605 | ) |
| Other – net                                                             |       | 279                                           |       | 520 |   |
| Changes in  assets and liabilities:                                          |       |                                          |       |   |   |
| Accounts  receivable – customers                                        |       | (1,854                                        | )          | (982 | ) |
| Unbilled revenue                                                             |       | (5,646                                        | )          | (4,622 | ) |
| Other accounts  receivable                                                   |       | 354                                           |       | (350 | ) |
| Receivable from  the U.S. government                                         |       | 2,526                                         |       | 1,505 |   |
| Materials and  supplies                                                      |       | (107                                          | )          | (84 | ) |
| Prepayments and  other current assets                                        |       | 723                                           |       | 159 |   |
| Regulatory assets  — supply cost balancing accounts                     |       | (779                                          | )          | (1,910 | ) |
| Costs and  estimated earnings in excess of billings on uncompleted contracts |       | (6,081                                        | )          | (1,370 | ) |
| Other assets                                                                 |       | (1,790                                        | )          | 233 |   |
| Accounts payable                                                             |       | 5,102                                         |       | 1,036 |   |
| Income taxes  receivable/payable                                             |       | (1,876                                        | )          | 3,150 |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | 2,899                                         |       | 173 |   |
| Accrued pension  and other postretirement benefits                           |       | 2,629                                         |       | 2,306 |   |
| Other  liabilities                                                           |       | 153                                           |       | 1,207 |   |
| Net cash  provided                                                           |       | 27,654                                        |       | 30,347 |   |
| **Cash  Flows From Investing Activities:**                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Construction  expenditures                                                   |       | (38,822                                       | )          | (19,880 | ) |
| Business  acquisition                                                        |       | (2,298                                        | )          | — |   |
| Proceeds from  sale of property                                              |       | —                                        |       | 623 |   |
| Net cash used                                                                |       | (41,120                                       | )          | (19,257 | ) |
| **Cash  Flows From Financing Activities:**                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Proceeds from issuance  of common shares                                     |       | 424                                           |       | 507 |   |
| Proceeds from  stock option exercises                                        |       | 53                                            |       | 1,127 |   |
| Receipt of  advances for and contributions in aid of construction            |       | 3,776                                         |       | 4,391 |   |
| Refunds on  advances for construction                                        |       | (2,709                                        | )          | (3,418 | ) |
| Repayments of  long-term debt                                                |       | (198                                          | )          | (212 | ) |
| Net change in  notes payable to banks                                        |       | 19,550                                        |       | (3,500 | ) |
| Dividends paid                                                               |       | (8,621                                        | )          | (8,017 | ) |
| Other                                                                        |       | (136                                          | )          | 83 |   |
| Net cash  provided (used)                                                    |       | 12,139                                        |       | (9,039 | ) |
| **Net  (decrease) increase in cash and cash equivalents**                    |       | (1,327                                        | )          | 2,051 |   |
| **Cash and  cash equivalents, beginning of period**                          |       | 1,698                                         |       | 3,223 |   |
| **Cash  and cash equivalents, end of period**                                |       | $                                             | 371        |   | $ | 5,274 |   |

 

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

 

6

----

Tableof Contents

 

**GOLDEN STATE WATER COMPANY****BALANCE SHEETS**

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

 
| **(in thousands)**                                                                                 | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Utility  Plant, at cost**                                                                             | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                                                                                                    |       |                    |       |                        |       |
| Water                                                                                                   |       | $                       | 943,859    |                        | $          | 922,459 |   |
| Electric                                                                                                |       | 65,453                  |       | 65,078                      |       |
|                                                                                                    |       | 1,009,312               |       | 987,537                     |       |
| Less -  Accumulated depreciation                                                                        |       | (313,907                | )          | (298,856                    | )          |
|                                                                                                    |       | 695,405                 |       | 688,681                     |       |
| Construction  work in progress                                                                          |       | 59,610                  |       | 43,552                      |       |
| Net utility  plant                                                                                      |       | 755,015                 |       | 732,233                     |       |
|                                                                                                    |       |                    |       |                        |       |
| **Other  Property and Investments**                                                                     |       | 7,825                   |       | 7,838                       |       |
|                                                                                                    |       |                    |       |                        |       |
| **Current  Assets**                                                                                     | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Cash and cash  equivalents                                                                              |       | 365                     |       | 1,389                       |       |
| Accounts  receivable-customers (less allowance for doubtful accounts of $538 in 2008  and $519 in 2007) |       | 17,177                  |       | 15,741                      |       |
| Unbilled revenue                                                                                        |       | 21,263                  |       | 15,701                      |       |
| Inter-company  receivable                                                                               |       | 713                     |       | 563                         |       |
| Other accounts  receivable (less allowance for doubtful accounts of $275 in 2008 and $442 in  2007)     |       | 3,161                   |       | 3,195                       |       |
| Materials and  supplies, at average cost                                                                |       | 1,597                   |       | 1,562                       |       |
| Regulatory  assets – current                                                                       |       | 7,652                   |       | 5,116                       |       |
| Prepayments and  other current assets                                                                   |       | 1,804                   |       | 2,595                       |       |
| Unrealized gain  on purchased power contracts                                                           |       | 2,953                   |       | —                      |       |
| Deferred income  taxes - current                                                                        |       | 707                     |       | 3,845                       |       |
| Total current  assets                                                                                   |       | 57,392                  |       | 49,707                      |       |
|                                                                                                    |       |                    |       |                        |       |
| **Regulatory  and Other Assets**                                                                        | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Regulatory  assets                                                                                      |       | 80,418                  |       | 82,539                      |       |
| Other accounts  receivable                                                                              |       | 9,963                   |       | 9,723                       |       |
| Other                                                                                                   |       | 9,723                   |       | 7,933                       |       |
| Total regulatory  and other assets                                                                      |       | 100,104                 |       | 100,195                     |       |
|                                                                                                    |       |                    |       |                        |       |
| **Total  Assets**                                                                                       |       | $                       | 920,336    |                        | $          | 889,973 |   |

 

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

 

7

----

Table ofContents

 

**GOLDEN STATE WATER COMPANYBALANCE SHEETSCAPITALIZATION AND LIABILITIES(Unaudited)**

 
| **(in thousands)**                            | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Capitalization**                                 | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Common shares,  no par value, no stated value      |       | $                       | 163,736    |                        | $          | 163,180 |   |
| Earnings  reinvested in the business               |       | 126,346                 |       | 115,261                     |       |
| Total common  shareholder’s equity            |       | 290,082                 |       | 278,441                     |       |
| Long-term debt                                     |       | 260,829                 |       | 260,941                     |       |
| Total  capitalization                              |       | 550,911                 |       | 539,382                     |       |
|                                               |       |                    |       |                        |       |
| **Current  Liabilities**                           | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Long-term debt -  current                          |       | 223                     |       | 309                         |       |
| Accounts payable                                   |       | 31,076                  |       | 24,402                      |       |
| Inter-company  payable                             |       | 33,389                  |       | 23,764                      |       |
| Income taxes  payable to Parent                    |       | 1,189                   |       | 2,469                       |       |
| Accrued employee  expenses                         |       | 6,522                   |       | 5,677                       |       |
| Accrued interest                                   |       | 2,406                   |       | 2,424                       |       |
| Unrealized loss  on purchased power contracts      |       | —                  |       | 1,554                       |       |
| Regulatory  liabilities - current                  |       | —                  |       | 173                         |       |
| Deferred income  taxes - current                   |       | 436                     |       | —                      |       |
| Other                                              |       | 12,106                  |       | 13,459                      |       |
| Total current  liabilities                         |       | 87,347                  |       | 74,231                      |       |
|                                               |       |                    |       |                        |       |
| **Other  Credits**                                 | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Advances for  construction                         |       | 80,074                  |       | 78,917                      |       |
| Contributions in  aid of construction - net        |       | 88,485                  |       | 87,323                      |       |
| Deferred income  taxes                             |       | 79,605                  |       | 78,805                      |       |
| Unamortized  investment tax credits                |       | 2,291                   |       | 2,336                       |       |
| Accrued pension  and other postretirement benefits |       | 23,480                  |       | 20,851                      |       |
| Other                                              |       | 8,143                   |       | 8,128                       |       |
| Total other  credits                               |       | 282,078                 |       | 276,360                     |       |
|                                               |       |                    |       |                        |       |
| **Commitments  and Contingencies (Note 7)**        |       | —                  |       | —                      |       |
|                                               |       |                    |       |                        |       |
| **Total  Capitalization and Liabilities**          |       | $                       | 920,336    |                        | $          | 889,973 |   |

 

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

 

8

----

Table ofContents

 

**GOLDEN STATE WATER COMPANY****STATEMENTS OF INCOME**

**FOR THE THREE MONTHS****ENDED JUNE 30, 2008 AND 2007****(Unaudited)**

 
| ** **                                            | ** ** | **Three Months Ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------|------------|
| **(in thousands)**                               | ** ** | **2008**                                        | ** ** | **2007** | ** ** |
| **Operating  Revenues**                               | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Water                                                 |       | $                                               | 63,413     |   | $ | 58,894 |   |
| Electric                                              |       | 6,208                                           |       | 6,255 |   |
| Total operating  revenues                             |       | 69,621                                          |       | 65,149 |   |
|                                                  |       |                                            |       |   |   |
| **Operating  Expenses**                               | ** ** | ** **                                      | ** ** | ** ** | ** ** |
| Water purchased                                       |       | 12,896                                          |       | 11,877 |   |
| Power purchased  for pumping                          |       | 2,497                                           |       | 2,506 |   |
| Groundwater  production assessment                    |       | 2,890                                           |       | 2,549 |   |
| Power purchased  for resale                           |       | 2,595                                           |       | 2,915 |   |
| Unrealized  (gain) loss on purchased power contracts  |       | (1,664                                          | )          | 236 |   |
| Supply cost  balancing accounts                       |       | (672                                            | )          | (1,190 | ) |
| Other operating  expenses                             |       | 5,628                                           |       | 5,631 |   |
| Administrative  and general expenses                  |       | 11,934                                          |       | 11,676 |   |
| Depreciation and  amortization                        |       | 7,252                                           |       | 6,645 |   |
| Maintenance                                           |       | 3,795                                           |       | 4,037 |   |
| Property and  other taxes                             |       | 2,648                                           |       | 2,733 |   |
| Net gain on sale  of property                         |       | —                                          |       | (238 | ) |
| Total operating  expenses                             |       | 49,799                                          |       | 49,377 |   |
|                                                  |       |                                            |       |   |   |
| **Operating  Income**                                 |       | 19,822                                          |       | 15,772 |   |
|                                                  |       |                                            |       |   |   |
| **Other  Income and Expenses**                        |       |                                            |       |   |   |
| Interest expense                                      |       | (4,965                                          | )          | (5,182 | ) |
| Interest income                                       |       | 729                                             |       | 528 |   |
| Other                                                 |       | 5                                               |       | 47 |   |
|                                                  |       | (4,231                                          | )          | (4,607 | ) |
|                                                  |       |                                            |       |   |   |
| **Income  from operations before income tax expense** |       | 15,591                                          |       | 11,165 |   |
|                                                  |       |                                            |       |   |   |
| Income tax  expense                                   |       | 5,985                                           |       | 4,695 |   |
|                                                  |       |                                            |       |   |   |
| **Net  Income**                                       |       | $                                               | 9,606      |   | $ | 6,470 |   |

 

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

 

9

----

Table ofContents

 

**GOLDEN STATE WATER COMPANY****STATEMENTS OF INCOME**

**FOR THE SIX MONTHS****ENDED JUNE 30, 2008 AND 2007****(Unaudited)**

 
| ** **                                            | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------|------------|
| **(in thousands)**                               | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| **Operating  Revenues**                               | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Water                                                 |       | $                                             | 113,919    |   | $ | 107,582 |   |
| Electric                                              |       | 15,011                                        |       | 15,124 |   |
| Total operating  revenues                             |       | 128,930                                       |       | 122,706 |   |
|                                                  |       |                                          |       |   |   |
| **Operating  Expenses**                               | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Water purchased                                       |       | 20,683                                        |       | 20,586 |   |
| Power purchased  for pumping                          |       | 4,072                                         |       | 4,522 |   |
| Groundwater  production assessment                    |       | 5,265                                         |       | 4,828 |   |
| Power purchased  for resale                           |       | 6,834                                         |       | 7,196 |   |
| Unrealized gain  on purchased power contracts         |       | (4,507                                        | )          | (2,474 | ) |
| Supply cost  balancing accounts                       |       | (779                                          | )          | (1,910 | ) |
| Other operating  expenses                             |       | 11,744                                        |       | 11,331 |   |
| Administrative  and general expenses                  |       | 23,601                                        |       | 23,171 |   |
| Depreciation and  amortization                        |       | 14,494                                        |       | 13,289 |   |
| Maintenance                                           |       | 7,119                                         |       | 6,807 |   |
| Property and  other taxes                             |       | 5,409                                         |       | 5,562 |   |
| Net gain on sale  of property                         |       | —                                        |       | (605 | ) |
| Total operating  expenses                             |       | 93,935                                        |       | 92,303 |   |
|                                                  |       |                                          |       |   |   |
| **Operating  Income**                                 |       | 34,995                                        |       | 30,403 |   |
|                                                  |       |                                          |       |   |   |
| **Other  Income and Expenses**                        |       |                                          |       |   |   |
| Interest expense                                      |       | (10,017                                       | )          | (10,201 | ) |
| Interest income                                       |       | 1,086                                         |       | 1,061 |   |
| Other                                                 |       | 91                                            |       | 99 |   |
|                                                  |       | (8,840                                        | )          | (9,041 | ) |
|                                                  |       |                                          |       |   |   |
| **Income  from operations before income tax expense** |       | 26,155                                        |       | 21,362 |   |
|                                                  |       |                                          |       |   |   |
| Income tax expense                                    |       | 10,631                                        |       | 8,990 |   |
|                                                  |       |                                          |       |   |   |
| **Net  Income**                                       |       | $                                             | 15,524     |   | $ | 12,372 |   |

 

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

 

10

----

Table ofContents

 

**GOLDEN STATE WATER COMPANY****STATEMENTS OF CASH FLOW**

**FOR THE SIX MONTHS ENDED JUNE 30, 2008 AND 2007****(Unaudited)**

 
| ** **                                                        | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| **(in thousands)**                                           | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| **Cash  Flows From Operating Activities:**                        | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net income                                                        |       | $                                             | 15,524     |   | $ | 12,372 |   |
| Adjustments for  non-cash items:                                  |       |                                          |       |   |   |
| Depreciation and  amortization                                    |       | 14,494                                        |       | 13,289 |   |
| Provision for  doubtful accounts                                  |       | 367                                           |       | 154 |   |
| Deferred income  taxes and investment tax credits                 |       | 4,395                                         |       | 3,309 |   |
| Unrealized gain  on purchased power contracts                     |       | (4,507                                        | )          | (2,474 | ) |
| Stock-based  compensation expense                                 |       | 515                                           |       | 492 |   |
| Net gain on sale  of property                                     |       | —                                        |       | (605 | ) |
| Other — net                                                  |       | 175                                           |       | 467 |   |
| Changes in  assets and liabilities:                               |       |                                          |       |   |   |
| Accounts  receivable - customers                                  |       | (1,809                                        | )          | (911 | ) |
| Unbilled revenue                                                  |       | (5,562                                        | )          | (4,524 | ) |
| Other accounts  receivable                                        |       | (200                                          | )          | (685 | ) |
| Materials and  supplies                                           |       | (35                                           | )          | (84 | ) |
| Prepayments and  other current assets                             |       | 791                                           |       | 164 |   |
| Regulatory  assets - supply cost balancing accounts               |       | (779                                          | )          | (1,910 | ) |
| Other assets                                                      |       | (1,642                                        | )          | 184 |   |
| Accounts payable                                                  |       | 6,093                                         |       | 1,406 |   |
| Inter-company  receivable/payable                                 |       | 115                                           |       | 266 |   |
| Income taxes  payable from Parent                                 |       | (1,280                                        | )          | 2,036 |   |
| Accrued pension  and other postretirement benefits                |       | 2,629                                         |       | 2,306 |   |
| Other  liabilities                                                |       | 90                                            |       | 1,242 |   |
| Net cash provided                                                 |       | 29,374                                        |       | 26,494 |   |
|                                                              |       |                                          |       |   |   |
| **Cash  Flows From Investing Activities:**                        | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Construction  expenditures                                        |       | (36,004                                       | )          | (18,697 | ) |
| Proceeds from  sale of property                                   |       | —                                        |       | 623 |   |
| Net cash used                                                     |       | (36,004                                       | )          | (18,074 | ) |
|                                                              |       |                                          |       |   |   |
| **Cash  Flows From Financing Activities:**                        | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Receipt of  advances for and contributions in aid of construction |       | 3,585                                         |       | 4,124 |   |
| Refunds on  advances for construction                             |       | (2,614                                        | )          | (3,418 | ) |
| Repayments of  long-term debt                                     |       | (198                                          | )          | (212 | ) |
| Net change in  inter-company borrowings                           |       | 9,360                                         |       | 1,000 |   |
| Dividends paid                                                    |       | (4,400                                        | )          | (8,600 | ) |
| Other                                                             |       | (127                                          | )          | 86 |   |
| Net cash  provided (used)                                         |       | 5,606                                         |       | (7,020 | ) |
|                                                              |       |                                          |       |   |   |
| **Net  (decrease) increase in cash and cash equivalents**         |       | (1,024                                        | )          | 1,400 |   |
| **Cash  and cash equivalents, beginning of period**               |       | 1,389                                         |       | 1,735 |   |
| **Cash  and cash equivalents, end of period**                     |       | $                                             | 365        |   | $ | 3,135 |   |

 

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

 

11

----

Table of Contents

 

**AMERICAN STATES WATER COMPANY****AND****GOLDEN STATE WATER COMPANY****NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****(Unaudited)**

 

**Note 1 — Summary of SignificantAccounting Policies:**

 

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 254,000 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

Table of Contents

 

GSWC’s RelatedParty Transactions:GSWC and other subsidiaries provide and receive various services to and fromtheir parent, AWR, and among themselves. In addition, AWR has an $85 millionsyndicated credit facility. AWR borrows under this facility and provides fundsto its subsidiaries, including GSWC, in support of their operations. Amountsowed to AWR for borrowings under this facility represent the majority of GSWC’sinter-company payables on GSWC’s balance sheets as of June 30, 2008 and December 31,2007. The interest rate charged to GSWC is sufficient to cover AWR’s interestcost under the credit facility. GSWC also allocates certain corporate officeadministrative and general costs to its affiliates using allocation factorsagreed upon by the CPUC.

 

Sales and UseTaxes:  GSWC bills certain sales and use taxes leviedby state or local governments to its customers. Included in these sales and usetaxes are franchise fees, which GSWC pays to various municipalities (based onordinances adopted by these municipalities) in order to use public right of wayfor utility purposes. GSWC bills these franchise fees to its customers based ona CPUC-authorized rate. These franchise fees, which are required to be paidregardless of GSWC’s ability to collect from the customer, are accounted for ona gross basis. GSWC’s franchise fees billed to customers and recorded asoperating revenue were approximately $635,000 and $619,000 for the three monthsended June 30, 2008 and 2007, respectively, and $1,333,000 and $1,352,000for the six months ended June 30, 2008 and 2007, respectively. When GSWCacts as an agent, and the tax is not required to be remitted if it is notcollected from the customer, the taxes are accounted for on a net basis.

 

New AccountingPronouncements:   In September 2006, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“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 andliabilities until January 1, 2009. These nonfinancial items include assets and liabilities that arerecognized and disclosed at fair value in the financial statements on anonrecurring basis, such as Registrant’s reporting units measured at fair valuein a goodwill impairment 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, howeverit does require additional disclosures.  See Note 4 for information and relateddisclosures regarding the fair value measurements on Registrant’sderivatives.  The carrying value of otherfinancial assets and liabilities, including cash, accounts receivable, accountspayable and short-term debt, approximate fair value due to their shortmaturities or variable-rate nature of the respective borrowings.  Long-term debt is not carried at fair valuebut 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 compute the funded status recognized inRegistrant’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 benefit as an increasein additional paid-in capital beginning January 1, 2008. The impact ofthis change was not material to Registrant’s consolidated financial statements.

 

13

----

Table of Contents

 

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 Registrant to develop expected option terms by reviewingdetailed external information about employee exercise behavior.  The simplified method is no longer permittedif such information is available.  As aresult of the new guidance, Registrant’s expected term used for options grantedin 2008 was 5 years as compared to 6 years which was derived under thesimplified method used for grants in prior years.

 

In December 2007,the FASB issued SFAS No. 141(R) (revised 2007), “*Business Combinations”*. SFAS No. 141(R) whichestablishes principles and requirements for how the acquirer of a businessrecognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and any noncontrolling interest in theacquiree. SFAS No. 141(R) also provides guidance for recognizingand measuring the goodwill acquired in the business combination and determineswhat information to disclose to enable users of the financial statement toevaluate the nature and financial effects of the business combination.SFAS No. 141(R) is effective for financial statements issued forfiscal years beginning after December 15, 2008. Accordingly, any businesscombinations Registrant engages in will be recorded and disclosed followingexisting 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-profitorganizations.  SFAS No. 160 amendsARB 51 to establish accounting and reporting standards for the noncontrollinginterest in a subsidiary and for the deconsolidation of a subsidiary. It alsoamends certain of ARB 51’s consolidation procedures for consistency with therequirements of SFAS No. 141(R). SFAS No. 160 is effective forfinancial statements issued for fiscal years beginning after December 15,2008.  Registrant is evaluating thepotential impact of SFAS No. 160; however, this standard is not expectedto have any material impact on Registrant’s future consolidated financialstatements and disclosures.

 

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 withaccounting principles for rate-regulated enterprises, Registrant recordsregulatory assets, which represent probable future revenue associated withcertain costs that will be recovered from customers through the ratemakingprocess, and regulatory liabilities, which represent probable future reductionsin revenue associated with amounts that are to be credited to customers throughthe ratemaking process. At June 30, 2008, Registrant had approximately$13.1 million of regulatory assets not accruing carrying costs. Of this amount,$5.2 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 $6.2million “non-yielding” regulatory asset related to general rate case memorandumaccounts to be recovered over 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)**                             | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| **GSWC**                                            |       |                        |       |                            |       |
| Electric supply  cost balancing account             |       | $                           | 16,570     |                            | $          | 18,318 |   |
| Water supply  cost balancing accounts               |       | 11,128                      |       | 8,525                           |       |
| Costs deferred  for future recovery on Aerojet case |       | 21,009                      |       | 21,244                          |       |
| Pensions and  other postretirement obligations      |       | 10,842                      |       | 11,443                          |       |
| Flow-through  taxes, net                            |       | 5,154                       |       | 5,220                           |       |
| Electric  transmission line abandonment costs       |       | 3,081                       |       | 3,157                           |       |
| Asset retirement  obligations                       |       | 3,722                       |       | 3,547                           |       |
| Low income rate  assistance balancing accounts      |       | 4,792                       |       | 4,147                           |       |
| General rate case  memorandum accounts              |       | 6,212                       |       | 7,162                           |       |
| Santa Maria  adjudication memorandum accounts       |       | 4,075                       |       | 4,005                           |       |
| Refund of water  right lease revenues               |       | (2,691                      | )          | (2,945                          | )          |
| Other regulatory  assets, net                       |       | 4,176                       |       | 3,659                           |       |
| Total GSWC                                          |       | $                           | 88,070     |                            | $          | 87,482 |   |
| **CCWC**                                            |       |                        |       |                            |       |
| Asset retirement  obligations                       |       | $                           | 53         |                            | $          | 52 |   |
| Other regulatory  liabilities, net                  |       | (513                        | )          | (538                            | )          |
| Total AWR                                           |       | $                           | 87,610     |                            | $          | 86,996 |   |

 

Regulatorymatters are discussed in detail in the consolidated financial statements andthe notes thereto included in the Form 10-K for the year ended December 31,2007 filed with the SEC.  The discussionbelow focuses on significant matters and changes since December 31, 2007.

 

***Supply Cost Balancing Accounts******:***

 

***Electric Supply Cost Balancing Account***—Electric power costs incurred by GSWC’sBear Valley Electric Service (“BVES”) division continue to be charged to itselectric supply cost balancing account. The under-collection in the electricsupply cost balancing account is $16.6 million at June 30, 2008.  Of this amount, approximately $4.4 millionrelates to the under-collection remaining as of June 30, 2008 that wasincurred during the energy crisis in late 2000 and 2001, discussed below.  The remaining $12.2 million in the electricsupply cost balancing account relates to $3.2 million from the tariff chargedto GSWC by Southern California Edison (“Edison”) for the abandonment of atransmission line upgrade discussed below, and $9.0 million for changes inpurchased energy and power system delivery costs including interest, also discussedbelow.

 

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 incurred duringthe energy crisis in late 2000 and 2001. GSWC sold 29,717,109 and 30,724,243kilowatt hours of electricity to its BVES’ customers for the three months endedJune 30, 2008 and 2007, respectively, and sold 73,414,752 and 73,408,022kilowatt hours of electricity to its customers for the six months ended June 30,2008 and 2007, respectively. As a result of the surcharge, the supply costbalancing account was reduced by approximately $667,000 and $663,000 for thethree months ended June 30, 2008 and 2007, respectively, and $1,641,000and $1,581,000 for the six months ended June 30, 2008 and 2007,respectively.  Approximately $18.7  million of the $23.1 million under-collectionincurred during the energy crisis in late 2000 and 2001 has been 

 

15

----

Table of Contents

 

recovered through thissurcharge. GSWC anticipates the surcharge, based on 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 CPUCdecision. The BVES division of GSWC is allowed to include up to a weightedaverage annual purchased energy cost of $77 per megawatt-hour (“MWh”) through August 2011in its electric supply cost balancing account. To the extent that the actualweighted average annual cost for power purchased exceeds the $77 per MWhamount, GSWC will not be able to include these amounts in its balancing accountand such amounts will be expensed unless a subsequent order is issued by theCPUC.  GSWC intends to seek such an orderin connection with BVES’ general rate case proceedings.  During the three and six months ended June 30,2008 there were no amounts expensed over the $77 per MWh cap. During the threeand six months ended June 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’s 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 June 30, 2008 for subsequent recovery from customers,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 loss during transmission, alsoaffect the balance of the electric supply cost balancing account.

 

In summary, for the threemonths ended June 30, 2008 and 2007, the under-collection decreased byapproximately $730,000 and $406,000, respectively, and $1,748,000 and$1,189,000 for the six months ended June 30, 2008 and 2007, respectively.

 

***Water Supply Cost Balancing Accounts—***As permitted by the CPUC, Registrantmaintains water supply cost balancing accounts for GSWC to account forunder-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.  Typically, under-collections orover-collections, when they occur, are tracked in the supply cost balancingaccounts for future recovery or refund through a surcharge (in the event of anunder-collection) or through a surcredit (in the event of an over-collection)on customers’ bills.  Registrant accruesinterest on its supply cost balancing accounts at the rate prevailing for90-day commercial paper.  Registrant doesnot maintain a supply cost balancing account for CCWC.

 

For the three monthsended June 30, 2008 and 2007, approximately $1.4 million and $1.6 millionof under-collections, respectively, were recorded in the water supply costbalancing accounts.  For the six monthsended June 30, 2008 and 2007, approximately $2.6 million and $3.1 millionof under-collections, respectively, were recorded in the water supply costbalancing accounts. 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 months ended June 30, 2008 and 2007, approximately$49,000 of over-collection and $250,000 of under-collection amortizationaffected the water supply cost balancing accounts, respectively.  During the six months ended June 30,2008 and 2007, approximately $247,000 and $570,000 of under-collectionamortization decreased the water supply cost balancing accounts, respectively.

 

As of June 30, 2008,there is approximately $11.1 million net under-collection in the water supplycost balancing accounts.  Of this amount,approximately $8.1 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 $1.1 million for Region III will beincluded in future filings for recovery. Further, the remaining $3.0 million net under-collections in the watersupply cost balancing accounts relate to GSWC’s Region I 

 

16

----

Table of Contents

 

net under-collection of$2.0 million and Region II’s net under-collection of $970,000.  Currently, there is a surcharge in place inRegion I expiring in January 2009 to recover this under-collection, and asurcredit at Region II to refund a previous over-collection expiring in August 2008.

 

***CostsDeferred for Future Recovery******:***

 

In 1999, GSWC suedAerojet-General Corporation (“Aerojet”) for contaminating the Sacramento CountyGroundwater Basin, which affected certain GSWC wells. On a related matter, GSWCalso filed a lawsuit against the State of California (the “State”). The CPUCauthorized memorandum accounts to allow for recovery, from customers, of costsincurred by GSWC in prosecuting the cases against Aerojet and the State, lessany recovery from the defendants or others. On July 21, 2005, the CPUC authorized GSWC to collect approximately$21.3 million of the Aerojet litigation memorandum account, through a ratesurcharge, which will continue for no longer than 20 years. Beginning in October 2005,new rates went into effect to begin amortizing the memorandum account over a20-year period.  A rate surchargegenerating approximately $277,000 and $285,000 was billed to customers duringthe three months ended June 30, 2008 and 2007, respectively, and $490,000and $505,000 during the six months ended June 30, 2008 and 2007,respectively.  GSWC will keep the Aerojetmemorandum account open until the earlier of full amortization of the balanceor 20 years. However, no costs will be added to the memorandum account, otherthan on-going interest charges approved by the CPUC decision. Pursuant to thedecision, additional interest of approximately $109,000 and $278,000 was addedto the Aerojet litigation memorandum account during the three months ended June 30,2008 and 2007, respectively, and $256,000 and $554,000 during the six monthsended June 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 $6.9 million as of June 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.

 

GSWC was also authorizedto amortize, with interest, the remaining $2.8 million of the$5.5 million in rates over a ten-year period, plus interest. This amounthas been transferred into a separate memorandum account included withinregulatory assets and a surcharge has been implemented in the third quarter of2007 for recovery of these costs. A rate surcharge generating approximately$84,000 and $133,000 was billed to customers during the three and six monthsended June 30, 2008, respectively. All litigation costs, including interest, that have been incurred since December 31,2005, totaling approximately $1.4 million, have also been transferred fromrate base to a separate new memorandum account, subject to a reasonablenessreview by 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.

 

17

----

Table of Contents

 

***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 is currentlyresponding 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 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 final decision deferred BVES’ interim targetpurchase levels for the years 2004 through 2007, management believes that theCPUC’s decision effectively forecloses any exposure to financial penalties forthe year 2007 and earlier.

 

**Note 3 — Earnings perShare/Capital Stock:**

 

Registrant computesearnings 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 June 30,** | ** ** | **For The Six Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------------------|---------------------------------------------------------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** **                                                    | **2008**                                                          | ** ** | **2007**                                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                                            |                                                          | $                                                                 | 9,283      |                                                            | $          | 7,322 |   | $ | 14,587 |   | $ | 14,306 |   |
| Less: (a)                                                             | Distributed  earnings to common shareholders                  |                                                              | 4,312      |                                                            | 4,017      |   | 8,622 |   | 8,021 |   |
|                                                                  | Distributed  earnings to participating securities             |                                                              | 23         |                                                            | 64         |   | 43 |   | 128 |   |
| Undistributed  earnings                                               |                                                          | 4,948                                                             |       | 3,241                                                           |       | 5,922 |   | 6,157 |   |
|                                                                  |                                                          |                                                              |       |                                                            |       |   |   |   |   |
| (b)                                                                   | Undistributed  earnings allocated to common shareholders      |                                                              | 4,922      |                                                            | 3,190      |   | 5,893 |   | 6,061 |   |
|                                                                  | Undistributed  earnings allocated to participating securities |                                                              | 26         |                                                            | 51         |   | 29 |   | 96 |   |
|                                                                  |                                                          |                                                              |       |                                                            |       |   |   |   |   |
| Total income  available to common shareholders, basic (a)+(b)         |                                                          | $                                                                 | 9,234      |                                                            | $          | 7,207 |   | $ | 14,515 |   | $ | 14,082 |   |
|                                                                  |                                                          |                                                              |       |                                                            |       |   |   |   |   |
| Weighted average  Common Shares outstanding, basic                    |                                                          | 17,248                                                            |       | 17,094                                                          |       | 17,243 |   | 17,066 |   |
| **Basic  earnings per Common Share**                                  |                                                          | $                                                                 | 0.54       |                                                            | $          | 0.42 |   | $ | 0.84 |   | $ | 0.83 |   |
|                                                                       |                                                               |                                                                   |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |

 

Diluted EPS is based uponthe weighted average number of common shares, including both outstanding sharesand shares potentially issuable in connection with stock options and restrictedstock units granted under 

 

18

----

Table of Contents

 

Registrant’s 2000 StockIncentive Plan, 2008 Stock Incentive Plan and 2003 Non-Employee Directors StockPlan, and net income. At June 30, 2008 and 2007 there were 569,155 and580,215 options outstanding, respectively, under these Plans. At June 30,2008 and 2007, there were also approximately 76,373 and 61,081 restricted stockunits outstanding, respectively.

 

The following is areconciliation of Registrant’s net income and weighted average common sharesoutstanding for calculating diluted net income per share:

 
| **Diluted**                                                           | ** ** | **For The Three Months  Ended June 30,** | ** ** | **For The Six Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2008**                                                          | ** ** | **2007**                                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Common  shareholders earnings, basic                                  |       | $                                                                 | 9,234      |                                                            | $          | 7,207 |   | $ | 14,515 |   | $ | 14,082 |   |
| Undistributed  earnings for dilutive stock options (1)                |       | —                                                            |       | —                                                          |       | 29 |   | — |   |
| Total common  shareholders earnings, diluted                          |       | $                                                                 | 9,234      |                                                            | $          | 7,207 |   | $ | 14,544 |   | $ | 14,082 |   |
|                                                                  |       |                                                              |       |                                                            |       |   |   |   |   |
| Weighted average  common shares outstanding, basic                    |       | 17,248                                                            |       | 17,094                                                          |       | 17,243 |   | 17,066 |   |
| Stock-based  compensation (2)                                         |       | 77                                                                |       | 52                                                              |       | 119 |   | 55 |   |
| Weighted average  common shares outstanding, diluted                  |       | 17,325                                                            |       | 17,146                                                          |       | 17,362 |   | 17,121 |   |
| **Diluted  earnings per Common Share**                                |       | $                                                                 | 0.53       |                                                            | $          | 0.42 |   | $ | 0.84 |   | $ | 0.82 |   |

 

----

(1)          Undistributed earnings allocated to participatingsecurities were not included as of June 30, 2007 due to their antidilutiveeffect on diluted earnings per share.

 

(2)          In applying the treasury stock method of reflectingthe dilutive effect of outstanding stock-based compensation in the calculationof diluted EPS, 356,923 and 276,574 stock options at June 30, 2008 and2007, respectively, were deemed to be outstanding in accordance with SFAS No. 128,*“Earnings Per Share”*.  All of the 76,373 restricted stock units at June 30,2008 were included in the calculation of diluted EPS for the three and sixmonths ended June 30, 2008.

 

Stock options of 194,232and 87,041 were outstanding at June 30, 2008 and 2007, respectively, butnot included in the computation of diluted EPS because the related optionexercise price was greater than the average market price of AWR’s common sharesfor the six months ended June 30, 2008 and 2007.  Stock options of 18,000 and 216,600 wereoutstanding at June 30, 2008 and 2007, respectively, but not included inthe computation of diluted EPS because they were antidilutive. Also notincluded in the calculation of EPS were 61,081 restricted stock units at June 30,2007 because they were antidilutive.

 

Registrant has aShareholder Rights Plan designed to protect the Company’s shareholders in theevent of an unsolicited unfair offer to acquire the Company. The rights forJunior Participating Preferred Shares (the “Rights”) are exercisable basedsolely on “a non-market-based contingency”, and are not contingent upon themarket price of AWR’s stock. Therefore, the shares that would be issued if theRights are exercised are not included in the calculation of diluted earningsper share.

 

During the six monthsended June 30, 2008 and 2007, Registrant issued 19,896 and 13,494 commonshares, for approximately $424,000 and $507,000, respectively, under theRegistrant’s Common Share Purchase and Dividend Reinvestment Plan, and the 401(k) Plan.  In addition, during the six months ended June 30,2008 and 2007, Registrant issued 2,002 and 46,787 common shares forapproximately $53,000 and $1,127,000, respectively, as a result of the exerciseof 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.

 

Registrant purchased10,477 and 3,271 common shares on the open market during the three months endedJune 30, 2008 and 2007, respectively, under the Registrant’s CommonShare 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 six months ended June 30,2008 and 2007, Registrant purchased 24,837 and 3,553, respectively, commonshares on the open market under these plans for the same purpose.

 

During the three monthsended June 30, 2008 and 2007, AWR paid quarterly dividends to shareholdersof approximately $4.3 million, or $0.250 per share, and $4.0 million, or $0.235per share, respectively.  During the sixmonths ended June 30, 2008 and 2007, AWR paid quarterly dividends toshareholders of approximately $8.6 million, or $0.500 per share, and $8.0million, or $0.470 per share, respectively.

 

19

----

Table of Contents

 

**Note 4 — Derivative Instruments:**

 

Registrant has certain block-forward purchasepower contracts that are subject to SFAS No. 133, *“Accountingfor Derivative Instruments and Hedging Activities”*, as amended bySFAS Nos. 138 and 149. A derivative financial instrument or other contractderives its value from another investment or designated benchmark. SFAS No. 133requires companies to record derivatives on the balance sheet as assets andliabilities, and to measure those instruments at their fair value. During 2002,GSWC became a party to block-forward purchase power contracts that qualified asderivative instruments under SFAS No. 133. Contracts with Pinnacle WestCapital Corporation (“PWCC”) which became effective in November 2002 havenot been designated as normal purchases and normal sales.  In June 2007, PWCC sold the contractsbetween PWCC and GSWC to Morgan Stanley Capital Group, Inc. (“MSCG”)effective November 1, 2007.   Settlement of these contractsoccurred on a cash or net basis through 2006 and occurs by physical deliverythereafter through the expiration of the contracts on December 31, 2008. Registranthas no other derivative financial instruments.

 

As a result of the contracts with MSCG, on amonthly basis, the related asset or liability is adjusted to reflect the fairmarket value at the end of the month. Registrant adopted SFAS No. 157 effective January 1, 2008 forfinancial assets and liabilities measured on a recurring basis.  SFAS No. 157 applies to all financialassets and financial liabilities that are being measured and reported on a fairvalue basis. There was no impact in the adoption of SFAS No. 157 to theconsolidated financial statements. However, SFAS No. 157 requiresdisclosure that establishes a framework for measuring fair value and expandsdisclosure about fair value measurements. The statement requires fair valuemeasurements to be classified and disclosed in one of the following threecategories:

 

*Level 1*: Unadjusted quoted prices in activemarkets that are accessible at the measurement date for identical, unrestrictedassets or liabilities;

 

*Level 2*: Quoted prices in markets that are notactive, or inputs which are observable, either directly or indirectly, forsubstantially the full term of the asset or liability, or

 

*Level 3*: Prices or valuation techniques thatrequire inputs that are both significant to the fair value measurement andunobservable (i.e., supported by little or no market activity).

 

Registrant’s valuation model utilizes various inputsthat include quoted market prices for energy over the duration of thecontracts. The market prices used to determine the fair value for thisderivative instrument were estimated based on independent sources such asbroker quotes and publications that are not observable in or corroborated bythe market. When such inputs have a significant impact on the measurement offair value, the instrument is categorized in Level 3.  Accordingly, the valuation of the derivativeon Registrant’s purchased power contract with MSCG has been classified as Level3.

 

The following table presents changes in the fairvalue of the derivative for the three months ended June 30, 2008.

 
| **(dollars in thousands)**                                         | ** ** | **Gains (Losses)** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|
| Balance,  March 31, 2008                                                |       | $                       | 1,289      |   |
| Unrealized gain on  purchased power contracts included in operating expenses |       | 1,664                   |       |
| Balance,  June 30, 2008                                                 |       | $                       | 2,953      |   |

 

The following table presents changes in the fairvalue of the derivative for the six months ended June 30, 2008.

 
| **(dollars in thousands)**                                         | ** ** | **Gains (Losses)** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|
| Balance,  December 31, 2007                                             |       | $                       | (1,554     | ) |
| Unrealized gain  on purchased power contracts included in operating expenses |       | 4,507                   |       |
| Balance,  June 30, 2008                                                 |       | $                       | 2,953      |   |

 

As these contracts are settled, the realizedgains or losses are recorded in power purchased for resale, and the previouslyrecorded unrealized gains or losses are reversed. The fair market value of $3.0million recognized on the balance sheet in current assets as of June 30,2008 is expected to be recognized as a reduction to income by the end of thecontracts which expire on December 31, 2008.

 

20

----

Table of Contents

 

**Note 5 — Income Taxes:**

 

As a regulatedutility, GSWC treats certain temporary differences as flow-throughadjustments in computing its income tax provision consistent with theincome tax approach approved by the CPUC for ratemaking purposes.Flow-through adjustments increase or decrease tax expense in oneperiod, with an offsetting increase or decrease occurring in anotherperiod. 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 resultedin Registrant recognizing certain tax benefits in accordance with FIN 48. Consequently, Registrant’s total unrecognized tax benefit decreased by$1,265,000 from $5,113,000 at December 31, 2007 and March 31, 2008 to$3,848,000 at June 30, 2008.  Theamount of the unrecognized tax benefits that, if recognized, would affect theeffective tax rate decreased by $118,000 from $118,000 at December 31,2007 and March 31, 2008 to no amount at June 30, 2008. Associated with these changes, Registrant recognized $480,000 of interestincome, with a corresponding increase in interest receivable included innoncurrent assets. Upon receiving the RAR, Registrant filed a protest with theIRS’s office of Appeals in which it requested a conference to addressRegistrant’s disagreement with certain of the Agent’s adjustments.

 

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

 

**Note 6 — Employee Benefit Plans:**

 

The components of netperiodic benefit costs, before allocation to the overhead pool, for Registrant’spension plan, postretirement plan, and Supplemental Executive Retirement Plan (“SERP”)for the three and six months ended June 30, 2008 and 2007 are as follows:

 
| ** **                                    | ** ** | **For The Three Months Ended June 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 Six Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Other** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | ** **                                                          | ** ** | ** ** | ** ** | **Postretirement** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Pension Benefits**                                           | ** ** | **Benefits** | ** ** | **SERP** | ** ** |
| **(dollars in thousands)**          | ** ** | **2008**                                                            | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Components of Net Periodic Benefits Cost:** | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service  cost                                 |       | $                                                                   | 1,792      |   | $ | 1,880 |   | $ | 172 |   | $ | 210 |   | $ | 120 |   | $ | 212 |   |
| Interest  cost                                |       | 2,700                                                               |       | 2,486 |   | 322 |   | 336 |   | 126 |   | 82 |   |
| Expected  return on plan assets               |       | (2,470                                                              | )          | (2,266 | ) | (126 | ) | (114 | ) | — |   | — |   |
| Amortization  of transition                   |       | —                                                              |       | — |   | 210 |   | 210 |   | — |   | — |   |
| Amortization  of prior service cost           |       | 60                                                                  |       | 82 |   | (100 | ) | (100 | ) | 460 |   | 80 |   |
| Amortization  of actuarial (gain) loss        |       | —                                                              |       | 308 |   | — |   | 50 |   | (28 | ) | (12 | ) |
| Net  periodic pension cost                    |       | $                                                                   | 2,082      |   | $ | 2,490 |   | $ | 478 |   | $ | 592 |   | $ | 678 |   | $ | 362 |   |

 

Registrant expects to contribute approximately $4,166,000and $659,000 to pension and postretirement medical plans in 2008,respectively.  No contributions were madeduring the three and six months ended June 30, 2008.

 

21

----

Table of Contents

 

**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 ownership of wells contaminated withhazardous chemicals are themselves PRPs under the Comprehensive 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 eminent domain,also known as condemnation, where doing so is necessary and in the publicinterest. 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 aconsultant to perform an appraisal of the value of GSWC’s water system servingthe 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 June 30, 2008, management believes that the fair marketvalue of the Claremont water system exceeds the $37.8 million recorded net bookvalue and also exceeds the consultant’s estimates of its value. The ClaremontCity Council held a project priorities workshop in April 2007. The councilmembers agreed that the acquisition of GSWC’s water system was to remain apriority and authorized staff to obtain updated appraisals for the value of thewater systems. Requests for proposals have been sent to consulting firms by theCity.  In recent meetings held in February andJune  of 2008, the Claremont City Council stated that they had decided toauthorize additional studies of the acquisition of GSWC’s water system andplans to move forward on this matter.

 

22

----

Table of Contents

 

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 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 and torecapture 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 toperform a Supplemental Environmental Program (“SEP”). A SEP typically involvescapital expenditures resulting in a change of process, equipment, material, orindirect source reduction for the purposes of eliminating or reducing aircontaminant emissions. The SEP prepared by GSWC involves installation andoperation of 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 the SEP and assessed a nominal penalty of $25,000. During 2007,GSWC paid the penalty of $25,000 and agreed to perform its obligations underthe SEP. It is estimated that the total capital cost of the SEP will beapproximately $1.8 million with a required estimated completion date of April 30,2009. Upon timely performance of all its obligations under the SEP, GSWC willbe released from any and all claims or penalties arising from the NOV.Management believes that GSWC will be able to timely fulfill its obligationsunder the SEP and no further penalties are expected to be assessed. Managementalso believes it is probable that the capital costs of the SEP will be approvedin rate base by the CPUC. GSWC began execution of the SEP and has spentapproximately $244,000 as of June 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. As a requirement of the SEP, GSWC installed a temporary GAC treatmentsystem.  The temporary treatment systemwas put in service in March 2008. The return to service of the Watson Well will improve local groundwatersupply reliability.  GSWC also completedthe design of a permanent GAC treatment system.

 

23

----

Table of Contents

 

***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 from operationof the technology implemented at the subject site has indicated that thetechnology did not work as expected. Other remedial alternatives have beenconsidered and evaluated to mitigate dissolved contaminants in the groundwaterat the site.  In October 2007, aninterim remedial action plan was approved by the LARWQCB and all appropriatepermits have been acquired to begin remediation.  In March 2008, construction began onPhase 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 June 30, 2008, the totalamount spent to clean-up and remediate GSWC’s plant facility is approximately$2.6 million, of which $1.5 million has been paid by the State ofCalifornia 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 six months ended June 30, 2008, GSWC spent approximately$234,000 to clean-up and remediate this site and as of June 30, 2008, GSWChas an accrued liability of $1.0 million 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 June 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 likely the result of past corrosion control practices. Aninitial investigation and characterization will be completed to determine theextent of contamination before any soil extraction is initiated. 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.  On July 1, 2008, FBWS served writtendiscovery on the government (interrogatories and requests for production ofdocuments).  The government has 45 days to respond.  Inaddition, on July 15, 2008, the government filed a motion for partialsummary judgment.  The motion asks the Armed Services Board of ContractAppeals to rule that the liquidated damages assessed against FBWS are notbarred by cases finding that liquidated damages which far exceed actual damagesare a “penalty” and, therefore, are unenforceable.   At this time, management believes that theprobability of loss is remote and; therefore, no provision for loss has beenrecorded.  The U.S. Army has the right tooffset the claimed damages against amounts owed to this subsidiary, but has notexercised this right and has continued to make payments on outstandinginvoices.

 

24

----

Table of Contents

 

***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 theultimate resolution of this matter will have a material adverse effect on GSWC’sfinancial position, results of 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.

 

**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. All activitiesof GSWC are geographically located within California. All activities of CCWCare located in the state of Arizona. Activities of ASUS and its subsidiarieshave been conducted in California, Maryland, New Mexico, North Carolina, SouthCarolina, Texas and Virginia.  Both GSWCand CCWC are rate-regulated utilities. ASUS’ wholly-owned subsidiaries are regulated by the  state in which  the subsidiary conducts water and/orwastewater operations.  Rates are basedupon the terms of the contracts with the U.S. government which have been filedwith the commissions in 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 June 30, 2008** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                                 | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                                | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                        | 63,413     |   | $ | 6,208 |   | $ | 1,957 |   | $ | 8,735 |   | $ | — |   | $ | 80,313 |   |
| Operating  income (loss)               |       | 18,149                                                                                                   |       | 1,673 | (1) | 380 |   | (608 | ) | (13 | ) | 19,581 |   |
| Interest  expense, net                 |       | 3,894                                                                                                    |       | 342 |   | 116 |   | 206 |   | (39 | ) | 4,519 |   |
| Identifiable  assets                   |       | 716,964                                                                                                  |       | 38,051 |   | 43,736 |   | 2,700 |   | — |   | 801,451 |   |
| Depreciation  and amortization expense |       | 6,699                                                                                                    |       | 553 |   | 461 |   | 97 |   | — |   | 7,810 |   |
| Capital  additions                     |       | 19,615                                                                                                   |       | 350 |   | 547 |   | 1,091 |   | — |   | 21,603 |   |
|                                        |            |                                                                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)      Includes $1,664,000 unrealized gain on purchased powercontracts.

 
| ** **                             | ** ** | **As Of And For The Three Months Ended June 30, 2007** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                                 | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                                | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                        | 58,894     |   | $ | 6,255 |   | $ | 1,932 |   | $ | 12,165 |   | $ | — |   | $ | 79,246 |   |
| Operating  income (loss)               |       | 15,812                                                                                                   |       | (40 | )(2) | 169 |   | 1,527 |   | (11 | ) | 17,457 |   |
| Interest  expense, net                 |       | 4,284                                                                                                    |       | 370 |   | 97 |   | 272 |   | (39 | ) | 4,984 |   |
| Identifiable  assets                   |       | 674,361                                                                                                  |       | 39,521 |   | 42,179 |   | 1,064 |   | — |   | 757,125 |   |
| Depreciation  and amortization expense |       | 6,111                                                                                                    |       | 534 |   | 395 |   | 48 |   | — |   | 7,088 |   |
| Capital  additions                     |       | 8,524                                                                                                    |       | 634 |   | 444 |   | 313 |   | — |   | 9,915 |   |
|                                        |            |                                                                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(2)      Includes $236,000 unrealized loss on purchased powercontracts.

 

25

----

Table of Contents

 
| ** **                             | ** ** | **As Of And For The Six Months Ended June 30, 2008** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                               | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                              | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating revenues                     |       | $                                                                                                      | 113,919    |   | $ | 15,011 |   | $ | 3,540 |   | $ | 16,785 |   | $ | — |   | $ | 149,255 |   |
| Operating income  (loss)               |       | 29,911                                                                                                 |       | 5,084 | (3) | 313 |   | (1,149 | ) | (116 | ) | 34,043 |   |
| Interest  expense, net                 |       | 8,073                                                                                                  |       | 858 |   | 234 |   | 435 |   | (64 | ) | 9,536 |   |
| Identifiable  assets                   |       | 716,964                                                                                                |       | 38,051 |   | 43,736 |   | 2,700 |   | — |   | 801,451 |   |
| Depreciation and  amortization expense |       | 13,389                                                                                                 |       | 1,105 |   | 921 |   | 188 |   | — |   | 15,603 |   |
| Capital  additions                     |       | 35,455                                                                                                 |       | 549 |   | 1,418 |   | 1,400 |   | — |   | 38,822 |   |
|                                        |            |                                                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(3)      Includes $4,507,000 unrealized gain on purchased powercontracts.

 
| ** **                             | ** ** | **As Of And For The Six Months Ended June 30, 2007** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                               | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                              | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                      | 107,582    |   | $ | 15,124 |   | $ | 3,571 |   | $ | 25,239 |   | $ | — |   | $ | 151,516 |   |
| Operating income  (loss)               |       | 26,791                                                                                                 |       | 3,612 | (4) | 320 |   | 3,691 |   | (106 | ) | 34,308 |   |
| Interest  expense, net                 |       | 8,422                                                                                                  |       | 718 |   | 215 |   | 557 |   | 2 |   | 9,914 |   |
| Identifiable  assets                   |       | 674,361                                                                                                |       | 39,521 |   | 42,179 |   | 1,064 |   | — |   | 757,125 |   |
| Depreciation and  amortization expense |       | 12,222                                                                                                 |       | 1,067 |   | 792 |   | 96 |   | — |   | 14,177 |   |
| Capital  additions                     |       | 17,502                                                                                                 |       | 1,195 |   | 839 |   | 344 |   | — |   | 19,880 |   |
|                                        |            |                                                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(4)      Includes $2,474,000 unrealized gain on purchased powercontracts.

 

**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 a charge to income of $213,000 during the first quarter of 2008for settlement of the 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 and records totaling approximately$611,000.  The acquisition also resulted in the recording ofapproximately $1.1 million of goodwill and $571,000 of identifiable intangibleassets subject to amortization.   Thisacquisition was not material to Registrant’s financial position or results ofoperations.  

 

26

----

Table of Contents

 

**Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

# **General**

#  

AWR is the parent companyof GSWC, CCWC and ASUS and its subsidiaries, Fort Bliss Water Services Company(“FBWS”), Terrapin Utility Services, Inc. (“TUS”), Old Dominion UtilityServices, Inc. (“ODUS”), Palmetto State Utility Services, Inc. (“PSUS”)and Old North Utility Services, Inc. (“ONUS”). AWR was incorporated as aCalifornia corporation in 1998 as a holding company.  AWR has three reportable segments: water,electric and contracted services. 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.

 

GSWC is a Californiapublic utility company engaged principally in the purchase, production anddistribution of water. GSWC also distributes electricity in one customerservice area. GSWC is regulated by the California Public Utilities Commission (“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.

 

GSWCserved 254,479 water customers and 23,056 electric customers at June 30,2008, or a total of 277,535 customers, compared with 278,093 total customers atJune 30, 2007. GSWC’s utility operations exhibit seasonal trends. AlthoughGSWC’s water utility operations have a diversified customer base, residentialand commercial customers account for the majority of GSWC’s water sales andrevenues. Revenues derived from commercial and residential water customersaccounted for approximately 83.3% and 82.7% of total waterrevenues for the three months ended June 30, 2008 and 2007,respectively, and 85.8% and 86.1% for the six months ended June 30, 2008and 2007, respectively.

 

CCWC is an Arizona publicutility company engaged principally in the purchase, production anddistribution of water.  CCWC served13,485 customers as of June 30, 2008, compared with 13,444 customers at June 30,2007. Located in the town of Fountain Hills, Arizona and a portion of the Cityof Scottsdale, Arizona, the majority of CCWC’s customers are residential. TheArizona Corporation Commission (“ACC”) regulates CCWC.

 

ASUS, through itswholly-owned subsidiaries, has contracted with the U.S. government to providewater and/or wastewater services, including the operation and maintenance ofwater and wastewater systems pursuant to 50-year fixed price contracts, whichare subject to periodic prospective price redeterminations and modificationsfor changes in circumstances. During the first quarter of 2008, ASUS commencedoperations at three bases located in North Carolina and South Carolina.  All of the contracts with the U.S. governmentmay be terminated, in whole or in part, prior to the end of the 50-year termfor 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 two yearsafter commencement of operations and every three years thereafter. Prices aresubject to equitable adjustment based upon changes in circumstances and changesin wages and fringe benefits to the extent provided in each of the contracts.

 

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 rights permitsand contracts owned or controlled by Natomas. On January 31, 2006, ASUSand Natomas entered into a water purchase and sale agreement under which ASUSwill 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 to ASUS, in perpetuity, water rights and entitlementsto divert from the Sacramento River up to 5,000 acre-feet of

 

27

----

Table of Contents

 

water per year forconsumptive use, subject to certain regulatory approvals. Terms of theacquisition, among other things, include a base price of $2,500 per acre-footof water, with payments contingent on achievement of specific milestones andevents over a 10-year period. After first determining whether a need for thewater exists in Sutter County, ASUS may use the water rights acquired fromNatomas to serve existing GSWC’s customers, to re-sell to other beneficialusers, 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 beyondthe Natomas service area.  Natomas willpay to 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. Additionally, GSWCfiled for a Certificate of Public Convenience and Necessity (“CPCN”) with theCPUC on May 31, 2006 to provide retail water service in a portion ofSutter County, California within the Natomas service area. CPUC review of theapplication was deferred pending completion of an environmental assessment forthe proposed new water service territory. GSWC anticipates completing aProponents Environmental Assessment and the filing of a revised CPCNapplication no later than September 15, 2008. All of the agreements withNatomas are subject to receipt of various regulatory approvals required fortheir 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 due to increased customer awareness; the impact ofincreased water quality standards on the cost of operations and capitalexpenditures; demands on water supply caused by population growth, morestringent water quality standards, deterioration in source water quality,climate change and restrictions on the delivery of purchased water affecting deliveries of water from theColorado River and the State Water Project; capital expenditures needed toupgrade water systems and increased costs and risks associated with litigationrelating to water quality and water supply, including suits initiated byRegistrant to protect its water supply; 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 stock offerings in the ensuing years. Registrant may seek toincrease its $85 million revolving credit facility by up to $30 million and/orissue common stock in 2008.

 

Operating revenues andincome from contracted services at ASUS and its subsidiaries are earnedprimarily from the operation and maintenance and periodic replacement of systemassets of the water and/or wastewater systems for the U.S. government atvarious military bases. All of the operations and maintenance contracts withthe U.S. government are 50-year firm, fixed-price contracts with prospectiveprice redeterminations. ASUS also may generate revenues from the constructionof additional infrastructure improvements at these bases pursuant to the termsof these 50-year contracts or pursuant to supplemental contracts. ASUS plans tocontinue seeking contracts for the operation and maintenance of water andwastewater services at military bases.

 

28

----

Table of Contents

 

Derivative accounting isrequired for the purchased power contracts at GSWC’s Bear Valley ElectricService (“BVES”) division.  Unrealizedgains and losses on purchased power contracts have been impacting GSWC’searnings since 2002 when GSWC entered into certain purchased powercontracts.  These contracts qualified asderivative instruments under SFAS No. 133, *“Accountingfor Derivative Instruments and Hedging Activities.”* The power purchased under the contract is onlyused to service electric customers’ demand and Registrant does not engage intrading of purchased power.   Although the unrealized gains and lossesresult in significant fluctuations to the income statement, there is no effecton Registrant’s cash flows. When analyzing the financial performance of AWR,Registrant excludes the effect of unrealized derivative gains or losses, asthey are not reflective of day-to-day operations.  The unrealizedderivative gains and losses are reflective of changes in future electricitycosts that are outside of management’s control. Due to increasing energy prices, during the three months ended June 30,2008, Registrant recorded a pretax unrealized gain on purchased power of $1.7million, or $0.06 per share, as compared to an unrealized loss of $236,000, or$0.01 per share, during the three months ended June 30, 2007, a netincrease of $0.07 per share.  During thesix months ended June 30, 2008, Registrant recorded a pretax unrealizedgain of $4.5 million, or $0.15 per share, as compared to a gain of $2.5million, or $0.09 per share, for the same period in 2007, a net increase of$0.06 per share.

 

**Summary Results by Segment**

 

AWR has three reportable segments: water,electric and contracts operation. 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 through ASUS and its subsidiaries.

 

*Second Quarter Results*

 

The tables below set forth summaries of theresults by segment (amounts in thousands) for the three months ended June 30,2008 and 2007:

 
| ** **             | ** ** | **Operating Revenues** | ** ** | **Pretax Operating Income** | ** ** |
|------------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| ** **             | ** ** | **3 Months**           | ** ** | **3 Months**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Ended**                   | ** ** | **Ended**                             | ** ** | **$** | ** ** | **%** | ** ** | **Ended** | ** ** | **Ended** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **             | ** ** | **6/30/2008**               | ** ** | **6/30/2007**                         | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** | **6/30/2008** | ** ** | **6/30/2007** | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water                  |       | $                           | 65,370     |                                  | $          | 60,826 |   | $ | 4,544 |   | 7.5 | % | $ | 18,529 |   | $ | 15,981 |   | $ | 2,548 |   | 15.9 | % |
| Electric               |       | 6,208                       |       | 6,255                                 |       | (47 | ) | -0.8 | % | 1,673 |   | (40 | ) | 1,713 |   | 4282.5 | % |
| Contracted  services   |       | 8,735                       |       | 12,165                                |       | (3,430 | ) | -28.2 | % | (608 | ) | 1,527 |   | (2,135 | ) | -139.8 | % |
| AWR  parent            |       | —                      |       | —                                |       | — |   | — |   | (13 | ) | (11 | ) | (2 | ) | -18.2 | % |
| Totals  from operation |       | $                           | 80,313     |                                  | $          | 79,246 |   | $ | 1,067 |   | 1.3 | % | $ | 19,581 |   | $ | 17,457 |   | $ | 2,124 |   | 12.2 | % |

 

***Water-***For the three months ended June 30, 2008, pretaxoperating income for water increased by $2.5 million, or 15.9%, primarily dueto a $3.0 million increase in dollar water margin as compared to the sameperiod of 2007 caused by higher water rates approved by the CPUC subsequent to June 30,2007, partially offset by lower water sales. There was a slight decrease in water sales of approximately 1.5% duringthe second quarter of 2008 compared to the same period in 2007. Differences intemperature and rainfall in Registrant’s service areas as well as the effectsof conservation due to increased customer awareness, impact sales of water tocustomers causing fluctuations in Registrant’s revenues and earnings between comparableperiods.  See further discussion onconservation included in the *“Regulatory Matters”*section.  Higher operating expenses, asmore fully described later, decreased pretax operating income by $481,000.

 

***Electric-***For the three months ended June 30, 2008, pretaxoperating income from electric operations increased by $1.7 million dueprimarily to a $1.9 million increase in the unrealized gain on purchased powercontracts.   The unrealized gain onpurchased power contracts increased operating income by approximately $1.7million for the three months ended June 30, 2008, as compared to anunrealized loss of $236,000 for the same period in 2007.  Offsetting this increase was a slightdecrease in electric margin of $55,000 and higher other operating expenses of$132,000.

 

29

----

Table of Contents

 

***Contracted Services -***For the three months ended June 30,2008, pretax operating income for contracted services decreased by $2.1million.  This was primarily due to asignificant wastewater expansion construction project at Fort Bliss in 2007with the U.S. government. In December 2006, a subsidiary of ASUS finalizedan agreement with the U.S. government for the construction of certainimprovements to the existing wastewater infrastructure located at Fort Bliss inEl Paso, Texas.  The $20.6 millionspecial project was a firm-fixed price contract, and was an amendment to the50-year contract with the U.S. government to manage the entire water andwastewater systems at Fort Bliss.  Thisproject generated approximately $2.1 million in pretax operating income duringthe second quarter of 2007. The project was completed in August 2007.  While ASUS’ subsidiaries did undertakesimilar construction activity in the second quarter of 2008, they were on asmaller scale and there was no singularly significant project during the threemonths ended June 30, 2008. Earnings and cash flows from amendments andmodifications to the original 50-year contracts with the U.S. government aresporadic and may or may not continue in the future periods.

 

Higher administrative andgeneral expenses in the second quarter of 2008 also contributed to the decreasein ASUS’ pretax operating income  due tothe commencement of the operation of water and wastewater systems at militarybases in North and South Carolina during the first quarter of 2008.  Furthermore, final decisions on the generalrate case for GSWC’s Region II and the application to recover general officeexpenses at the corporate headquarters allocated to Regions II and III wereapproved on November 16, 2007.  Thedecisions also imposed an increased allocation of corporate headquarters’expenses to ASUS and its wholly-owned subsidiaries, which caused a decrease incontracted services’ second quarter 2008 pretax operating income ofapproximately $170,000.  This higherallocation of expenses was not contemplated at the time the contracts with theU.S. government were negotiated and will be addressed in future priceredeterminations as described below.

 

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.  The contract price for each ofthese military contracts is subject to price redetermination two years aftercommencement 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. Resolution of these price redeterminations is expected later in 2008 andto date, ASUS has received ‘interim increases’ to the management fees receivedfor operating and maintaining the water and wastewater systems at Fort Eustis,Fort Story and Fort Monroe in Virginia, and the wastewater system at Fort Leealso in Virginia. The increases given were to cover inflation and wereeffective on the second anniversary dates of when ASUS began operating thesebases (February 23, 2006 for Fort Lee and April 3, 2006 for the otherthree bases).

 

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 being 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 the infrastructureat Fort Bliss, which is substantially more than originally estimated by theU.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 it by the third quarter of 2008.  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.

 

On July 1, 2008,ASUS served written discovery on the U.S. government (interrogatories andrequests for production of documents) related to the liquidated damages claimedby the U.S. government, mentioned previously.  The government has 45 daysto respond.   In addition, on July 15, 2008, the U.S. governmentfiled a motion asking the Armed Services Contracting Board to rule thatthe liquidated damages assessed against ASUS are not barred by cases findingthat liquidated damages which far exceed actual damages are a “penalty” and,therefore, are unenforceable.

 

30

----

Table of Contents

 

*Year-to-Date Results*

 

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

 
| ** **             | ** ** | **Operating Revenues** | ** ** | **Pretax Operating Income** | ** ** |
|------------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| ** **             | ** ** | **6 Months**           | ** ** | **6 Months**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **             | ** ** | **Ended**                   | ** ** | **Ended**                             | ** ** | **$** | ** ** | **%** | ** ** | **Ended** | ** ** | **Ended** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **             | ** ** | **6/30/2008**               | ** ** | **6/30/2007**                         | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** | **6/30/2008** | ** ** | **6/30/2007** | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
|                   |       |                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Water                  |       | $                           | 117,459    |                                  | $          | 111,153 |   | $ | 6,306 |   | 5.7 | % | $ | 30,224 |   | $ | 27,111 |   | $ | 3,113 |   | 11.5 | % |
| Electric               |       | 15,011                      |       | 15,124                                |       | (113 | ) | -0.7 | % | 5,084 |   | 3,612 |   | 1,472 |   | 40.8 | % |
| Contracted  services   |       | 16,785                      |       | 25,239                                |       | (8,454 | ) | -33.5 | % | (1,149 | ) | 3,691 |   | (4,840 | ) | -131.1 | % |
| AWR  parent            |       | —                      |       | —                                |       | — |   | — |   | (116 | ) | (106 | ) | (10 | ) | -9.4 | % |
| Totals  from operation |       | $                           | 149,255    |                                  | $          | 151,516 |   | $ | (2,261 | ) | -1.5 | % | $ | 34,043 |   | $ | 34,308 |   | $ | (265 | ) | -0.8 | % |

 

***Water-***For the six months ended June 30, 2008, pretaxoperating income for water increased by $3.1 million, or 11.5%, primarily dueto a $5.7 million increase in the dollar water margin as compared to the sameperiod of 2007 caused by higher water rates approved by the CPUC subsequent to June 30,2007 and a favorable change in the water supply mix, partially offset by lowerwater sales.  There was a 5% decrease inwater sales during the six months ended June 30, 2008 compared to the sameperiod in 2007.  The 2007 resultsbenefited from lower than average precipitation. Increased conservation effortsdue to heightened customer awareness also decreased water sales. Due to thedecrease in usage, Registrant’s water revenues were lower by approximately $3.5million, or approximately $0.08 per share. Differences in temperature and rainfall in Registrant’s service areas aswell as the effects of conservation due to increased customer awareness, impactsales of water to customers causing fluctuations in Registrant’s revenues andearnings between comparable periods.  Seefurther discussion on conservation included in the *“RegulatoryMatters”* section.  Higheroperating expenses, as more fully described later, also decreased pretaxoperating income by $2.6 million.

 

***Electric-***For the six months ended June 30, 2008, pretaxoperating income from electric operations increased by $1.5 million or 40.8%due in large part to an increase of $2.0 million in the pretax unrealized gainon BVES’ purchased power contracts during the six months ended June 30,2008 as compared to the same period of 2007. The unrealized gain for the sixmonths ended June 30, 2008 increased operating income by approximately$4.5 million as compared to $2.5 million in the same period in 2007.  Without the effects of the derivative, pretaxelectric operating income decreased by $561,000 during the six months ended June 30,2008 due to a $328,000 decrease in electric margin caused by lower newconnection and reconnection revenues and the recording of a regulatoryliability of approximately $128,000 with a corresponding reduction in electricrevenues for probable refunds to customers related to the 8.4 MW naturalgas-fueled generation plant.

 

 In April 2005, new customer rates wentinto effect related to this generation plant, which resulted in an increase ofapproximately $2.3 million in annual revenue based on an estimated totalcapital-related cost of $13 million. The rates are subject to refundpending the CPUC’s final cost review, which is scheduled to occur  as part of the filing of BVES’ general ratecase. The CPUC also ordered GSWC to establish a memorandum account to track thecapital-related costs of the generation plant. If actual recorded costs in thememorandum account are less than the costs authorized by the CPUC of$13 million, the revenue requirement for the difference is to be refundedto customers. During the third quarter of 2007, GSWC received vendor credits ofapproximately $851,000, which reduced the actual recorded costs of thegeneration plant to approximately $12.5 million. Finally, increases in maintenance,depreciation, administrative and general, and other operating expenses furtherdecreased electric’s pretax operating income by $233,000.

 

***Contracted Services -***For the six months ended June 30,2008, pretax operating income for contracted services decreased by $4.8million.  This was primarily due to asingularly significant wastewater expansion construction project in 2007 withthe U.S. government, previously discussed. This project generated approximately$4.3 million in pretax operating income during the six months ended June 30,2007. The project was completed in August 2007. While ASUS’ subsidiariesdid undertake similar construction activity in the first half of 2008, theywere on a smaller scale and there was no singularly significant project duringthe six months ended June 30, 2008. Earnings and cash flows from amendmentsand modifications to the original 50-year contracts with the U.S. governmentare sporadic and may or may not continue in the future periods.

 

31

----

Table ofContents

 

Higher administrative andgeneral expenses in the  first six monthsof 2008 also contributed to the decrease in ASUS’ pretax operating incomeprimarily due to the commencement of the operation and wastewater services atmilitary bases in North and South Carolina and an increase in outside servicesfor legal and consulting work.  Higheroutside services were incurred during the first six months of 2008 inconnection with the acquisition of a subcontractor’s business that providedwastewater services to ASUS’ subsidiaries at the various military bases.  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.  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 this transaction,ASUS also recorded acharge of $213,000 during the first quarter of 2008 for settlement of thepreexisting relationship with the subcontractor.

 

Furthermore, finaldecisions on the general rate case for GSWC’s Region II and the application torecover general office expenses at the corporate headquarters allocated toRegions II and 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 six months ended June 30, 2008 of approximately$335,000.  This higher allocation ofexpenses was not contemplated at the time the contracts with the U.S.government were negotiated.  Aspreviously discussed in the quarterly results, the timely receipt of priceredeterminations is critical in order to cover ASUS’ increasing costs foroperating and maintaining the water and wastewater systems at the militarybases.

 

The following discussionand analysis for the three and six months ended June 30, 2008 and 2007provides information on AWR’s consolidated operations and assets and wherenecessary, includes specific references to AWR’s individual segments and/orother subsidiaries: GSWC, CCWC, ASUS and its subsidiaries.

 

32

----

Table of Contents

 

***ConsolidatedResults of Operations — Three Months Ended June 30, 2008 and 2007 (amountsin thousands):***

*** ***
| ** **                                           | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                           | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| OPERATING  REVENUES                                  |       |              |       |              |       |       |       |       |       |
| Water                                                |       | $                 | 65,370     |              | $          | 60,826     |       | $          | 4,544      |   | 7.5 | % |
| Electric                                             |       | 6,208             |       | 6,255             |       | (47        | )          | -0.8       | %          |
| Contracted  services                                 |       | 8,735             |       | 12,165            |       | (3,430     | )          | -28.2      | %          |
| Total  operating revenues                            |       | 80,313            |       | 79,246            |       | 1,067      |       | 1.3        | %          |
|                                                 |       |              |       |              |       |       |       |       |       |
| OPERATING  EXPENSES                                  |       |              |       |              |       |       |       |       |       |
| Water  purchased                                     |       | 13,079            |       | 12,077            |       | 1,002      |       | 8.3        | %          |
| Power  purchased for pumping                         |       | 2,655             |       | 2,673             |       | (18        | )          | -0.7       | %          |
| Groundwater  production assessment                   |       | 2,890             |       | 2,549             |       | 341        |       | 13.4       | %          |
| Power  purchased for resale                          |       | 2,595             |       | 2,915             |       | (320       | )          | -11.0      | %          |
| Unrealized  (gain) loss on purchased power contracts |       | (1,664            | )          | 236               |       | (1,900     | )          | -805.1     | %          |
| Supply  cost balancing accounts                      |       | (672              | )          | (1,190            | )          | 518        |       | -43.5      | %          |
| Other  operating expenses                            |       | 7,053             |       | 6,559             |       | 494        |       | 7.5        | %          |
| Administrative  and general expenses                 |       | 14,943            |       | 13,664            |       | 1,279      |       | 9.4        | %          |
| Depreciation  and amortization                       |       | 7,810             |       | 7,088             |       | 722        |       | 10.2       | %          |
| Maintenance                                          |       | 4,770             |       | 4,353             |       | 417        |       | 9.6        | %          |
| Property  and other taxes                            |       | 2,839             |       | 2,843             |       | (4         | )          | -0.1       | %          |
| ASUS  construction expenses                          |       | 4,434             |       | 8,260             |       | (3,826     | )          | -46.3      | %          |
| Net  gain on sale of property                        |       | —            |       | (238              | )          | 238        |       | -100.0     | %          |
| Total  operating expenses                            |       | 60,732            |       | 61,789            |       | (1,057     | )          | -1.7       | %          |
|                                                 |       |              |       |              |       |       |       |       |       |
| OPERATING  INCOME                                    |       | 19,581            |       | 17,457            |       | 2,124      |       | 12.2       | %          |
|                                                 |       |              |       |              |       |       |       |       |       |
| OTHER  INCOME AND EXPENSES                           |       |              |       |              |       |       |       |       |       |
| Interest  expense                                    |       | (5,294            | )          | (5,570            | )          | 276        |       | -5.0       | %          |
| Interest  income                                     |       | 775               |       | 586               |       | 189        |       | 32.3       | %          |
| Other                                                |       | 7                 |       | 63                |       | (56        | )          | -88.9      | %          |
|                                                 |       | (4,512            | )          | (4,921            | )          | 409        |       | -8.3       | %          |
|                                                 |       |              |       |              |       |       |       |       |       |
| INCOME  FROM OPERATIONS BEFORE INCOME TAX EXPENSE    |       | 15,069            |       | 12,536            |       | 2,533      |       | 20.2       | %          |
|                                                 |       |              |       |              |       |       |       |       |       |
| Income  tax expense                                  |       | 5,786             |       | 5,214             |       | 572        |       | 11.0       | %          |
|                                                 |       |              |       |              |       |       |       |       |       |
| NET  INCOME                                          |       | $                 | 9,283      |              | $          | 7,322      |       | $          | 1,961      |   | 26.8 | % |

 

Net income for the threemonths ended June 30, 2008 was $9.3 million, equivalent to $0.54 and $0.53per common share on a basic and fully diluted basis, respectively, compared to$7.3 million or $0.42 per basic and fully diluted common share for the threemonths ended June 30, 2007. Impacting the comparability in the results ofthe two periods on a fully diluted per share basis are the followingsignificant items:

 

33

----

Table of Contents

 

·                  Anunrealized gain on purchased power contracts which increased pretax income by$1.7 million, or $0.06 per share, as compared to an unrealized loss whichdecreased pretax income by $236,000, or $0.01 per share, for the same period in2007, a net increase of $0.07 per share.

 

·                  The dollar watermargin increased by $3.0 million, or $0.10 per share, during the second quarter2008 due to increased water rates approved by the CPUC subsequent to June 30,2007.  Water sales decreased slightly byapproximately 1.5%.

 

·                  Pretax operatingincome for contracted services declined by $2.1 million, or $0.07 per share, during the second quarter 2008 dueprimarily to a significant wastewater construction project in 2007 at FortBliss.  ASUS recognized pretax operatingincome of $2.1 million from this wastewater expansion project during the secondquarter 2007.  There was no singularlysignificant project during the second quarter of 2008.

 

·                  GSWC recorded anet pretax gain on sale of property of $238,000, or $0.01 per share, during thethree months ended June 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 theInternal Revenue Service’s (“IRS’s”) examination of the 2002 income tax return.

 

·                  Higher otherexpenses primarily consisting of administrative and general expenses anddepreciation expense as described below, were offset by a decrease in theeffective tax rate.

 

***Operating Revenues***

 

*Water*

 

For the three monthsended June 30, 2008, revenues from water operations increased by 7.5% to$65.4 million, compared to $60.8 million for the three months ended June 30,2007. Contributing to this increase were rate increases approved by the CPUC subsequentto June 30, 2007, which added approximately $5.5 million in the secondquarter of 2008 to water revenues.  Thisincrease was partially offset by a decrease of approximately 1.5% in watersales resulting from the effects of conservation due to increased customerawareness. Differences in temperature and rainfall in Registrant’s serviceareas as well as conservation efforts impact sales of water to customers,causing fluctuations in Registrant’s revenues and earnings between comparableperiods.

 

*Electric*

 

For the three monthsended June 30, 2008, revenues from electric operations decreased slightlyby 0.8% to $6.2 million compared to $6.3 million for the three months ended June 30,2007 due primarily to lower electric usage and a slight decrease in totalcustomers.

 

*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 three months ended June 30, 2008, revenues from contractedservices decreased by $3.4 million, or 28.2%, to $8.7 million compared to $12.2million for the three months ended June 30, 2007 primarily due to revenuesin 2007 related to the wastewater expansion project at Fort Bliss, previouslydiscussed. This special project, which began in early 2007, generated $9.1million of construction revenues for the three months ended June 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 in constructionrevenues at Andrews Air Force Base pursuant to its 50-year firm-fixed pricecontract, as well as other construction revenues at the other military bases,during the three months ended June 30, 2008.  There were also additional revenues of $2.2million during 2008 generated from operating and maintaining the water andwastewater systems under the two new contracts in North Carolina and SouthCarolina, both of which began during the first quarter of 2008.

 

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, and price redeterminations and equitable adjustments by the U.S.government in order to recover operating expenses and profit margin. Ifadequate rate relief

 

34

----

Table of Contents

 

and priceredeterminations and adjustments are not granted in a timely manner, operatingrevenues 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 assessments and water supply cost balancing accounts.Supply costs for the electric segment consist of purchased power for resale(including the cost of natural gas) and the electric supply cost balancingaccount*.* Water and electric margins arecomputed by taking total revenues, less total supply costs. Registrant uses thesemargins and related percentages as an important measure in evaluating itsoperating results. Registrant believes this measure is a useful internalbenchmark in evaluating the utility business performance within its water andelectric segments. Registrant reviews these measurements regularly and comparesthem to historical periods and to  theoperating budget as approved. However, this measure, which is not presented inaccordance with GAAP, may not be comparable to similarly titled measures usedby other entities and should not be considered as an alternative to operatingincome, which is determined in accordance with GAAP, as an indicator ofoperating performance.

 

Total supply costscomprise the largest segment of total operating expenses. Supply costsaccounted for approximately 34% and 31% of total operating expenses for thethree months ended June 30, 2008 and 2007, respectively. The table belowprovides the amount of increases (decreases), percent changes in supply costs,and margins during the three months ended June 30, 2008 and 2007 (amountsin thousands):

 
| ** **                                       | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                       | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| WATER  OPERATING REVENUES **(1)**                |       | $                 | 65,370     |              | $          | 60,826     |       | $          | 4,544      |   | 7.5 | % |
| WATER  SUPPLY COSTS:                             |       |              |       |              |       |       |       |       |       |
| Water  purchased **(1)**                         |       | $                 | 13,079     |              | $          | 12,077     |       | $          | 1,002      |   | 8.3 | % |
| Power  purchased for pumping **(1)**             |       | 2,655             |       | 2,673             |       | (18        | )          | -0.7       | %          |
| Groundwater  production assessment **(1)**       |       | 2,890             |       | 2,549             |       | 341        |       | 13.4       | %          |
| Water  supply cost balancing accounts **(1)**    |       | (1,441            | )          | (1,631            | )          | 190        |       | -11.6      | %          |
| TOTAL  WATER SUPPLY COSTS                        |       | $                 | 17,183     |              | $          | 15,668     |       | $          | 1,515      |   | 9.7 | % |
| WATER  MARGIN **(2)**                            |       | $                 | 48,187     |              | $          | 45,158     |       | $          | 3,029      |   | 6.7 | % |
| PERCENT  MARGIN - WATER                          |       | 73.7              | %          | 74.2              | %          |       |       |       |       |
|                                             |       |              |       |              |       |       |       |       |       |
| ELECTRIC  OPERATING REVENUES **(1)**             |       | $                 | 6,208      |              | $          | 6,255      |       | $          | (47        | ) | -0.8 | % |
| ELECTRIC  SUPPLY COSTS:                          |       |              |       |              |       |       |       |       |       |
| Power  purchased for resale **(1)**              |       | $                 | 2,595      |              | $          | 2,915      |       | $          | (320       | ) | -11.0 | % |
| Electric  supply cost balancing accounts **(1)** |       | 769               |       | 441               |       | 328        |       | 74.4       | %          |
| TOTAL  ELECTRIC SUPPLY COSTS                     |       | $                 | 3,364      |              | $          | 3,356      |       | $          | 8          |   | 0.2 | % |
| ELECTRIC  MARGIN **(2)**                         |       | $                 | 2,844      |              | $          | 2,899      |       | $          | (55        | ) | -1.9 | % |
| PERCENT  MARGIN - ELECTRIC                       |       | 45.8              | %          | 46.3              | %          |       |       |       |       |

 

----

(1)                                  As reported on AWR’s Consolidated Statementsof Income, except for supply cost balancing accounts. The sum of water andelectric supply cost balancing accounts in the table above are shown on AWR’sConsolidated Statements of Income and totaled ($672,000) and ($1,190,000) forthe three months ended June 30, 2008 and 2007, respectively.

 

(2)                                  Water and electric margins do not include anydepreciation and amortization, maintenance expense, unrealized gains and losseson purchased power contracts, or other operating expenses.

 

35

----

Table of Contents

 

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. GSWC has theopportunity to change the supply-related costs recovered through rates, byapplication to the CPUC through a general rate case or advice letterproceeding. GSWC believes that its applications for recovery of supply-relatedcosts accurately reflect the water supply situation as it is known at the time.Without a “full-cost” balancing account authorized by the CPUC, earnings mayfluctuate from adverse changes in supply costs related to unforeseencontamination or other loss of water supply.

 

For the three monthsended June 30, 2008 and 2007, GSWC’s water supply mix remained consistentat approximately 41% purchased water. Purchased water costs for the three months ended June 30, 2008increased by 8.3% to $13.1 million compared to $12.1 million for the threemonths ended June 30, 2007 due primarily to higher water rates chargedfrom wholesale suppliers.  Average ratesfrom wholesale suppliers increased in Regions I, II and III byapproximately 8%, 6% and 5%, respectively. In general, the supply cost balancing account as discussed above allowsGSWC to track incremental rate changes from suppliers, for future recovery inwater rates.

 

For the three monthsended June 30, 2008, the slight decrease of 0.7% in power purchased for pumpingwas principally due to lower customer demand. Groundwater production assessments were higher by 13.4% due to increasesin assessment rates (pump tax rates) levied against groundwater production,effective July 2007.  Average pumptax rates increased in Region II and III by approximately 8% and 6%,respectively, between the second quarters of 2008 and 2007.  These increases in groundwater productionassessments were partially offset by lower customer demand.  Again, the supply cost balancing account tracksthe increases in pump tax rates for future recovery in water rates.

 

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 $190,000in the water supply cost balancing account provision during the three monthsended June 30, 2008 as compared to the same period in 2007 was primarilycaused by: (i) a $299,000 increase in the amortization of the water supplycost balancing accounts for surcharges currently in effect; (ii) a netdecrease totaling $29,000 of under-collections in 2008 compared to the sameperiod in 2007 caused by recent CPUC decisions that updated the authorizedrates for supply costs, therefore, lowering the level of under-collectionsbeing recorded, and (iii) a $42,000 decrease in interest earned on thesupply cost balancing accounts (Registrant accrues interest on its supply costbalancing accounts at the rate prevailing for 90-day commercial paper).  These increases to the water supply costbalancing account provision was offset by the recording of a $181,000 netunder-collection adjustment relating to Region III’s pre-2001 supply costswhich 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 three monthsended June 30, 2008, the cost of power purchased for resale to customersin GSWC’s BVES division decreased by 11% to $2.6 million compared to $2.9million for the three months ended June 30, 2007 reflecting an increase insales of surplus power to the spot market at higher energy prices.   Income from the spot market sales for thethree months ended June 30, 2008 decreased the cost of power purchased forresale and

 

36

----

Table of Contents

 

increased the electric supply cost balancing accountprovision, respectively, with no impact to the electric margin.   There was also a decrease in customer demandduring the second 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$1.7 million pretax unrealized gain on purchased power contracts for the threemonths ended June 30, 2008 is due to an increase in the current forwardmarket prices since March 31, 2008. There was a $236,000 pretax unrealizedloss on purchased power contracts for the three months ended June 30,2007. Unrealized gains and losses at BVES will continue to impact earningspositively or negatively during the life of the contract, which terminates atthe end of 2008.  As of June 30,2008, there is a cumulative unrealized gain of $3.0 million which will berecognized as a decrease 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 June 30,2008 and 2007, other operating expenses by segment consisted of the following(amounts in thousands):

 
| ** **                      | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                      | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water  Services                 |       | $                 | 5,294      |              | $          | 5,375      |       | $          | (81        | ) | -1.5 | % |
| Electric  Services              |       | 499               |       | 433               |       | 66         |       | 15.2       | %          |
| Contracted  Services            |       | 1,260             |       | 751               |       | 509        |       | 67.8       | %          |
| Total  other operating expenses |       | $                 | 7,053      |              | $          | 6,559      |       | $          | 494        |   | 7.5 | % |

 

For the three months ended June 30, 2008, otheroperating expenses for water services decreased slightly by $81,000 or 1.5% dueprimarily to lower chemicals and water treatment costs, including supplies andmaterials, of approximately $176,000.  Therewere also decreases of $54,000 in equipment rental and $25,000 in miscellaneousother expenses.These decreases were partially offset by an increase in labor costs of$174,000 due to higher wages and related benefits.

 

There was an increase of $66,000 in other operatingexpenses for electric services primarily due to higher wages and relatedbenefits of $26,000 and an increase of $16,000 in bad debt expense.

 

Contracted services experienced increases in otheroperating expenses of $509,000 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 $882,000 during the second quarter of2008.  These increases werepartially offset by decreases at the other military bases during the secondquarter of 2008 resulting from lower outside services paid to the subcontractorthat used to provide wastewater services to certain of ASUS’ subsidiaries. On January 31,2008, ASUS and its subsidiaries agreed to buy out all current and future rightswhich this subcontractor had to provide wastewater services at any bases ownedand operated by ASUS and any of its present and/or future subsidiaries. For the three months ended June 30, 2008, most of these services wereperformed internally at lower cost.

 

37

----

Table of Contents

 

***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 generalcorporate expenses. For the three months ended June 30, 2008 and 2007,administrative and general expenses by segment consisted of the following(amounts in thousands):

 
| ** **                                 | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                 | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water  Services                            |       | $                 | 10,856     |              | $          | 10,694     |       | $          | 162        |   | 1.5 | % |
| Electric  Services                         |       | 1,558             |       | 1,531             |       | 27         |       | 1.8        | %          |
| Contracted  Services                       |       | 2,529             |       | 1,439             |       | 1,090      |       | 75.7       | %          |
| Total  administrative and general expenses |       | $                 | 14,943     |              | $          | 13,664     |       | $          | 1,279      |   | 9.4 | % |

 

For thethree months ended June 30, 2008, administrative and general expensesincreased by $189,000 in water and electric services compared to the threemonths ended June 30, 2007 due primarily to an increase in labor costs dueto higher wages largely related to Registrant’s annual performance-based salaryreview program, partially offset by a decrease in outside services relating tolower tax and legal services.

 

There was an increase of$1.1 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.

 

***Depreciation and Amortization***

 

For the three monthsended June 30, 2008 and 2007, depreciation and amortization by segmentconsisted of the following (amounts in thousands):

 
| ** **                           | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                           | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water  Services                      |       | $                 | 7,160      |              | $          | 6,506      |       | $          | 654        |   | 10.1 | % |
| Electric  Services                   |       | 553               |       | 534               |       | 19         |       | 3.6        | %          |
| Contracted  Services                 |       | 97                |       | 48                |       | 49         |       | 102.1      | %          |
| Total  depreciation and amortization |       | $                 | 7,810      |              | $          | 7,088      |       | $          | 722        |   | 10.2 | % |

 

For the three months endedJune 30, 2008, overall depreciation and amortization expense increased by10.2% to $7.8 million compared to $7.1 million for the three months ended June 30,2007 reflecting, among other things, the effects of closing approximately $55.2million of additions to utility plant during 2007, depreciation on which beganin January 2008.  There were alsochanges to the composite depreciation rates recently approved by the CPUC.Registrant anticipates that depreciation expense will continue to increase dueto Registrant’s on-going construction program at its regulated subsidiaries.Registrant believes that depreciation expense related to property additionsapproved by the appropriate regulatory agency will be recovered through waterand electric rates.

 

38

----

Table of Contents

 

***Maintenance***

 

For the three monthsended June 30, 2008 and 2007, maintenance expense by segment consisted ofthe following (amounts in thousands):

 
| ** **           | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **           | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services       |       | $                 | 3,709      |              | $          | 4,241      |       | $          | (532       | ) | -12.5 | % |
| Electric  Services   |       | 156               |       | 7                 |       | 149        |       | 2128.6     | %          |
| Contracted  Services |       | 905               |       | 105               |       | 800        |       | 761.9      | %          |
| Total  maintenance   |       | $                 | 4,770      |              | $          | 4,353      |       | $          | 417        |   | 9.6 | % |

 

For the three months ended June 30, 2008,maintenance expense for water services decreased by 12.5% to $3.7 millioncompared to $4.2 million for the three months ended June 30, 2007 dueprincipally to a decrease in emergency maintenance on GSWC’s wells and watersupply sources in its Region II service area.

 

There was an increase of $149,000 in maintenance forelectric services related to the 8.4 MW natural gas-fueled generation plant.

 

There was an increase of$800,000 in contracted services maintenance expense due primarily to thecommencement of the operation of water andwastewater systems at military bases in North Carolina and South Carolina thatbegan during the first quarter of 2008, which added $680,000 in maintenanceexpense.  The level of maintenance costsat these bases also reflects the age and condition of the respectiveinfrastructure.  There was also increasedmaintenance expense of $102,000 necessary at bases in Virginia.

 

***Property and Other Taxes***

 

For the three months endedJune 30, 2008 and 2007, property and other taxes by segment consisted ofthe following (amounts in thousands):

 
| ** **                      | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                      | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                  |       | $                 | 2,656      |              | $          | 2,609      |       | $          | 47         |   | 1.8 | % |
| Electric  Services              |       | 71                |       | 200               |       | (129       | )          | -64.5      | %          |
| Contracted  Services            |       | 112               |       | 34                |       | 78         |       | 229.4      | %          |
| Total property  and other taxes |       | $                 | 2,839      |              | $          | 2,843      |       | $          | (4         | ) | -0.1 | % |

 

For the three monthsended June 30, 2008, overall property and other taxes remained relativelyunchanged.  Additional property taxesresulting from higher assessed values, and increases in payroll taxes based onincreased labor costs, were offset by lower franchise fees at BVES.

 

39

----

Table of Contents

 

***Construction Expenses***

 

For the three monthsended June 30, 2008, ASUS construction expenses decreased to $4.4 millioncompared to $8.3 million for the same period in 2007 reflecting primarily thecosts incurred in 2007 for the wastewater expansion project at Fort Bliss.  As previously mentioned, ASUS entered into a$20.6 million project in 2007 for the construction of certain improvementsto the existing wastewater infrastructure located at Fort Bliss in El Paso,Texas.   For the three months ended June 30,2007, this project generated $7.0 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 that were completed in the secondquarter of 2008.

 

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

 

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

 

For the three months ended June 30, 2007, waterservices recorded a pretax gain of $238,000 on the sale of property it owned inthe City of Claremont. There was no similar gain in the same period of2008.  Earnings and cash flows from thesetransactions are sporadic and may or may not continue in future periods.

 

***Interest Expense***

 

For the three monthsended June 30, 2008 and 2007, interest expense by segment consisted of thefollowing (amounts in thousands):

 
| ** **                   | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 5,085      |              | $          | 5,294      |       | $          | (209       | ) | -3.9 | % |
| Contracted  Services         |       | 209               |       | 276               |       | (67        | )          | -24.3      | %          |
| Total interest  expense      |       | $                 | 5,294      |              | $          | 5,570      |       | $          | (276       | ) | -5.0 | % |

 

For the three monthsended June 30, 2008, overall interest expense decreased by 5.0% to $5.3million compared to $5.6 million for the three months ended June 30, 2007primarily reflecting lower short-term interest rates.  The average interest rates on short-termborrowings for the three months ended June 30, 2008 was 3.3%, as comparedto an average of 6.1% during the same period of 2007. This was partially offsetby an increase in short-term borrowings. Average bank loan balances outstandingunder an AWR credit facility for the three months ended June 30, 2008 wereapproximately $53 million, as compared to an average of $33 million during thesame period of 2007.

 

***Interest Income***

 

For the three monthsended June 30, 2008 and 2007, interest income by segment consisted of thefollowing (amounts in thousands):

 
| ** **                   | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 772        |              | $          | 582        |       | $          | 190        |   | 32.6 | % |
| Contracted  Services         |       | 3                 |       | 4                 |       | (1         | )          | -25.0      | %          |
| Total interest  expense      |       | $                 | 775        |              | $          | 586        |       | $          | 189        |   | 32.3 | % |

 

Interest income for waterand electric services increased by $190,000 for the three months ended June 30,2008 due primarily to the recording of $480,000 interest income in connectionwith the IRS’s examination of the 2002 income tax return.  This increase was partially offset by lessinterest earned on short-term cash surplus and a

 

40

----

Table of Contents

 

decrease of $169,000 ininterest accrued on the uncollected balance of the Aerojet litigationmemorandum account authorized by the CPUC due to lower interest rates.

 

***Other***

 

For the three months ended June 30, 2008 and 2007,water services recorded other income of $7,000 and $63,000, respectively, as aresult of its ownership interest in a non-operating equity investment.

 

***Income Tax Expense***

 

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

 
| ** **                   | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 6,099      |              | $          | 4,741      |       | $          | 1,358      |   | 28.6 | % |
| Contracted  Services         |       | (313              | )          | 473               |       | (786       | )          | -166.2     | %          |
| Total income tax  expense    |       | $                 | 5,786      |              | $          | 5,214      |       | $          | 572        |   | 11.0 | % |

 

For the three monthsended June 30, 2008, income tax expense for water and electric servicesincreased by 28.6% to $6.1 million compared to $4.7 million for the threemonths ended June 30, 2007 due primarily to an increase in pretaxincome.  The effective tax rate (“ETR”)for water and electric services for the three months ended June 30, 2008was 38.4% as compared to a 42.0% ETR applicable to the three months ended June 30,2007.  The ETR decreased primarily due tochanges between book and taxable income that are treated as flow-throughadjustments (principally plant-, rate-case- and compensatory-related in nature)in accordance with regulatory requirements.  Flow-through adjustmentsincrease or decrease tax expense in one period, with an offsetting increase ordecrease occurring in another period.

 

Income tax expense forcontracted services decreased to a tax benefit of $313,000 compared to taxexpense of $473,000 for the three months ended June 30, 2007 due primarilyto a decrease in pretax income.  The ETRfor contracted services for the three months ended June 30, 2008 was 38.5%as compared to a 37.7% ETR applicable to the three months ended June 30,2007.

 

41

----

Table of Contents

 

***ConsolidatedResults of Operations — Six Months Ended June 30, 2008 and 2007 (amountsin thousands):***

*** ***
| ** **                                        | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                        | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                        | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| OPERATING  REVENUES                               |       |              |       |              |       |       |       |       |       |
| Water                                             |       | $                 | 117,459    |              | $          | 111,153    |       | $          | 6,306      |   | 5.7 | % |
| Electric                                          |       | 15,011            |       | 15,124            |       | (113       | )          | -0.7       | %          |
| Contracted  services                              |       | 16,785            |       | 25,239            |       | (8,454     | )          | -33.5      | %          |
| Total operating  revenues                         |       | 149,255           |       | 151,516           |       | (2,261     | )          | -1.5       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OPERATING  EXPENSES                               |       |              |       |              |       |       |       |       |       |
| Water purchased                                   |       | 21,032            |       | 20,950            |       | 82         |       | 0.4        | %          |
| Power purchased  for pumping                      |       | 4,335             |       | 4,791             |       | (456       | )          | -9.5       | %          |
| Groundwater  production assessment                |       | 5,265             |       | 4,828             |       | 437        |       | 9.1        | %          |
| Power purchased  for resale                       |       | 6,834             |       | 7,196             |       | (362       | )          | -5.0       | %          |
| Unrealized gain on  purchased power contracts     |       | (4,507            | )          | (2,474            | )          | (2,033     | )          | 82.2       | %          |
| Supply cost  balancing accounts                   |       | (779              | )          | (1,910            | )          | 1,131      |       | -59.2      | %          |
| Other operating  expenses                         |       | 15,049            |       | 13,156            |       | 1,893      |       | 14.4       | %          |
| Administrative  and general expenses              |       | 29,770            |       | 26,671            |       | 3,099      |       | 11.6       | %          |
| Depreciation and  amortization                    |       | 15,603            |       | 14,177            |       | 1,426      |       | 10.1       | %          |
| Maintenance                                       |       | 8,542             |       | 7,326             |       | 1,216      |       | 16.6       | %          |
| Property and  other taxes                         |       | 5,759             |       | 5,773             |       | (14        | )          | -0.2       | %          |
| ASUS  construction expenses                       |       | 8,309             |       | 17,329            |       | (9,020     | )          | -52.1      | %          |
| Net gain on sale  of property                     |       | —            |       | (605              | )          | 605        |       | -100.0     | %          |
| Total operating  expenses                         |       | 115,212           |       | 117,208           |       | (1,996     | )          | -1.7       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OPERATING INCOME                                  |       | 34,043            |       | 34,308            |       | (265       | )          | -0.8       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| OTHER INCOME AND  EXPENSES                        |       |              |       |              |       |       |       |       |       |
| Interest expense                                  |       | (10,672           | )          | (11,066           | )          | 394        |       | -3.6       | %          |
| Interest income                                   |       | 1,136             |       | 1,152             |       | (16        | )          | -1.4       | %          |
| Other                                             |       | 121               |       | 132               |       | (11        | )          | -8.3       | %          |
|                                              |       | (9,415            | )          | (9,782            | )          | 367        |       | -3.8       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| INCOME FROM  OPERATIONS BEFORE INCOME TAX EXPENSE |       | 24,628            |       | 24,526            |       | 102        |       | 0.4        | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| Income tax expense                                |       | 10,041            |       | 10,220            |       | (179       | )          | -1.8       | %          |
|                                              |       |              |       |              |       |       |       |       |       |
| NET INCOME                                        |       | $                 | 14,587     |              | $          | 14,306     |       | $          | 281        |   | 2.0 | % |

 

Net income for the sixmonths ended June 30, 2008 was $14.6 million, equivalent to $0.84 percommon share on a basic and fully diluted basis, compared to $14.3 million or$0.83 and $0.82 per basic and fully diluted common share for the six monthsended June 30, 2007, respectively. Impacting the comparability in theresults of the two periods on a fully diluted per share basis are the followingsignificant items:

 

42

----

Table of Contents

 

·                  An unrealized gain on purchased power contracts which increased pretaxincome by $4.5 million, or $0.15 per share, as compared to $2.5 million, or$0.09 per share, for the same period in 2007, a net increase of $0.06 pershare.

 

·                  The dollar water margin increased by $5.7 million, or$0.19 per share, during the six months ended June 30, 2008 due toincreased water rates approved by the CPUC subsequent to June 30, 2007 anda favorable supply mix change.  However,this increase was partially offset by the decrease in water sales. A 5%decrease in water usage during the six months ended June 30, 2008 resultedin a $3.5 million decrease in water revenues. The 2007 results benefited fromlower than average precipitation, while in 2008 water revenues were impacted bythe effects of conservation due to increased customer awareness.

 

·                  Pretax operating income for contracted servicesdeclined by $4.8 million, or $0.16 per share, during the six months ended June 30,2008 due primarily to a significant wastewater construction project in 2007 atFort Bliss.  ASUS recognized pretaxoperating income of $4.3 million from the wastewater expansion project duringthe six months ended June 30, 2007. There was no similar significant project during the six months ended June 30,2008.  Higher administrative and generalexpenses also contributed to the decrease in ASUS’ pretax operating income.

 

·                  GSWC recorded a net gain on sale of property of$605,000, or $0.02 per share, during the six months ended June 30,2007.  There was no similar gain in thesame period of 2008.

 

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

 

·                  Higher other expenses at GSWC in 2008 primarilyconsisting of administrative and general, maintenance and depreciation expensesas described below, partially offset by a lower effective tax rate, contributedto an overall decrease of $0.07 per diluted share to the results of operations.

 

***Operating Revenues***

 

*Water*

 

For the six months ended June 30,2008, revenues from water operations increased by 5.7% to $117.5 million,compared to $111.2  million for the sixmonths ended June 30, 2007. Contributing to this increase were rateincreases approved by the CPUC subsequent to June 30, 2007, which addedapproximately $9.8 million to water revenues during the six months ended June 30,2008.  This increase was partially offsetby a decrease of approximately 5% in water sales due to comparably wetterweather and increasing customer awareness in conservation during 2008 whichcaused water revenues to be lower by approximately $3.5 million.  Differences in temperature and rainfall inRegistrant’s service areas as well as the effects of conservation due toincreased customer awareness in conservation, impact sales of water tocustomers causing fluctuations in Registrant’s revenues and earnings betweencomparable periods.

 

*Electric*

 

For the six months ended June 30,2008, revenues from electric operations decreased slightly by 0.7% to $15.0million compared to $15.1 million for the six months ended June 30, 2007due primarily to the increase of $128,000 in a regulatory liability forprobable refunds to customers related to the 8.4 MW natural gas-fueledgeneration plant, previously discussed, with a corresponding decrease inrevenues.  There was also a decrease inother electric revenues which are comprised of new connection and reconnectionfees.  The number of total customers alsodecreased slightly.  Electric usage wasconsistent between the two periods.

 

 

43

----

Table of 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 six months ended June 30, 2008, revenues from contractedservices decreased by $8.5 million, or 33.5%, to $16.8 million compared to$25.2 million for the six months ended June 30, 2007 primarily due torevenues in 2007 related to the wastewater expansion project at Fort Bliss,previously discussed.  This specialproject, which began in early 2007, generated $19.5 million of constructionrevenues for the six months ended June 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 the future periods. The year over year revenue decrease resultingfrom this special project was partially offset by an increase of $3.4 millionin construction revenues at Andrews Air Force Base pursuant to its 50-yearfirm-fixed price contract during the six months ended June 30, 2008.  There were also additional revenues totaling$3.8 million during 2008 generated from operating and maintaining the water andwastewater systems under the two new contracts in North Carolina and SouthCarolina, both of which began during the first quarter of 2008.  Finally, there was an increase inconstruction revenues of $3.9 million at the other military bases during thesix months ended June 30, 2008.

 

Registrant relies uponrate approvals by state regulatory agencies in California and Arizona toprovide for a return on invested and borrowed capital used to fund utility plant,and price redeterminations and equitable adjustments by the U.S. government inorder to recover operating expenses and profit margin. If adequate rate reliefand price redeterminations and adjustments are not granted in a timely manner,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 assessments and water supply cost balancing accounts.Supply costs for the electric segment consist of purchased power for resale(including the cost of natural gas) and the electric supply cost balancingaccount*.* Water and electric margins arecomputed by taking total revenues, less total supply costs. Registrant usesthese margins and related percentages as an important measure in evaluating itsoperating results. Registrant believes this measure is a useful internalbenchmark in evaluating the utility business performance within its water andelectric segments. Registrant reviews these measurements regularly and comparesthem to historical periods and to its operating budget as approved. However,this measure, which is not presented in accordance with GAAP may not becomparable to similarly titled measures used by other entities and should notbe considered 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 32% and 31% of total operating expenses for the sixmonths ended June 30, 2008 and 2007, respectively. The table belowprovides the amount of increases (decreases), percent changes in supply costs,and margins during the six months ended June 30, 2008 and 2007 (amounts inthousands):

 

44

----

Table of Contents

 
|                                             | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
|                                             | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
|                                             | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| WATER OPERATING  REVENUES **(1)**                |       | $                 | 117,459    |              | $          | 111,153    |       | $          | 6,306      |   | 5.7 | % |
| WATER SUPPLY  COSTS:                             |       |              |       |              |       |       |       |       |       |
| Water purchased **(1)**                          |       | $                 | 21,032     |              | $          | 20,950     |       | $          | 82         |   | 0.4 | % |
| Power purchased  for pumping **(1)**             |       | 4,335             |       | 4,791             |       | (456       | )          | -9.5       | %          |
| Groundwater  production assessment **(1)**       |       | 5,265             |       | 4,828             |       | 437        |       | 9.1        | %          |
| Water supply  cost balancing accounts **(1)**    |       | (2,603            | )          | (3,157            | )          | 554        |       | -17.5      | %          |
| TOTAL WATER  SUPPLY COSTS                        |       | $                 | 28,029     |              | $          | 27,412     |       | $          | 617        |   | 2.3 | % |
| WATER MARGIN **(2)**                             |       | $                 | 89,430     |              | $          | 83,741     |       | $          | 5,689      |   | 6.8 | % |
| PERCENT MARGIN -  WATER                          |       | 76.1              | %          | 75.3              | %          |       |       |       |       |
|                                             |       |              |       |              |       |       |       |       |       |
| ELECTRIC  OPERATING REVENUES **(1)**             |       | $                 | 15,011     |              | $          | 15,124     |       | $          | (113       | ) | -0.7 | % |
| ELECTRIC SUPPLY  COSTS:                          |       |              |       |              |       |       |       |       |       |
| Power purchased  for resale **(1)**              |       | $                 | 6,834      |              | $          | 7,196      |       | (362       | )          | -5.0 | % |
| Electric supply  cost balancing accounts **(1)** |       | 1,824             |       | 1,247             |       | 577        |       | 46.3       | %          |
| TOTAL ELECTRIC  SUPPLY COSTS                     |       | $                 | 8,658      |              | $          | 8,443      |       | $          | 215        |   | 2.5 | % |
| ELECTRIC MARGIN **(2)**                          |       | $                 | 6,353      |              | $          | 6,681      |       | $          | (328       | ) | -4.9 | % |
| PERCENT MARGIN -  ELECTRIC                       |       | 42.3              | %          | 44.2              | %          |       |       |       |       |

 

----

(1)                                  As reported onAWR’s Consolidated Statements of Income, except for supply cost balancingaccounts. The sum of water and electric supply cost balancing accounts in thetable above are shown on AWR’s Consolidated Statements of Income and totaled($779,000) and ($1,910,000) for the six months ended June 30, 2008 and2007, respectively.

 

(2)                                  Water andelectric margins do not include any depreciation and amortization, maintenanceexpense, unrealized gains and losses on purchased power contracts, or otheroperating 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 ownwells can increase/decrease actual supply-related costs relative to the mixapproved for recovery through rates, thereby impacting earnings either negativelyor positively. GSWC has the opportunity to change the supply-related costsrecovered through rates, by application to the CPUC through a general rate caseproceeding. GSWC believes that its applications for recovery of supply-relatedcosts accurately reflect the water supply situation as it is known at the time.Without a “full-cost” balancing account authorized by the CPUC, earnings mayfluctuate from adverse changes in supply costs related to unforeseencontamination or other loss of water supply.

 

For the six months ended June 30,2008, 40.0% of GSWC’s water supply mix was purchased as compared to 40.4%purchased for the six months ended June 30, 2007. Because the cost ofwater purchased is generally higher than pumped water from our GSWC’s wells, thischange in mix resulted in a slight improvement in water’s percent margin in2008 compared to the same period in 2007.

 

45

----

Table of Contents

 

Purchased water costs forthe six months ended June 30, 2008 increased slightly by 0.4%.  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 supply mix allowed GSWC to serve a portion ofthe increased customer demand from groundwater production rather than wholesalepurchases, primarily because of the return to service or replacement of wellswhich had been removed from service as a result of water quality issues and mechanicalproblems.

 

For the six months ended June 30,2008, the decrease of 9.5% in power purchased for pumping was principally dueto lower customer demand, partially offset by a favorable change in the supplymix, as discussed above.  Groundwaterproduction assessments were higher by 9.1% due to a favorable change in supplymix and increases in assessment rates (pump tax rates) levied againstgroundwater production, effective July 2007.  Average pump tax rates increased in Region IIand III by approximately 8% and 6%, respectively, between the two periods.  These increases in groundwater productionassessments 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.

 

An increase of $554,000in the water supply cost balancing account provision during the six monthsended June 30, 2008 as compared to the same period in 2007 was primarilycaused by: (i) a $324,000  increasein the amortization of the water supply cost balancing accounts; (ii) anet decrease totaling $211,000 of under-collections in 2008 compared to thesame period in 2007 caused by recent CPUC decisions that updated the authorizedrates for supply costs, therefore, lowering the level of under-collectionsbeing recorded, and (iii) a $199,000 decrease in interest earned on thesupply cost balancing accounts.  Theseincreases to the water supply cost balancing account provision were offset bythe recording of an $181,000 net under-collection adjustment relating to RegionIII’s pre-2001 supply costs which were approved by the CPUC in May of2008.  Upon approval by the CPUC, aregulatory asset was established for these previously incurred supply costs.

 

For the six months ended June 30,2008, the cost of power purchased for resale to customers in GSWC’s BVESdivision decreased by 5% to $6.8 million compared to $7.2 million for the sixmonths ended June 30, 2007 reflectingan increase in sales of surplus power to the spot market at higher energy prices.   Income from the spot market sales for thesix months ended June 30, 2008 decreased the cost of power purchased forresale and 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$4.5 million pretax unrealized gain on purchased power contracts for the sixmonths ended June 30, 2008 is due to an increase in the current forwardmarket prices since December 31, 2007. There was a $2.5 million pretaxunrealized gain on purchased power contracts for the six months ended June 30,2007. Unrealized gains and losses at BVES will continue to impact earningspositively or negatively during the life of the contract, which terminates atthe end of 2008.  As of June 30,2008, there is a cumulative unrealized gain of $3.0 million which will berecognized as a decrease 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 six months ended June 30,2008 and 2007, other operating expenses by segment consisted of the following(amounts in thousands):

 

46

----

Table of Contents

 
| ** **                      | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                      | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                  |       | $                 | 10,996     |              | $          | 10,826     |       | $          | 170        |   | 1.6 | % |
| Electric  Services              |       | 1,086             |       | 823               |       | 263        |       | 32.0       | %          |
| Contracted  Services            |       | 2,967             |       | 1,507             |       | 1,460      |       | 96.9       | %          |
| Total other  operating expenses |       | $                 | 15,049     |              | $          | 13,156     |       | $          | 1,893      |   | 14.4 | % |

 

For the six months ended June 30, 2008, otheroperating expenses for water services increased by 1.6% due primarily to anincrease in labor costs of $470,000 due to higher wages and related benefits,as well as an increase of $166,000 in bad debt expense.   These increases were partially offset bylower outsideservice costs of $265,000 related to the removal of nitrate and perchlorate atvarious groundwater treatment plants that occurred in 2007.  There was also a decrease of $85,000 inequipment rental and $116,000 relating to other miscellaneous operatingexpenses.

 

There was an increase of $263,000 in other operatingexpenses for electric services primarily due to higher wages and relatedbenefits of $153,000, as well as an increase of $67,000 in bad debt expense.

 

Contracted services experienced increases in otheroperating expenses of $1.5 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, partiallyoffset by lower other operating expenses at Fort Bliss and ODUS.  As a result of these new bases, otheroperating expenses, which included transition costs associated with thestart-up of these bases (most of which was recovered from the U.S. government)increased by $1.7 million during the six months ended June 30, 2008.

 

***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 generalcorporate expenses. For the six months ended June 30, 2008 and 2007,administrative and general expenses by segment consisted of the following(amounts in thousands):

 
| ** **                                 | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                 | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                             |       | $                 | 21,700     |              | $          | 21,358     |       | $          | 342        |   | 1.6 | % |
| Electric  Services                         |       | 3,080             |       | 2,972             |       | 108        |       | 3.6        | %          |
| Contracted  Services                       |       | 4,990             |       | 2,341             |       | 2,649      |       | 113.2      | %          |
| Total  administrative and general expenses |       | $                 | 29,770     |              | $          | 26,671     |       | $          | 3,099      |   | 11.6 | % |

 

For the sixmonths ended June 30, 2008, administrative and general expenses increasedby $450,000 in water and electric services compared to the six months ended June 30,2007 due primarily to an increase in labor costs due to higher wages largelyrelated to Registrant’s annual performance-based salary review program,partially offset by a decrease in outside services relating to lower tax andlegal services.

 

There was an increase of$2.6 million in contracted services administrative and general expenses dueprimarily to an increase of $1.7 million 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.  There were also increases at the other basesincluding: (i) anincrease of approximately $388,000 in outside services for legal and

 

47

----

Table of Contents

 

consulting work,including costs incurred in connection with a business acquisition, discussedpreviously; (ii) an approximate $442,000 increase in labor and employeebenefit costs, and (iii) a charge of $213,000relating to a business acquisition and related settlement of the preexistingrelationship between ASUS and its wastewater subcontractor.

 

There was also an increase of $335,000 in allocation from thecorporate headquarters to ASUS and its subsidiaries. A final decision on thegeneral rate case for GSWC’s Region II and the application to cover generaloffice expenses allocated to Regions II and III were approved on November 16,2007 and imposed an increased allocation of corporate headquarters’ expenses tocontracted services.

 

***Depreciation and Amortization***

 

For the six months ended June 30,2008 and 2007, depreciation and amortization by segment consisted of thefollowing (amounts in thousands):

 
| ** **                           | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                           | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                       |       | $                 | 14,310     |              | $          | 13,014     |       | $          | 1,296      |   | 10.0 | % |
| Electric  Services                   |       | 1,105             |       | 1,067             |       | 38         |       | 3.6        | %          |
| Contracted  Services                 |       | 188               |       | 96                |       | 92         |       | 95.8       | %          |
| Total  depreciation and amortization |       | $                 | 15,603     |              | $          | 14,177     |       | $          | 1,426      |   | 10.1 | % |

 

For the six months ended June 30,2008, overall depreciation and amortization expense increased by 10.1% to $15.6million compared to $14.2 million for the six months ended June 30, 2007reflecting, among other things, the effects of closing approximately $55.2 millionof additions to utility plant during 2007, depreciation on which began in January 2008.  There were also changes to the compositedepreciation rates recently 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.

 

***Maintenance***

 

For the six months ended June 30,2008 and 2007, maintenance expense by segment consisted of the following(amounts in thousands):

 
| ** **           | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **           | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **           | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services       |       | $                 | 6,935      |              | $          | 6,930      |       | $          | 5          |   | 0.1 | % |
| Electric  Services   |       | 329               |       | 179               |       | 150        |       | 83.8       | %          |
| Contracted  Services |       | 1,278             |       | 217               |       | 1,061      |       | 488.9      | %          |
| Total  maintenance   |       | $                 | 8,542      |              | $          | 7,326      |       | $          | 1,216      |   | 16.6 | % |

 

There was an increase of $150,000 in maintenance forelectric services related to the 8.4 MW natural gas-fueled generation plant.

 

There was an increase of$1.1 million in contracted services maintenance expense due primarily to thecommencement of the operation of water andwastewater systems at military bases in North Carolina and South Carolina thatbegan during the first quarter of 2008, which added $880,000 in maintenanceexpense.  The level of maintenance costsat these bases also reflect the age and condition of the respectiveinfrastructure.  There was also increasedmaintenance expense of $197,000 necessary at the Virginia bases.

 

48

----

Table of Contents

 

***Property and Other Taxes***

 

Forthe six months ended June 30, 2008 and 2007, property and other taxes bysegment consisted of the following (amounts in thousands):

 
| ** **                      | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                      | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                  |       | $                 | 5,386      |              | $          | 5,211      |       | $          | 175        |   | 3.4 | % |
| Electric  Services              |       | 178               |       | 503               |       | (325       | )          | -64.6      | %          |
| Contracted  Services            |       | 195               |       | 59                |       | 136        |       | 230.5      | %          |
| Total property  and other taxes |       | $                 | 5,759      |              | $          | 5,773      |       | $          | (14        | ) | -0.2 | % |

 

Forthe six months ended June 30, 2008, overall property and other taxesremained relatively unchanged. Additional property taxes resulting from higherassessed values, and increases in payroll taxes based on increased labor costs,were offset by lower franchise fees at BVES.

 

***Construction Expenses***

 

Forthe six months ended June 30, 2008, ASUS’ construction expenses decreasedto $8.3 million compared to $17.3 million for the same period in 2007reflecting primarily the costs incurred in 2007 for the wastewater expansionproject at Fort Bliss. As previously mentioned, ASUS entered into a$20.6 million project in 2007 for the construction of certain improvementsto the existing wastewater infrastructure located at Fort Bliss in El Paso,Texas. For the six months ended June 30, 2007, this project generated$15.2 million in construction expenses. The project was completed in August 2007.The decrease in construction expenses because of this project was partially offsetby other smaller construction projects that were completed during the sixmonths ended June 30, 2008.

 

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

 

For the six months ended June 30,2007, water services recorded a net pretax gain of $605,000 on the sale ofproperty primarily related to a gain of $325,000 relating to GSWC’s sale of aparcel of land to  the Los AngelesUnified School District for the purpose of constructing a high school. Therewas also a pretax gain of $238,000 on the sale of property it owned in the Cityof Claremont. There were no similar gains in the same period of 2008. Earningsand cash flows from these transactions are sporadic and may or may not continuein future periods.

 

***Interest Expense***

 

Forthe six months ended June 30, 2008 and 2007, interest expense by segmentconsisted of the following (amounts in thousands):

 
| ** **                   | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 10,233     |              | $          | 10,492     |       | $          | (259       | ) | -2.5 | % |
| Contracted  Services         |       | 439               |       | 574               |       | (135       | )          | -23.5      | %          |
| Total interest  expense      |       | $                 | 10,672     |              | $          | 11,066     |       | $          | (394       | ) | -3.6 | % |

 

Forthe six months ended June 30, 2008, overall interest expense decreased by3.6% to $10.7 million compared to $11.1 million for the six months ended June 30,2007 primarily reflecting lower short-term interest rates. The average interestrate on short-term borrowings for the six months ended June 30, 2008 was3.8%, as compared to an average of 6.1% during the same period of 2007. Thiswas partially offset by an increase in short-term borrowings. Average bank loanbalances outstanding under an AWR credit facility for the six months ended June 30,2008 were approximately $48 million, as compared to an average of $34 millionduring the same period of 2007.

 

49

----

Table of Contents

 

***Interest Income***

 

Forthe six months ended June 30, 2008 and 2007, interest income by segmentconsisted of the following (amounts in thousands):

 
| ** **                   | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 1,132      |              | $          | 1,135      |       | $          | (3         | ) | -0.3 | % |
| Contracted  Services         |       | 4                 |       | 17                |       | (13        | )          | -76.5      | %          |
| Total interest  expense      |       | $                 | 1,136      |              | $          | 1,152      |       | $          | (16        | ) | -1.4 | % |

 

Interestincome for water and electric services decreased slightly by 0.3% due to lessinterest earned on short-term cash surplus and a decrease of $298,000 ininterest accrued on the uncollected balance of the Aerojet litigationmemorandum account authorized by the CPUC due to lower interest rates. Thesedecreases were almost completely offset by the recording of $480,000 ininterest income in connection with the IRS’s examination of the 2002 income taxreturn.

 

***Other***

 

For the six months ended June 30,2008 and 2007, water services recorded other income of $121,000 and $132,000,respectively, as a result of its ownership interest in a non-operating equityinvestment.

 

***Income Tax Expense***

 

Forthe six months ended June 30, 2008 and 2007, income tax expense by segmentconsisted of the following (amounts in thousands):

 
| ** **                   | ** ** | **6 Months** | ** ** | **6 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                   | ** ** | **6/30/2008**     | ** ** | **6/30/2007**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and  Electric Services |       | $                 | 10,652     |              | $          | 9,034      |       | $          | 1,618      |   | 17.9 | % |
| Contracted  Services         |       | (611              | )          | 1,186             |       | (1,797     | )          | -151.5     | %          |
| Total income tax  expense    |       | $                 | 10,041     |              | $          | 10,220     |       | $          | (179       | ) | -1.8 | % |

 

Forthe six months ended June 30, 2008, income tax expense for water andelectric services increased by 17.9% to $10.7 million compared to $9.0 millionfor the six months ended June 30, 2007 due primarily to an increase inpretax income. The ETR for water and electric services for the six months endedJune 30, 2008 was 40.6% as compared to a 42.2% ETR applicable to the sixmonths ended June 30, 2007. The ETR decreased primarily due to changesbetween book and taxable income that are treated as flow-through adjustments(principally plant-, rate-case- and compensatory-related in nature) inaccordance with regulatory requirements.  Flow-through adjustmentsincrease or decrease tax expense in one period, with an offsetting increase ordecrease occurring in another period.

 

Incometax expense for contracted services decreased to a tax benefit of $611,000compared to tax expense of $1.2 million for the six months ended June 30,2007 due primarily to a decrease in pretax income. The ETR for contractedservices for the six months ended June 30, 2008 was 38.6% as compared to a37.8% ETR applicable to the six months ended June 30, 2007.

 

50

----

Table of 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 with aggregate bank commitments of $85 million thatis currently utilized to support operations. Up to $20million of this facility may be used for letters of credit. As of June 30,2008, an aggregate of $56.8 million in cash borrowings were included in currentliabilities and approximately $11.1 million of letters of credit wereoutstanding under this facility. As of June 30, 2008, AWR has $17.1million available to borrow under the credit facility. AWR also has aRegistration Statement on file with the Securities and Exchange Commission forthe sale from time to time of debt and equity securities. As of June 30,2008, $156.5 million was available for issuance under this RegistrationStatement which will expire on November 30, 2008. AWR may seek to increasethe $85 million revolving credit facility by up to $30 million and/or issuecommon stock in 2008. Proceeds from the issuance of common stock would be usedto pay down short-term borrowings.

 

AWRfunds its operating expenses and pays dividends on its outstanding commonshares primarily through dividends from GSWC and through proceeds from equityissuances not invested in subsidiaries. The ability of GSWC to pay dividends toAWR is restricted by California law. Under restrictions of the Californiatests, at June 30, 2008, approximately $126.3 million was available fromthe retained earnings of GSWC to pay dividends to AWR. GSWC is also subject tocontractual restrictions on its ability to pay dividends. GSWC’s maximumability to pay dividends is restricted by certain Note Agreements to the sum of$21 million plus 100% of consolidated net income from various dates plus theaggregate net cash proceeds received from capital stock offerings or otherinstruments convertible into capital stock from various dates. Under the mostrestrictive of the Note Agreements, $233.8 million was available to paydividends to AWR as of June 30, 2008. GSWC is also prohibited from payingdividends if, after giving effect to the dividend, its total indebtedness tocapitalization ratio (as defined) would be more than 0.6667 to 1. Dividends inthe amount of $4.4 million were paid to AWR by GSWC during the three monthsended June 30, 2008. No dividends were declared and paid to AWR by GSWCduring the three months ended March 31, 2008 due to sufficient cashresiding at the AWR level.

 

AWR has paid common dividends for over 75 consecutive years. On July 29,2008, AWR declared a regularquarterly dividend of $0.250 per Common Share. The dividend, totalingapproximately $4.3 million,will be paid on September 1, 2008 to common shareholders of recordat the close of business on August 8, 2008. During the six months ended June 30,2008 and 2007, AWR paid quarterly dividends to shareholders, totalingapproximately $8.6 million or $0.500 per share and $8.0 million or $0.470 pershare, respectively. AWR presently intends to continue paying quarterly cashdividends in the future, on March 1, June 1, September 1 and December 1,

 

51

----

Table of Contents

 

subject to earnings and financial condition,regulatory requirements and such other factors as the Board of Directors maydeem relevant.

 

AWRanticipates that interest costs will increase in future periods due to the needfor additional 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.

 

In August2008, Standard & Poor’s reaffirmed a rating of “A stable” for both AWR andGSWC.

 

*Cash Flows from Operating Activities*:

 

Registrant’sfuture cash flows from operating activities will be affected by utilityregulation; infrastructure investment; maintenance expenses; inflation;compliance with environmental, health and safety standards; production costs;customer growth; per customer usage of water; weather and seasonality. Inaddition, future cash flows from non-regulated subsidiaries will depend on newbusiness activities, including military base operations and the construction ofnew and/or replacement infrastructure at the different military bases, timelyredetermination of prices and requests for equitable adjustments of prices andtimely collection of 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 Notice of Appeal of this assessment stating itsdisagreement with the position taken by the U.S. Army. The U.S. Army hasresponded to the appeal and has disagreed with all of FBWS’ assertions. On July 1,2008, FBWS served written discovery on the government (interrogatories andrequests for production of documents) related to the liquidated damages claimedby the U.S. government.  The U.S. government has 45 days torespond.   In addition, on July 15, 2008, the government fileda motion for partial summary judgment.  The motion asks the ArmedServices Board of Contract Appeals 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.

 

Cashflows from operating activities have generally been sufficient to meet operatingrequirements and a portion of capital expenditure requirements. Registrant willseek access to debt and equity capital markets to meet the balance of capitalexpenditure requirements. There can be no assurance that Registrant will beable to successfully access such markets on favorable terms or at all.Operating cash flows can be negatively affected by changes in the regulatoryenvironments.

 

Takinginto account the factors noted above, Registrant also obtains cash fromnon-operating sources such as the proceeds from debt issuances, customeradvances for and contributions in aid of construction and equity offerings,discussed below in financing activities.

 

Netcash provided by operating activities was $27.7 million for the six monthsended June 30, 2008 as compared to $30.3 million for the same period endedJune 30, 2007. The overall decrease of $2.6 million was primarilyattributable to a $4.7 million increase in ASUS’ costs and estimated earningsin excess of billings on uncompleted contracts during the six months ended June 30,2008. This was caused primarily by an increase in construction activities atAndrews Air Force Base that will be billed and collected in future periods. Thiswas offset by an increase of $1.0 million in cash collected during the sixmonths ended June 30, 2008 from the U.S. government on projects, primarilyat Fort Bliss. The timing of cash receipts and disbursements related to otherworking capital items also affected the changes in net cash provided byoperating activities. Changes in cash flows from operating activities weregenerally consistent with changes in the results of operations as adjusted bychanges in working capital in the normal course of business.

 

*Cash Flows from Investing Activities*:

 

Netcash used in investing activities, which consists primarily of constructionexpenditures at GSWC, increased to $41.1 million for the six months ended June 30,2008 as compared to $19.3 million for the same period in 2007. This increasewas primarily due to higher construction expenditures totaling $18.9 millionconsistent with Registrant’s capital investment plan for 2008. Also in 2008,ASUS completed the acquisition of substantially all of the net assets of thesubcontractor that provided the wastewater services to ASUS’ subsidiaries atmilitary bases for an aggregate purchase price of $2.3 million related to thenet assets. In 2007, cash used in investing activities also included proceedsreceived on the sale of property. There were no proceeds received on the saleof property during 2008.

 

52

----

Table of Contents

 

Cashflows used in investing activities are expected to rise during 2008 asconstruction expenditures are expected to be approximately $55 million to $60million during 2008. Registrant intends to invest capital prudently to provideessential services to its regulated customer base, while working with itsregulators to have the opportunity to earn a fair rate of return on investment.Registrant’s infrastructure investment plan consists of both infrastructurerenewal programs, where it replaces infrastructure as needed, and major capitalinvestment projects, where it will construct new water treatment and deliveryfacilities. Projected capital expenditures and other investments are subject toperiodic review and revision to reflect changes in economic conditions andother factors.

 

*Cash Flows from Financing Activities*:

 

Registrant’sfinancing activities include the issuance and repayments of long-term debt andnotes payable to banks, primarily through its wholly owned subsidiary, GSWC,the issuance of common shares, proceeds from stock option exercises, and thepayment of dividends on common shares. In order to finance new infrastructure,Registrant also receives customer advances for and contributions in aid ofconstruction (net of refunds).

 

Netcash provided by financing activities was $12.1 million for the six monthsended June 30, 2008 as compared to net cash used of $9.0 million for thesame period in 2007. The increase of $21.1 million in net cash provided byfinancing activities was primarily caused by an increase of $23.1 million innotes payable to banks to fund operations. This increase was partially offsetby an increase of $604,000 in dividends paid to AWR’s shareholders and adecrease of $1.1 million in the proceeds from stock option exercises.

 

***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 contributionsfrom customers, home builders and real estate developers to fund constructionnecessary to extend service to new areas. Advances for construction arerefundable generally at rates ranging from 10% to 22% of the revenues receivedfrom the installation for which funds were advanced or in equal annualinstallments over periods of time ranging from 10 to 40 year periods. Amountswhich are no longer refundable are reclassified to contributions in aid ofconstruction. Utility plant funded by advances and contributions is excludedfrom rate base. Generally, GSWC depreciates contributed property and amortizescontributions in aid of construction at the composite rate of the relatedproperty.

 

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 June 30, 2008, $50 millionremained for issuance under this Registration Statement, which will expire on November 30,2008.

 

*Cash Flows from Operating Activities*:

 

Netcash provided by operating activities was $29.4 million for the six monthsended June 30, 2008 as compared to $26.5 million for the same period in2007. The increase of $2.9 million is primarily attributable to the timing ofcash receipts and disbursements related to working capital items affecting thechanges in net cash provided by operating activities. Changes in cash flowsfrom operating activities were generally consistent with changes in the resultsof operations as adjusted by changes in working capital in the normal course ofbusiness.

 

*Cash Flows from Investing Activities*:

 

Netcash used in investing activities increased to $36.0 million for the six monthsended June 30, 2008 as compared to $18.1 million for the same period in2007. This increase was primarily due to higher capital expenditures consistentwith GSWC’s 2008 capital improvement plan. In 2007, cash used in investingactivities also included proceeds received on the sale of property. There wereno proceeds received on the sale of property during 2008.

 

53

----

Table of Contents

 

*Cash Flows from Financing Activities*:

 

Netcash provided by financing activities was $5.6 million for the six months endedJune 30, 2008 as compared to net cash used of $7.0 million for the sameperiod in 2007. The increase in net cash provided by financing activities wasprimarily caused by an $8.4 million increase in the net change in intercompanyborrowings and a $4.2 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, providesfunding to its subsidiaries.

 

**Contractual Obligations and OtherCommitments**

 

Registrant has various contractual obligations whichare recorded as liabilities in the consolidated financial statements. Otheritems, such as certain purchase commitments and operating leases are notrecognized as liabilities in the consolidated financial statements, but arerequired to be disclosed. In addition to contractual maturities, Registrant hascertain debt instruments that contain annual sinking fund or other principalpayments. Registrant believes that it will be able to refinance debtinstruments at their maturity through public issuance, or private placement, ofdebt or equity. Annual principal and interest payments are generally made fromcash flow from operations.

 

There have been no material changes to AWR’s contractual obligations and other commitments since December 31, 2007. See *“Managements’ Discussion and Analysis of Financial Condition and Results of Operation—Contractual Obligations, Commitments and Off Balance Sheet Arrangements”*section of the Registrant’s Form 10-K for the year-ended December 31, 2007 for a detailed discussion of contractual obligations and other commitments.

 

**RegulatoryMatters**

 

GSWCis subject to regulation by the CPUC, which has broad powers with respect toservice and facilities, rates, classification of accounts, valuation ofproperties, the purchase, disposition and mortgaging of properties necessary oruseful in rendering public utility service, the issuance of securities, thegranting of certificates of public convenience and necessity as to theextension of services and facilities and various other matters. CCWC is subjectto comparable regulation by the ACC.

 

Ratesthat GSWC and CCWC are authorized to charge are determined by the CPUC and theACC, respectively, in general rate cases and are derived using rate base, costof service and cost of capital, as projected for a future test year inCalifornia and using a historical test year, as adjusted, in Arizona. Ratescharged to customers vary according to customer class and rate jurisdiction andare generally set at levels allowing for recovery of prudently incurred costs,including a fair return on rate base. Rate base generally consists of theoriginal cost of utility plant in service, plus certain other assets, such asworking capital and inventory, less accumulated depreciation on utility plantin 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 Regions II and III plus the general office will undergo rate review in asingle case. Region I’s most recent rate case was decided on January 31,2008, and will file its next rate case in January 2010, for rates in years2011 and 2012. GSWC will then file all three 

 

54

----

Table of Contents

 

regions in July 2011,with an 18 month processing schedule, for years 2013, 2014, and 2015. Accordingto the new rate case schedule, all Regions will then be reviewed in a singlecase for the ensuing three-year cycle. The new consolidated GRC is expected tohave an 18-month processing schedule. In California, rates may also beincreased by offsets for certain expense increases, including but not limitedto supply cost offset and balancing account amortization, advice letter filingsrelated to certain plant additions and other operating cost increases. Offsetrate increases and advice letter filings typically have a two- to four- monthregulatory processing lag.

 

Underthe new rate case plan adopted by the CPUC in May 2007, GSWC filed a separateapplication to review the rate of return authorized by the CPUC. In prioryears, the rate of return was determined as part of the general rate caseprocess along with all other operating costs. This new procedure to separatethe rate of return from the general rate case is the same process that the CPUCutilizes to determine the rate of return for energy companies under CPUCjurisdiction. GSWC filed its first cost of capital application under the newrate case plan on May 1, 2008. The application requests the CPUC to adopta new rate of return on rate-base (“RORB”) of 10% on average for calendar years 2009, 2010, and 2011, based on areturn on equity (“ROE”) of 12.1%. According to the rate case plan, the CPUCintends to process the cost of capital proceeding in six months, at which time,the rate of return authorized by the CPUC will be implemented into rates on acompany-wide basis. If approved as filed, the new adopted ROE and RORB areexpected to generate approximately $12 million of additional annual revenue in2009. The scoping memo for this proceeding has been bifurcated it into twophases. Phase I will establish ROE’s for the utilities in the case. Phase IIwill address automatic adjustment mechanisms 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. In addition, ASUS’ subsidiaries are regulatedby their respective commissions in the state in which they operate. However,the amounts charged by the subsidiaries of ASUS for water and wastewaterservices at military bases are based upon the terms of 50-year contracts withthe U.S. government and supplemental fixed price construction contracts. Theoperations and maintenance contracts provide that prices will be redeterminedat the end of two years after commencement of operations at each military baseand every three years thereafter. In addition, prices may be equitably adjustedfor changes in law, wage and benefit increases and other circumstances. ASUShas, however, experienced delays in the redetermination of rates. For thesupplemental construction contracts, prices may be changed through the changeorder process if significant unforeseen issues arise during the constructionprocess.

 

***Recent Changes in Rates***

 

*Rate increases in 2008:*

 

In January 2008, theCPUC approved rate increases for the seven ratemaking areas in the Region Icustomer service area. The authorized rate increases will provide GSWCadditional annual revenues of approximately $6.4 million in 2008 based on anauthorized ROE of 10.2%. The new rates were effective January 1, 2008. On March 3,2008, the Department of Ratepayer Advocates (“DRA”) filed an application forrehearing of the Region I GRC decision on various legal grounds. As permittedby the CPUC, GSWC filed a response to DRA’s application. GSWC is not able topredict the outcome of this matter.

 

In January 2008, theCPUC also approved attrition year rate increases for Regions II and Region IIIcustomer service areas effective January 1, 2008. The authorized rateincreases will provide GSWC additional annual revenues of approximately $3.6million for Region II representing the second year of a three-year rate caseincrease approved by the CPUC in 2007. The increase of approximately $3.0million for Region III is the third year of a three-year rate increase approvedin 2006.

 

The combined rateincreases for Regions I, II and III are designed to generate approximately$13.0 million annually, based upon normalized sales levels approved by theCPUC, effective January 1, 2008.

 

*Rate increases in 2007:*

 

In February 2006,GSWC filed an application with the CPUC for rate increases in Region II and tocover general office expenses at the Corporate Headquarters. The rate increasesfor the Corporate Headquarters’ expenses would also increase Region III ratesfor 2007. Due to delays in issuing a decision on these applications, the CPUChad previously approved interim rate increases totaling $1.2 million and$135,000 for Region II and Region III, respectively, that became effective January 1,2007. On November 16, 2007, the CPUC approved the general rate increasesfor the Region II service area and additional rate increases in Region II andIII to recover general office 

 

55

----

Table of Contents

 

expenses at the Corporate Headquarters. Based on thedecisions issued by the CPUC on November 16, 2007, the approved revenueincreases for 2007 were approximately $6.4 million for Region II andapproximately $3.0 million to recover Corporate Headquarters’ expensesallocated to Region III. The rate increases were retroactive to January 1,2007. Accordingly, during the fourth quarter of 2007, GSWC recorded the revenuedifference between the interim rates implemented on January 1, 2007 andthe final rates authorized by the CPUC for the period from January 1 tothe implementation of the authorized rates. This resulted in the recording of a$7.2 million regulatory asset and corresponding increase in revenues during thefourth quarter of 2007. A surcharge was implemented in the first quarter of2008 to begin recovering this amount from customers.

 

ForGSWC’s Region III rate case approved by the CPUC on January 12, 2006, theCPUC also approved the second year increases for Region III in an estimatedamount of approximately $2.3 million, effective January 1, 2007.Based on certain corrections to the rate calculation, GSWC also filed anApplication for Rehearing to request additional revenues in connection with theJanuary 2006 decision. On July 31, 2008, the CPUC adopted astipulation jointly filed by GSWC and DRA. The stipulation addressed all of thepending issues including proposing a 12-month surcharge enabling GSWC torecover revenues of approximately $541,000 for the period January 1, 2006and July 31, 2008.  In addition, it was stipulated that tariffs inRegion III should be adjusted  foradditional revenues generated from the date the stipulation was approved. The adjustment will result in an annual increase in revenues ofapproximately $228,000.    As aresult of the CPUC’s approval, a regulatory asset of $541,000 was establishedin July 2008 with a corresponding increase to income. This regulatoryasset will be recovered through the 12-month surcharge.

 

***Pending Rate Changes***

 

*GSWC*

 

Accordingto the CPUC’s new water rate case plan adopted in May 2007 discussedabove, GSWC filed its general rate case for Region II and III plus the generaloffice on July 1, 2008. The new rates are to be effective for 2010, 2011and 2012. GSWC filed for revenue increases and if approved as filed, the rateincreases for Region II are expected to generate approximately $20.3 million inannual revenues starting in 2010, $2.6 million in 2011 and $4.2 million in2012, and increases of $30.0 million starting in 2010, $1.7 million in 2011 and$3.7 million in 2012 for Region III.

 

In June 2008,GSWC’s BVES division filed its general rate case with the CPUC’s electricdivision. The filing was the first full general rate case for BVES since 1996. Costs incurred in connectionwith the construction of the generating facility are expected to be reviewed bythe CPUC as part of the 2008 general rate case. The filing requests anoverall annual revenue increase of $6.8 million.  All of the increase isto the base rate portion of BVES’ rates.  The $6.8 million increaserepresents an overall increase of approximately 23% over current rates. BVEShas included a request for a phased-in implementation 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%. BVESexpects to file a second application in the third quarter of 2008 to addressthe revenue requirement for the purchased power component of rates once a newpurchased power contract is executed later this year.

 

*CCWC*

 

CCWCfiled a rate case with the ACC in August 2004 for its water system inFountain Hills, Arizona. In September 2005, the ACC approved a rateincrease for CCWC. The rate increase was effective on October 1, 2005 andgenerated additional annual revenues of approximately $1.1 million, an 18%increase over 2004 revenues. During this GRC, CCWC sought to have its ratesdetermined using a fair value rate base. The ACC elected not to use fair valuein setting the rates. CCWC appealed ACC’s use of only original cost lessdepreciation rate base to determine the revenue requirement. Because CCWC’sfair value rate base was higher, the use of original cost exclusively todetermine the revenue requirement deprived CCWC of a substantial amount ofoperating income. Following the approval of this rate case, CCWC filed anappeal with the Arizona Court of Appeals. On February 13, 2007, theArizona Court of Appeals upheld CCWC’s challenge to the ACC’s failure to usefair value rate base in the determination of operating income. The process theACC utilized resulted in a lower revenue requirement and was found to be inviolation of the Arizona Constitution. However, the Court also held that theACC’s determination of the return on equity, while not well-explained, was madebased on the evidence, was a matter within the agency’s substantial discretionand was lawful. The ACC decided to not seek review, and the matter was returnedto the ACC 

 

56

----

Tableof Contents

 

on remand formodification of the original ACC decision consistent with the decision of theCourt of Appeals. Testimony was filed by ACC staff and the Residential UtilityConsumer Office. The ACC conducted evidentiary hearings on the remanded case inJanuary 2008. The ACC rendered its final decision on July 17, 2008. Thedecision reduced the ROE from the 9.3% in the original decision by 200 basispoints resulting in a return on fair value rate base of 6.4%. The net increasein CCWC rates is $12,000.

 

Duringthe course of remand proceedings in the 2004 rate case, in the fourth quarterof 2007, CCWC filed its new general rate case with the ACC. Unlike California,there is not a three-year cycle in Arizona. The only filing requirement is thata utility cannot have two applications pending at the same time, and thetypical rule is that rates should be in effect for one year before filinga new case. In the 2007 filing, CCWC requested rate increases which areexpected to generate approximately $3.1 million in additional annualrevenues. The processing of this case was expected to take approximately18 months. However, the ACC suspended processing of the 2007 rate caseuntil completion of the proceedings on remand of the 2004 rate case. As aresult of the final determination in the 2004 rate case, CCWC intends to pursuethe 2007 case as promptly as possible including request for interim rates.

 

***OtherRegulatory Matters***

 

**Water Policy Application**

 

In September 2006, GSWC filed a Water Policy Application with theCPUC for authority to implement certain rate setting mechanisms, including theelimination of disincentives to conserve water and eliminate fluctuations inrevenues due to weather by, the establishment of a Water Revenue AdjustmentMechanism (“WRAM”) to decouple sales from revenues.

 

In February 2007,the CPUC opened an Order Instituting Investigation to Consider Policies toAchieve Conservation Objectives (the “Conservation OII”). GSWC’s Water PolicyApplication was consolidated into the CPUC’s Conservation OII. In a subsequentruling, the CPUC ruled that GSWC’s WRAM proposals would be consolidated intothe Conservation OII, but that the other issues included in GSWC’s Water PolicyApplication would not. The CPUC also directed GSWC to re-submit an increasingblock rate proposal for the existing ratemaking areas. GSWC was directed tofile a separate application to consider the other proposals in the policyapplication.

 

Currently,Registrant is actively participating in the CPUC’s Conservation OII. Throughthe Conservation OII, the CPUC proposes to eliminate disincentives to promoteconservation. Among other potential solutions being considered by the CPUC arerevisions to tariff structures to create increasing rate blocks, so thatgreater water sales  will be tempered byhigher unit pricing to consumers, and sales adjustment mechanisms, toessentially de-couple volume of sales from GSWC’s revenue requirement calculation.On October 19, 2007, GSWC and the DRA filed a settlement agreementregarding the conservation rate design and a WRAM. The settlement with DRAproposes to keep the existing ratemaking areas unconsolidated and to implementincreasing block rates in each individual ratemaking area. If the settlement isapproved by the CPUC, GSWC would implement an increasing block rate design as ameans to encourage water conservation. GSWC would also establish a WRAMbalancing account to track revenue shortfalls for later recovery fromcustomers.

 

In May 2007,the CPUC issued a ruling in the Conservation OII which directed the parties inthe proceeding to address the issue of whether the adoption of a revenueadjustment mechanism should affect the water utilities’ authorized rate ofreturn. GSWC and other parties submitted testimony and evidentiary hearings onthis issue were held in November 2007. In July 2008, the assignedAdministrative Law Judge issued a Proposed Decision (“PD”) in the ConservationOII. In addition, on the same day, an Alternate Decision (“AD”) was issued bythe assigned Commissioner’s office. Both decisions recommended approval of theGSWC/DRA settlement regarding conservation rate design and implementation of aWRAM. The two decisions differ with regards to their recommendations to changethe authorized rate of return. The PD recommends an adjustment to the rate ofreturn with the implementation of the WRAM, and the AD recommends deferring theissue to the upcoming cost of capital proceeding. GSWC expects the CPUC toissue a final decision in the third quarter of 2008.

 

**Westborough Development, 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, 

 

57

----

Tableof Contents

 

the CPUC rejected theadvice letter without prejudice, and invited GSWC to re-file the advice letteronce the City of Folsom protest was resolved, or file an application for CPUCapproval of the service territory expansion.

 

In June 2007,GSWC signed an agreement with the City of Folsom and the City agreed not tocontest GSWC’s providing water service to Westborough and relinquished allclaims concerning GSWC’s providing water service to the area. As compensationto the City of Folsom to resolve its claim, GSWC has agreed to pay the City ofFolsom $550,000. Aerojet will reimburse GSWC for 50%, or $275,000, of thesettlement payment. As of June 30, 2008, GSWC has recorded anobligation of $550,000 to the City of Folsom and an additional receivable of$275,000 from Aerojet for the amount to be reimbursed. During the third quarterof 2007, GSWC filed a second advice letter after resolving the issue with theCity. That advice letter was subsequently protested by the Sacramento CountyWater Agency (“SCWA”). GSWC filed a response to the SCWA protest. In November 2007,the Water Division of the CPUC rejected the advice letter without prejudice andGSWC has been in discussions with SCWA and Aerojet to resolve the objectionsraised by SCWA in their protest. During the second quarter of 2008, theobjections raised by SCWA in their protest were removed. 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 recovery from Aerojet of the $17.5 millionin legal and expert costs and accrued interest from January 1, 2004 in theAerojet litigation, previously discussed, is contingent upon the issuance ofland use approvals for development of Aerojet property which includes theWestborough development and the receipt of certain fees in connection with thatdevelopment.

 

**Supply CostMemorandum/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 accountstrack differences between the current cost for supply items (water, power, andpump 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 June 30,2008, there is approximately $11.1 million net under-collection in the water supplycost balancing accounts. Of this amount, approximately $8.1 million relates toGSWC’s Region III customer service area. In May 2008, the CPUC approved asurcharge to begin recovering $7.0 million of this under-collection over 24months.   The remaining $3.0 million net under-collections in thewater supply cost balancing accounts relate to GSWC’s Region I netunder-collection of $2.0 million and Region II’s net under-collection of$970,000. Currently, there is a surcharge in place in Region I expiring in January 2009to recover this under-collection, and a surcredit at Region II to refund aprevious over-collection expiring in August 2008.

 

**Santa Maria GroundwaterAdjudication and Memorandum Accounts**

 

In 1997, the Santa Maria Valley Water ConservationDistrict (“plaintiff”) filed a lawsuit against multiple defendants, includingGSWC, the City of Santa Maria, and several other public water purveyors. Theplaintiff’s lawsuit sought an adjudication of the Santa Maria Groundwater Basin(the “Basin”). A stipulated settlement of the lawsuit has been reached, subjectto CPUC approval. The settlement, among other things, if approved by the CPUC,would preserve GSWC’s historical pumping rights and secure supplemental waterrights for use in case of drought or other reductions in the natural yield ofthe Basin. GSWC, under the stipulation, has a right to 10,000 acre-feet ofgroundwater replenishment provided by the Twitchell Project, a storage andflood control reservoir 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.

 

On February 11, 2008, the court issued itsfinal judgment, which approves and incorporates the stipulation.  Thejudgment awards GSWC prescriptive rights to groundwater against thenon-stipulating parties.  In addition, the judgment grants GSWC the rightto use the Basin for temporary storage and to recapture 45 percent of thereturn flows that are generated from its importation of State Water Projectwater.  Pursuant to this judgment, the court retains jurisdiction over allof the parties to make supplemental orders or to amend the judgment asnecessary. On 

 

58

----

Tableof Contents

 

March 20,2008, the non-stipulating parties filed notices of appeal. Registrant is unableto predict the outcome of the appeal.

 

GSWChas incurred costs of approximately $6.9 million as of June 30, 2008,including legal and expert witness fees, in defending its groundwater supply inthe Basin. Such costs had been recorded in utility plant for future raterecovery. In February 2006, GSWC filed an application with the CPUC forrecovery of $5.5 million of these costs, representing the amount of thecosts that had been incurred as of December 31, 2005. In February 2007,GSWC reached a settlement with the CPUC’s DRA authorizing recovery of the$5.5 million requested in GSWC’s application. The settlement deferredreview of the remaining legal costs pending final resolution of the lawsuit. InMay 2007, the CPUC issued a decision that approved the settlement with theDRA. Pursuant to the decision, GSWC was authorized to place in rate base$2.7 million of the $5.5 million of previously incurred litigationcosts. GSWC was also authorized to amortize, with interest, the remaining$2.8 million of the $5.5 million in rates over a ten-year period.This amount has been transferred into a separate memorandum account includedwithin regulatory assets and a surcharge was implemented in the third quarterof 2007 for recovery of these costs.

 

Alllitigation costs, including interest, that have been incurred since December 31,2005, totaling approximately $1.4 million, have also been transferred fromrate base to a separate new memorandum account, subject to a reasonablenessreview by the CPUC in a subsequent phase of this proceeding or in a newproceeding. In April 2008, the Administrative Law Judge closed theproceeding without ruling on the stipulation or authorizing recovery of theremaining costs. The ruling directed GSWC to file a new application. Inaccordance with this ruling, GSWC intends to file a new application. Managementbelieves that these additional costs will be approved and the recovery of thesecosts through rates is probable.

 

**CPUC Subpoena**

 

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 is currently responding to data requestssubmitted by the CPUC. Management cannot predict the outcome of theinvestigation or audit at this time.

 

**Bear Valley Electric Service**

 

GSWC’sBVES division has been filing compliance reports with the CPUC regarding itspurchases of energy from renewable energy resources. The filings indicated thatBVES had not achieved interim target purchase levels of renewable energyresources and thus, on its face, might be subject to a potential penalty. GSWChas formally contested the potential penalty reflected in the compliancereport. The CPUC has been considering the future timing and applicability ofrenewable energy resource requirements as they apply to smaller energyutilities like BVES. On May 30, 2008, the CPUC issued its final decisionregarding the renewable responsibilities of small utilities (including BVES). Thefinal decision affirmed the renewable obligation targets for the smallutilities but also allowed the small utilities to defer compliance under theCPUC’s flexible compliance rules. BVES will need to continue its efforts toprocure renewable resources each year going forward, and where that may provedifficult because the market for such resources is very constrained, then BVESwill be required to describe in detail the problems that warrant furtherdeferral, in accordance with the CPUC’s flexible compliance rules. Because thefinal decision 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.

 

Therehave been no other material 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.

 

59

----

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.

 

*DrinkingWater Standard:*

 

Duringthe first quarter of 2008, one of GSWC’s water systems located in northernCalifornia violated a drinking water standard.  GSWC routinely monitorsfor the presence of drinking water contaminants including total trihalomethanes(“TTHM”).  The TTHM samples taken in the first quarter of 2008indicated that this water system exceeded the maximum contaminant level (“MCL”)for TTHM.   During the first quarter, GSWC implemented variousoperational changes and conducted increased monitoring over the quarter in anattempt to identify and control the factors leading to the formation of TTHM inthe distribution system.** **Theresults of these studies indicate that source water quality is the predominatefactor in this situation. Water imported from the Sacramento-San Joaquin Deltaexperienced salt water intrusion and had high levels of organic compoundsfrom agricultural drainage during the first quarter. These compounds form TTHMduring the treatment process.  GSWC has no control over the quality of thesource water that is purchased from the Contra Costa Canal.  To remedy thesituation, GSWC has initiated the change to use chloramines as disinfectant. Chloraminationis an accepted and widely used method to mitigate TTHM. Before the treatmentprocess could be converted to chloramination, GSWC increased the purchase of chloraminatedwater from the Contra Costa Water District beginning in March 2008 andthroughout the second quarter of 2008. Based on the results of recentcompliance samples, GSWC is now in compliance of the TTHM MCL. The purchase oftreated water has resulted in incremental costs. GSWC has filed an advice letter with the CPUC toallow the establishment of a memorandum account to recover future additionalcosts.

 

*EnvironmentalClean-Up and Remediation:*

 

During the first quarter of 2008, hydrocarbon contaminatedsoil was found at a plant site (“Ballona Plant”)  located in GSWC’s Southwest customer servicearea where an abandoned water tank was demolished. The contamination appears tobe shallow and likely the result of past corrosion control practices. An initialinvestigation and characterization will be completed to determine the extent ofcontamination before any soil extraction is initiated. At this time, GSWC isunable to reasonably estimate the cost of clean-up. Historically, this type ofclean-up cost has been included in rates as approved by the CPUC.

 

Additional information on these requirements and othersignificant environmental matters is described in *“Management’sDiscussion and Analysis of**Financial Condition andResults of Operation”* included in Registrant’s 2007 Annual Report onForm 10-K for the year ended December 31, 2007. There have been noother material changes in any of the environmental matters discussed in the Form 10-Ksince December 31, 2007.

 

**WaterSupply**

 

***State Water Project***

 

GSWC managesa portfolio of water supplies, including groundwater production, use of treatedsurface 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 public agency organized and managed to provide asupplemental, imported supply of water to its member public agencies. GSWC has46 connections to MWD’s water distribution facilities and those of memberagencies. The Company purchases MWD water through six separate member agenciesaggregating more than 75,000 acre-feet annually. MWD’s principal sources ofwater are the Colorado River and the State Water Project (“SWP”) which conveyswater 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 the Sacramento/San Joaquin River Delta adjacent to theSan 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. A significant failure of the Delta leveesystem would substantially interfere with 

 

60

----

Tableof Contents

 

water exports, thuspotentially disrupting the water supply available to GSWC from northern Californiavia MWD. In light of these risks, the state Department of Water Resources andthe Governor have convened a series of interdisciplinary task forces to developproposals to preserve the environmental viability of the Delta and safeguardthe water supply. GSWC continues to participate in and monitor developmentsrelated to the Delta and efforts to craft a workable solution to the riskspresented by reliance on the Delta for water supply conveyance to southernCalifornia.

 

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 was legally insufficient andfailed to consider recent declines in delta smelt abundance.  A new BiOp,responsive to recent scientific findings and to the judge’s order, is expectedto be completed by September 2008.  The judge also imposed interimrestrictions on pumping until the new BiOp is completed, including significantreductions in deliveries to contractual customers of the SWP, including MWD, ofup to 37% of baseline deliveries.  Actual curtailments will depend onweather conditions, fish and flow patterns in the Delta.  MWD recentlyestimated that its deliveries from the SWP in light of the court order were 30%below the level that would have been expected based on hydrological andoperating conditions.

 

***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.

 

InJune, 2008, Governor Arnold Schwarzenegger proclaimed a statewide drought andissued an Executive Order to address “a dire situation”, arising from seriousdrought conditions and water delivery reductions in California. Water storagein many of the state’s major reservoirs is far below normal. The Colorado RiverBasin, which provides water to Southern California via the Metropolitan WaterDistrict of Southern California, is experiencing a record eight-year drought.The governor said the drought “is an urgent reminder of the immediate need toupgrade California’s water infrastructure.”

 

Theabove average precipitation level in early 2008 in California was offset by dryweather experienced since March of 2008. The precipitation level in theState for the three months ended June 30, 2008 was 0.78 inches, which wasmuch lower than the 10-year average precipitation of 2.60 inches for the sameperiod. The precipitation level for the month of June 2008 was only 0.02inches, the fourth driest month on record for the past 113 years. The U.S.Drought Monitor’s July 3, 2008 publication forecasted little rainfallacross California, and it is unlikely that the state will experiencesignificant improvement in the near future.

 

GSWCis investing in infrastructure improvements to protect water supplies fromsource to tap and encouraging its customers to conserve. GSWC intends toimplement an increasing block rate design as a means to encourage waterconservation.

 

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.*

 

61

----

Tableof Contents

 

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

 

Registrant is exposed tocertain market risks, including fluctuations in interest rates, and commodityprice risks primarily relating to changes in the market price of electricity.Market risk is the potential loss arising from adverse changes in prevailingmarket rates and prices. Therehave been no material changes regarding Registrant’s market risk position fromthe information provided in its Annual Report on Form 10-K for the yearended December 31, 2007. The quantitative and qualitative disclosuresabout market risk are discussed in *Item 7A-Quantitative andQualitative Disclosures About Market Risk*, contained in Registrant’sAnnual 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 June 30, 2008, that has materially affected or is reasonablylikely to materially affect our internal control over financial reporting.

 

**Item 4T. Controls and Procedures**

 

Notapplicable.

 

62

----

Table of Contents

 

**PART II**

 

**Item 1. Legal Proceedings**

 

There havebeen no material developments in any of the legal proceedings described in our2007 Annual Report 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 second   quarter of 2008.  The following table provides informationabout repurchases of common shares by AWR during the second 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** | ** ** |
|-------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 1 - 30, 2008 |       | 10,000                                           |       | $                                                | 36.11      |                                                                                                                                      | —     |                                                                                                                                | NA         |   |
| May 1 - 31, 2008   |       | 37                                               |       | $                                                | 35.00      |                                                                                                                                      | —     |                                                                                                                                | NA         |   |
| June 1 - 30, 2008  |       | 440                                              |       | $                                                | 35.32      |                                                                                                                                      | —     |                                                                                                                                | NA         |   |
| Total                   |       | 10,477                                           | (2)        | $                                                | 36.07      |                                                                                                                                      | —     |                                                                                                                                | NA         | (3) |

 

----

(1)         None of the commonshares were purchased pursuant to any publicly announced stock repurchaseprogram.

 

(2)         Ofthis amount, 10,000 common shares were acquired on the open market foremployees pursuant to the Company’s 401(k) Plan.  The remainder of the common shares wereacquired on the open market for participants in the Company’s Common SharePurchase and Dividend Reinvestment Plan.

 

(3)         Noneof these plans contain a maximum number of common shares that may bepurchased in the open market under the plans.

 

**Item 3. Defaults Upon Senior Securities**

 

None

 

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

 

The annual meeting of shareholderswas held on May 20, 2008. The following table presents the voting resultsof the election of Class II directors at this meeting:

 
| **Name**             | ** ** | **“Votes For”** | ** ** | **“Votes Withheld”** | ** ** |
|----------------------|------------|--------------------------------|------------|-------------------------------------|------------|
| N.P. Dodge, Jr. |       | 14,456,706                     |       | 1,079,563                           |       |
| Robert F. Kathol     |       | 14,475,944                     |       | 1,060,326                           |       |
| Gary F. King         |       | 14,498,576                     |       | 1,037,694                           |       |
| Lloyd E. Ross        |       | 14,473,546                     |       | 1,062,724                           |       |

 

63

----

Table of Contents

 

Registrant has oneother class of directors, which include James L. Anderson, Diana M. Bonta, AnneM. Holloway and Floyd E. Wicks, whose terms will expire at the annual meetingin 2009.

 

Registrant’sshareholders also approved the American States Water Company 2008 StockIncentive Plan, with 8,872,391 voting in favor, 1,229,104 against, and 678,318abstaining.

 

Registrant’sshareholders also ratified the appointment of PricewaterhouseCoopers LLP as ourindependent registered public accounting firm, with 14,803,123 voting in favorof the appointment, 143,147 opposing the appointment, and 589,997 abstainingfrom voting on the appointment.

 

Finally,Registrant’s shareholders approved a proposal to transact any other businesswhich may properly come before the meeting, or any adjournment thereof, with9,226,004 voting in favor, 5,514,488 against, and 795,775 abstaining.

 

Noother items were submitted during the second quarter of the fiscal year coveredby this report to a vote of security holders through the solicitation ofproxies or otherwise.

 

**Item 5. Other Information**

 

(a)         On July 29, 2008, theBoard of Directors of AWR declared a regular quarterly dividend of $0.250 percommon share. The dividend will be paid September 1, 2008 to shareholdersof record as of the close of business on August 8, 2008.

 

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

 

## **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)         Filedconcurrently herewith

 

(2)         Furnishedconcurrently herewith

 

64

----

Table of 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/ Robert J. Sprowls |
|   |   |   |                          | Robert J. Sprowls |
|   |   |   |                          | Executive Vice President-Finance, Chief Financial |
|   |   |   |                          | Officer, Treasurer and Corporate Secretary |
|   |   |   |                          |   |

 

Dated: August 8,2008

 

65

----