**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

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**(MarkOne)**
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                                                                           |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                             |
| ** ** | ** ** | **For the quarterly period ended September 30,  2005**                                                                                                                                                                                                                                                                                                                                                      |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                       |
|       |       | **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: 0-8176**

 

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|                                                               | **Southwest Water Company** |
|---------------------------------------------------------------|-----------------------------|
|  (Exact name of registrant as specified in  its charter) |
|                                                          |
| **Delaware**                                                  |                        | **95-1840947** |
| (State or other jurisdiction of                               |                        | (I.R.S. Employer |
| incorporation or organization)                                | ** **                  | Identification No.) |
|                                                          |                        |   |
| **One Wilshire Building**                                     |                        |   |
| **624 South Grand Avenue, Suite 2900**                   |                        |   |
| **Los Angeles, California**                                   |                        | **90017-3782** |
| (Address of principal executive offices)                      | ** **                  | (Zip Code) |
|                                                               |                             |  |  |

 

**(213) 929-1800**(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes ýNo o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ýNo o

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes oNo ý

 

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date. On November 7,2005, there were 20,502,370 common shares outstanding.

 

 

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**SOUTHWEST WATER COMPANY**

 

**INDEX**

 
| **Part I.**  | **Financial  Information:** |                                                                                                                                 |
|-------------------|-----------------------------|--------------------------------------------------------------------------------------------------------------------------------------|
|              |                        |                                                                                                                                 |
|              | Item 1.                     | Financial Statements:                                                                                                                |   |
|              |                        |                                                                                                                                 |   |
|              |                        | Condensed Consolidated  Statements of Income (unaudited) –  Three Months and Nine Months Ended September 30, 2005 and 2004 |   |
|              |                        |                                                                                                                                 |   |
|              |                        | Condensed Consolidated  Balance Sheets –   September 30, 2005 (unaudited) and December 31, 2004 (audited)             |   |
|              |                        |                                                                                                                                 |   |
|              |                        | Condensed Consolidated  Statements of Cash Flows (unaudited) –   Nine Months Ended September 30, 2005 and 2004             |   |
|              |                        |                                                                                                                                 |   |
|              |                        | Notes to Condensed  Consolidated Financial Statements (unaudited)                                                                    |   |
|              |                        |                                                                                                                                 |   |
|              | Item 2.                     | Management’s Discussion and  Analysis of   Financial Condition and Results of Operations                                        |   |
|              |                        |                                                                                                                                 |   |
|              | Item 3.                     | Quantitative  and Qualitative Disclosures About Market Risk                                                                          |   |
|              |                        |                                                                                                                                 |   |
|              | Item 4.                     | Controls and  Procedures                                                                                                             |   |
|              |                        |                                                                                                                                 |   |
| **Part II.** | **Other Information:**      |                                                                                                                                 |
|              |                        |                                                                                                                                 |   |
|              | Item 1.                     | Legal Proceedings                                                                                                                    |   |
|              |                        |                                                                                                                                 |   |
|              | Item 2.                     | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                         |   |
|              |                        |                                                                                                                                 |   |
|              | Item 6.                     | Exhibits                                                                                                                             |   |
|              |                        |                                                                                                                                 |   |
| **Signatures**    |                        |

 

i

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**PART I – FINANCIALINFORMATION**

 

***Item1. Financial Statements***

 

**SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)**

(inthousands except per share data)

 
| ** **                                                                                                                                                                 | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenues:**                                                                                                                                                              |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Utility group                                                                                                                                                              | ** ** | **$**                                       | **23,300** | ** **                                 | $          | 22,422 |   | **$** | **59,054** | ** ** | $ | 52,062 |   |
| Services group                                                                                                                                                             | ** ** | **31,368**                                  | ** ** | 30,231                                     |       | **92,127** | ** ** | 82,032 |   |
| ** **                                                                                                                                                                 |       | **54,668**                                  |       | 52,653                                     |       | **151,181** | ** ** | 134,094 |   |
| **Expenses:**                                                                                                                                                              |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Operating expenses - utility group                                                                                                                                         | ** ** | **12,835**                                  | ** ** | 13,712                                     |       | **33,492** | ** ** | 29,981 |   |
| Operating expenses - services group                                                                                                                                        | ** ** | **28,038**                                  | ** ** | 27,012                                     |       | **80,611** | ** ** | 74,845 |   |
| Selling, general and administrative expenses                                                                                                                               | ** ** | **7,665**                                   | ** ** | 6,877                                      |       | **22,974** | ** ** | 18,966 |   |
| ** **                                                                                                                                                                 |       | **48,538**                                  | ** ** | 47,601                                     |       | **137,077** | ** ** | 123,792 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Operating Income**                                                                                                                                                       | ** ** | **6,130**                                   | ** ** | 5,052                                      |       | **14,104** | ** ** | 10,302 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Other Income (Expense):**                                                                                                                                                |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Interest expense                                                                                                                                                           | ** ** | **(1,651**                                  | **)**      | (1,446                                     | )          | **(5,251** | **)** | (3,371 | ) |
| Interest income                                                                                                                                                            | ** ** | **119**                                     | ** ** | 544                                        |       | **332** | ** ** | 855 |   |
| Other                                                                                                                                                                      | ** ** | **27**                                      | ** ** | (135                                       | )          | **19** | ** ** | (271 | ) |
| ** **                                                                                                                                                                 |       | **(1,505**                                  | **)**      | (1,037                                     | )          | **(4,900** | **)** | (2,787 | ) |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Income From Continuing Operations Before Income  Taxes**                                                                                                                 | ** ** | **4,625**                                   | ** ** | 4,015                                      |       | **9,204** | ** ** | 7,515 |   |
| **Income Tax Provision**                                                                                                                                                   | ** ** | **1,619**                                   | ** ** | 1,484                                      |       | **3,280** | ** ** | 2,762 |   |
| **Income from Continuing Operations**                                                                                                                                      | ** ** | **3,006**                                   | ** ** | 2,531                                      |       | **5,924** | ** ** | 4,753 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Discontinued Operations:**                                                                                                                                               |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Income (loss) from operations of discontinued  subsidiary (net of income tax provisions(benefit) of $0, $(91), $(747), and  $141, respectively, for the periods presented) | ** ** | **—**                                  | ** ** | (159                                       | )          | **(1,219** | **)** | 191 |   |
| Loss on disposal of discontinued operations (net of  income tax benefit of $345 for the nine months ended September 30, 2005)                                         | ** ** | **—**                                  | ** ** | **—**                                 |       | **(3,683** | **)** | **—** | ** ** |
| **Net Income**                                                                                                                                                             | ** ** | **3,006**                                   | ** ** | 2,372                                      |       | **1,022** | ** ** | 4,944 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Dividends On Preferred Shares**                                                                                                                                          | ** ** | **6**                                       | ** ** | 6                                          |       | **18** | ** ** | 19 |   |
| **Net Income Applicable To Common Shareholders**                                                                                                                           | ** ** | **$**                                       | **3,000**  | ** **                                 | $          | 2,366 |   | **$** | **1,004** | ** ** | $ | 4,925 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Earnings (Loss) Per Common Share:**                                                                                                                                      |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Basic**                                                                                                                                                                  |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Income from continuing operations less dividends on  preferred shares                                                                                                      | ** ** | **$**                                       | **0.15**   | ** **                                 | $          | 0.14 |   | **$** | **0.30** | ** ** | $ | 0.28 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Income (loss) from discontinued operations                                                                                                                                 | ** ** | **—**                                  | ** ** | (0.01                                      | )          | **(0.25** | **)** | 0.01 |   |
| **Net Income Applicable To Common Shareholders**                                                                                                                           | ** ** | **$**                                       | **0.15**   | ** **                                 | $          | 0.13 |   | **$** | **0.05** | ** ** | $ | 0.29 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Diluted**                                                                                                                                                                |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Income from continuing operations less dividends on  preferred shares                                                                                                      | ** ** | **$**                                       | **0.15**   | ** **                                 | $          | 0.13 |   | **$** | **0.29** | ** ** | $ | 0.26 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Income (loss) from discontinued operations                                                                                                                                 | ** ** | **—**                                  | ** ** | (0.01                                      | )          | **(0.24** | **)** | 0.01 |   |
| **Net Income Applicable To Common Shareholders**                                                                                                                           | ** ** | **$**                                       | **0.15**   | ** **                                 | $          | 0.12 |   | **$** | **0.05** | ** ** | $ | 0.27 |   |
|                                                                                                                                                                       |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Weighted Average Outstanding Common Shares:**                                                                                                                            |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| **Basic**                                                                                                                                                                  |       | 19,880                                      | ** ** | 18,214                                     |       | 19,602 | ** ** | 17,048 |   |
| **Diluted**                                                                                                                                                                |       | 20,680                                      | ** ** | 19,109                                     |       | 20,269 | ** ** | 17,964 |   |

 

*Seeaccompanying notes to unaudited condensed consolidated financial statements.*

 

1

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**SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)**

 
| ** **                                                           | ** ** | **September 30, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------|-------------|----------------------------|------------|
| ** **                                                           | ** ** | **(in thousands)**          | ** **  |
| **ASSETS**                                                           |       |                        | ** **  |                       |       |
| **Current Assets:**                                                  |       |                        | ** **  |                       |       |
| Cash and cash equivalents                                            | ** ** | **$**                       | **6,751**   | ** **                 | $          | 1,388 |   |
| Restricted cash                                                      | ** ** | **28**                      | ** **  | 221                        |       |
| Trade accounts receivable, less allowance for  doubtful accounts     | ** ** | **28,137**                  | ** **  | 22,334                     |       |
| Assets held for sale                                                 | ** ** | **—**                  | ** **  | 15,869                     |       |
| Other current assets                                                 | ** ** | **12,650**                  | ** **  | 18,279                     |       |
| ** **                                                           |       | **47,566**                  | ** **  | 58,091                     |       |
| **Property, Plant and Equipment:**                                   |       |                        | ** **  |                       |       |
| Regulated utility property, plant and equipment—at  cost        | ** ** | **393,862**                 | ** **  | 359,375                    |       |
| Non-regulated operations property, plant and  equipment—at cost | ** ** | **17,502**                  | ** **  | 17,118                     |       |
| ** **                                                           |       | **411,364**                 | ** **  | 376,493                    |       |
| Less accumulated depreciation and amortization                       | ** ** | **80,182**                  | ** **  | 74,658                     |       |
| ** **                                                           |       | **331,182**                 | ** **  | 301,835                    |       |
| **Other Assets:**                                                    |       |                        | ** **  |                       |       |
| Goodwill                                                             | ** ** | **27,911**                  | ** **  | 26,806                     |       |
| Intangible assets, net                                               | ** ** | **3,023**                   | ** **  | 2,359                      |       |
| Other assets                                                         | ** ** | **16,107**                  | ** **  | 15,718                     |       |
| ** **                                                           |       | **$**                       | **425,789** | ** **                 | $          | 404,809 |   |
|                                                                 |       |                        | ** **  |                       |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                        |       |                        | ** **  |                       |       |
| **Current Liabilities:**                                             |       |                        | ** **  |                       |       |
| Current portion of long-term debt                                    | ** ** | **$**                       | **1,313**   | ** **                 | $          | 2,733 |   |
| Accounts payable                                                     | ** ** | **11,327**                  | ** **  | 12,242                     |       |
| Liabilities related to assets held for sale                          | ** ** | **—**                  | ** **  | 1,681                      |       |
| Other current liabilities                                            | ** ** | **23,125**                  | ** **  | 18,535                     |       |
| ** **                                                           |       | **35,765**                  | ** **  | 35,191                     |       |
| **Other Liabilities and Deferred Credits:**                          |       |                        | ** **  |                       |       |
| Long-term debt                                                       | ** ** | **97,878**                  | ** **  | 92,792                     |       |
| Bank lines of credit                                                 | ** ** | **27,000**                  | ** **  | 23,035                     |       |
| Advances for construction                                            | ** ** | **8,542**                   | ** **  | 9,196                      |       |
| Contributions in aid of construction                                 | ** ** | **92,429**                  | ** **  | 89,623                     |       |
| Deferred income taxes                                                | ** ** | **17,306**                  | ** **  | 15,528                     |       |
| Other liabilities and deferred credits                               | ** ** | **13,975**                  | ** **  | 13,246                     |       |
| **Total Liabilities and Deferred Credits**                           | ** ** | **292,895**                 | ** **  | 278,611                    |       |
| ** **                                                           | ** ** | ** **                  | ** **  |                       |       |
| **Commitments and Contingencies**                                    |       |                        | ** **  |                       |       |
|                                                                 |       |                        | ** **  |                       |       |
| **Stockholders’ Equity:**                                       |       |                        | ** **  |                       |       |
| Preferred stock                                                      | ** ** | **461**                     | ** **  | 461                        |       |
| Common stock                                                         | ** ** | **203**                     | ** **  | 194                        |       |
| Paid-in capital                                                      | ** ** | **110,156**                 | ** **  | 101,509                    |       |
| Retained earnings                                                    | ** ** | **22,074**                  | ** **  | 24,034                     |       |
| **Total Stockholders’ Equity**                                  | ** ** | **132,894**                 | ** **  | 126,198                    |       |
| ** **                                                           |       | **$**                       | **425,789** | ** **                 | $          | 404,809 |   |

 

*Seeaccompanying notes to unaudited condensed consolidated financial statements.*

 

2

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**SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**

 
| ** **                                                                                    | ** ** | **Nine Months Ended   September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                                                    | ** ** | **(in thousands)**                         | ** ** |
| **Cash Flows From Operating Activities:**                                                     |       |                                       | ** ** |   |   |
| Net income                                                                                    | ** ** | **$**                                      | **1,021**  | ** ** | $ | 4,942 |   |
| Income (loss) from discontinued operations                                                    | ** ** | **1,219**                                  | ** ** | (191 | ) |
| Loss on disposal of discontinued operations                                                   | ** ** | **3,683**                                  | ** ** | — |   |
| Income from continuing operations                                                             | ** ** | **5,923**                                  | ** ** | 4,751 |   |
| Adjustments to reconcile net income to net cash provided  by continuing operating activities: |       |                                       | ** ** |   |   |
| Depreciation and amortization                                                                 | ** ** | **7,548**                                  | ** ** | 5,510 |   |
| Stock-based compensation expense                                                              | ** ** | **702**                                    | ** ** | 755 |   |
| Loss on disposal of assets                                                                    | ** ** | **—**                                 | ** ** | 365 |   |
| Deferred income taxes                                                                         | ** ** | **1,778**                                  | ** ** | 1,436 |   |
| Changes in assets and liabilities, net of effects of  acquisitions and dispositions:          |       |                                       | ** ** |   |   |
| Restricted cash                                                                               | ** ** | **193**                                    | ** ** | 2,784 |   |
| Trade accounts receivable                                                                     | ** ** | **(4,667**                                 | **)**      | (9,089 | ) |
| Other current assets                                                                          | ** ** | **4,731**                                  | ** ** | (3,480 | ) |
| Other assets                                                                                  | ** ** | **(265**                                   | **)**      | 2,776 |   |
| Accounts payable                                                                              | ** ** | **(3,634**                                 | **)**      | (8,102 | ) |
| Other current liabilities                                                                     | ** ** | **4,053**                                  | ** ** | 6,050 |   |
| Other liabilities                                                                             | ** ** | **441**                                    | ** ** | (242 | ) |
| Other                                                                                         | ** ** | **1,143**                                  | ** ** | (2,788 | ) |
| **Net cash provided by continuing operating  activities**                                     | ** ** | **17,946**                                 | ** ** | 726 |   |
| ** **                                                                                    | ** ** | ** **                                 | ** ** |   |   |
| **Cash Flows From Investing Activities:**                                                     |       |                                       | ** ** |   |   |
| Additions to property, plant and equipment                                                    | ** ** | **(26,055**                                | **)**      | (15,963 | ) |
| Purchase of minority interest in subsidiary                                                   | ** ** | **—**                                 | ** ** | (2,900 | ) |
| Cash used to acquire customer units                                                           | ** ** | **—**                                 | ** ** | (575 | ) |
| Liabilities assumed in acquisition transactions                                               | ** ** | **—**                                 | ** ** | 123 |   |
| Acquisition transaction costs                                                                 | ** ** | **(158**                                   | **)**      | (1,005 | ) |
| Acquisition of utility companies                                                              | ** ** | **(8,500**                                 | **)**      | (45,768 | ) |
| Acquisition of contract operations                                                            | ** ** | **(2,001**                                 | **)**      | — |   |
| **Net cash used in investing activities**                                                     | ** ** | **(36,714**                                | **)**      | (66,088 | ) |
| ** **                                                                                    | ** ** | ** **                                 | ** ** |   |   |
| **Net proceeds from sale of discontinued  operations**                                        | ** ** | **9,852**                                  | ** ** | — |   |
| ** **                                                                                    | ** ** | ** **                                 | ** ** |   |   |
| **Cash Flows From Financing Activities:**                                                     |       |                                       | ** ** |   |   |
| Net proceeds from stock issuances                                                             | ** ** | **4,505**                                  | ** ** | 41,208 |   |
| Capital improvement reimbursements                                                            | ** ** | **144**                                    | ** ** | 386 |   |
| Contributions in aid of construction                                                          | ** ** | **2,842**                                  | ** ** | 2,593 |   |
| Borrowings on bank notes payable                                                              | ** ** | **3,965**                                  | ** ** | 25,688 |   |
| Proceeds from dividend reinvestment, employee stock  purchase and stock option plans          | ** ** | **3,074**                                  | ** ** | 592 |   |
| Dividends paid                                                                                | ** ** | **(2,982**                                 | **)**      | (2,550 | ) |
| Principal payments on long-term debt                                                          | ** ** | **(16,395**                                | **)**      | (1,297 | ) |
| Borrowings on long term debt                                                                  | ** ** | **20,000**                                 | ** ** | — |   |
| Payments on advances for construction                                                         | ** ** | **(654**                                   | **)**      | (185 | ) |
| Other financing activities, net                                                               | ** ** | **(220**                                   | **)**      | 14 |   |
| **Net cash provided by financing activities**                                                 | ** ** | **14,279**                                 | ** ** | 66,449 |   |
| ** **                                                                                    | ** ** | ** **                                 | ** ** |   |   |
| **Net increase in cash and cash equivalents**                                                 | ** ** | **5,363**                                  | ** ** | 1,087 |   |
| Cash and cash equivalents at beginning of period                                              | ** ** | **1,388**                                  | ** ** | 1,814 |   |
| **Cash and cash equivalents at end of period**                                                | ** ** | **$**                                      | **6,751**  | ** ** | $ | 2,901 |   |

 

*Seeaccompanying notes to unaudited condensed consolidated financial statements.*

 

3

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| ** **                                                                                       | ** ** | **Nine Months Ended   September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| **Supplemental Disclosure of Cash Flow Information**                                             |       |                                       | ** ** |   |   |
| **Cash paid (received) during the period for:**                                                  |       |                                       | ** ** |   |   |
| **Interest**                                                                                     | ** ** | **$**                                      | **5,193**  | ** ** | $ | 3,775 |   |
| **Income taxes**                                                                                 | ** ** | **$**                                      | **(1,345** | **)** | $ | 1,269 |   |
|                                                                                             |       |                                       | ** ** |   |   |
| **Non-cash investing and financing activities:**                                                 |       |                                       | ** ** |   |   |
| **Purchase of businesses**                                                                       |       |                                       | ** ** |   |   |
| Fair value of assets acquired                                                                    | ** ** | **$**                                      | **12,336** | ** ** | $ | 67,220 |   |
| Cash paid including transaction costs                                                            | ** ** | **(10,659**                                | **)**      | (46,773 | ) |
| Notes issued and settlement reserve fund                                                         | ** ** | **(500**                                   | **)**      | — |   |
| Liabilities assumed                                                                              | ** ** | **$**                                      | **1,177**  | ** ** | $ | 20,447 |   |
| **Sale of business**                                                                             |       |                                       | ** ** |   |   |
| Fair value of assets sold                                                                        | ** ** | **$**                                      | **12,047** | ** ** | $ | — |   |
| Disposition expenses                                                                             | ** ** | **(1,680**                                 | **)**      | — |   |
| Settlement reserve fund                                                                          | ** ** | **(1,102**                                 | **)**      | — |   |
| Cash received                                                                                    | ** ** | **$**                                      | **9,265**  | ** ** | $ | — |   |
| **Non-cash contributions in aid of construction  and advances for construction from developers** | ** ** | **$**                                      | **2,248**  | ** ** | $ | 5,394 |   |

 

*Seeaccompanying notes to unaudited condensed consolidated financial statements.*

 

4

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#### **SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

#### ** **

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)**

 

***Note 1. – Basis of Presentation***

 

SouthwestWater Company and its subsidiaries (collectively referred to in this report as “Southwest,”the “Company,” “we,” “us” or “our” except where the context otherwise requires)provide a broad range of services including water production, treatment anddistribution; wastewater collection and treatment; utility billing and collection;utility infrastructure construction management; and public works services. Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (“US GAAP”) for interim financial information and withthe instructions to Form 10-Q and with Rule 10-01 of Regulation S-X;accordingly, they do not include all information and notes required by US GAAPfor complete financial statements. Except as disclosed herein, there have beenno material changes in the information disclosed in the notes to theconsolidated financial statements contained in our Annual Report on Form 10-Kfor the year ended December 31, 2004 (the “2004 Annual Report”). Theunaudited condensed consolidated financial statements reflect all adjustmentswhich, in our opinion, are necessary to present fairly the financial positionof Southwest as of September 30, 2005, and our results of operations forthe three and nine months ended September 30, 2005 and 2004 and our cashflows for the nine months ended September 30, 2005 and 2004.

 

Theresults of interim periods are not necessarily indicative of results that maybe expected for any other interim period or for the full year.

 

SouthwestWater Company was incorporated in California in 1954 and reincorporated inDelaware in 1988.

 

Certain reclassificationshave been made to the prior period financial statement presentation to conformto the current period presentation including the reclassification related to discontinuedoperations described in Note 9.

 

***Note 2. – Earnings Per Share***

 

We report earnings per share (“EPS”) by computing “basicEPS” and “diluted EPS.”  Basic EPSmeasures our performance over the reporting period by dividing net income(loss) applicable to common stockholders by the weighted average number ofcommon shares outstanding during the period. Diluted EPS measures ourperformance over the reporting period after giving effect to all potentiallydilutive common shares that would have been outstanding if the dilutive commonshares had been issued. Stock options, convertible debentures and warrants giverise to potentially dilutive common shares. In July 2001, we issued $20.0 million of 6.85% fixed-rateconvertible subordinate debentures. The debentures are convertible at any timeprior to maturity in 2021, unless previously redeemed, at a conversion price of$11.569. At such time as the assumed conversion of the debentures has adilutive effect on earnings per share, the debentures will be included in thecalculation of diluted earnings per share, after adjusting net income for theafter-tax effect of the debenture interest expense.

 

We declareda 5% stock dividend on January 3, 2005. All per share amounts and numbersof shares outstanding reflect this dividend.

 

***DividendReinvestment and Stock Purchase Plan (“DSPP”):***We have astockholder-approved DSPP where existing stockholders may purchase additionalshares of our common stock by reinvesting all or a portion of the dividendspaid on owned shares of stock and by making optional cash payments of not lessthan $25 up to a maximum of $10,000 per month. We may permit optional cash payments in excess of this maximum if weapprove a request for waiver.  Newinvestors may join the plan by making an initial investment of not less than$250 up to a maximum of $10,000.  We maypermit initial investments in excess of this maximum if we approve a requestfor waiver.  For 2005, the purchase pricefor newly issued shares of common stock purchased directly from us will be themarket price less a discount of 5%.  The discountmay range from 0% to 5% as determined from time to time by us.

 

Under the DSPP, we issued317,063 and 363,289 shares to shareholders during the three and nine monthsended September 30, 2005, respectively. At September 30, 2005,500,000 shares had been authorized for issuance under the DSPP andapproximately 136,711 shares remain available for issuance.

 

5

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Thefollowing table is a reconciliation of the numerators (income or loss) anddenominators (shares) used in both basic and diluted EPS calculations:

 
| ** **                                                             | ** ** | **Three Months Ended   September 30,** |       | **Nine Months Ended   September 30,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                                    | ** ** | **2004**                                   |       | **2005** | ** ** | **2004** | ** ** |
| ** **                                                             | ** ** | **(in thousands except per share  data)**   | ** ** |
| **Earnings (loss) per share - basic**                                  |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Income from continuing operations                                      | ** ** | **$**                                       | **3,006**  | ** **                                 | $          | 2,532 |   | **$** | **5,923** | ** ** | $ | 4,753 |   |
| Less: dividends on preferred shares                                    | ** ** | **6**                                       | ** ** | 6                                          |       | **18** | ** ** | 19 |   |
|                                                                   |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Income from continuing operations applicable to  common shares         | ** ** | **3,000**                                   | ** ** | 2,526                                      |       | **5,905** | ** ** | 4,734 |   |
| Income (loss) from discontinued operations                             | ** ** | **—**                                  | ** ** | (159                                       | )          | **(4,902** | **)** | 191 |   |
| Net income applicable to common shares                                 | ** ** | **$**                                       | **3,000**  | ** **                                 | $          | 2,367 |   | **$** | **1,003** | ** ** | $ | 4,925 |   |
| Weighted average outstanding common shares                             | ** ** | **19,880**                                  | ** ** | 18,214                                     |       | **19,602** | ** ** | 17,048 |   |
|                                                                   |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Earnings per common share from continuing operations                   | ** ** | **$**                                       | **0.15**   | ** **                                 | $          | 0.14 |   | **$** | **0.30** | ** ** | $ | 0.28 |   |
| Earnings (loss) per common share from discontinued  operations         | ** ** | **—**                                  | ** ** | (0.01                                      | )          | **(0.25** | **)** | 0.01 |   |
| Earnings per common share                                              | ** ** | **$**                                       | **0.15**   | ** **                                 | $          | 0.13 |   | **$** | **0.05** | ** ** | $ | 0.29 |   |
|                                                                   |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| ** **                                                             | ** ** | **Three Months Ended   September 30,** |       | **Nine Months Ended   September 30,** | ** ** |
| ** **                                                             | ** ** | **2005**                                    | ** ** | **2004**                                   |       | **2005** | ** ** | **2004** | ** ** |
| ** **                                                             | ** ** | **(in thousands except per share  data)**   | ** ** |
| **Earnings (loss) per share - diluted**                                |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| ** **                                                             |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Income from continuing operations applicable to  common shares         | ** ** | **$**                                       | **3,000**  | ** **                                 | $          | 2,526 |   | **$** | **5,905** | ** ** | $ | 4,734 |   |
| Income (loss) from discontinued operations                             | ** ** | **—**                                  | ** ** | (159                                       | )          | **(4,902** | **)** | 191 |   |
| Net income applicable to common shares                                 | ** ** | **$**                                       | **3,000**  | ** **                                 | $          | 2,367 |   | **$** | **1,003** | ** ** | $ | 4,925 |   |
|                                                                   |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Weighted average outstanding common shares                             | ** ** | **19,880**                                  | ** ** | 18,214                                     |       | **19,602** | ** ** | 17,048 |   |
|                                                                   |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Plus: Shares issued on assumed exercise of stock  options and warrants | ** ** | **800**                                     | ** ** | 895                                        |       | **667** | ** ** | 916 |   |
| Weighted average outstanding common shares                             | ** ** | **20,680**                                  | ** ** | 19,109                                     |       | **20,269** | ** ** | 17,964 |   |
|                                                                   |       |                                        | ** ** |                                       |       |   | ** ** |   |   |
| Earnings per common share from continuing operations                   | ** ** | **$**                                       | **0.15**   | ** **                                 | $          | 0.13 |   | **$** | **0.29** | ** ** | $ | 0.26 |   |
| Earnings (loss) per common share from discontinued  operations         | ** ** | **—**                                  | ** ** | (0.01                                      | )          | **(0.24** | **)** | 0.01 |   |
| Earnings per common share                                              | ** ** | **$**                                       | **0.15**   | ** **                                 | $          | 0.12 |   | **$** | **0.05** | ** ** | $ | 0.27 |   |

 

***Note 3. –Stock-Based Compensation Plans***

 

At September 30, 2005, Southwest had threestock-based compensation plans: a Stock Option Plan (“SOP”), a Director StockOption Plan (“DOP”), and an Employee Stock Purchase Plan (“ESPP”). In accordancewith the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123,*Accounting for Stock-Based Compensation*,the fair value of each option grant is estimated on the date of grant using theBlack-Scholes option pricing model with the following weighted averageassumptions used for grants in 2005 and 2004:

 

6

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| ** **               | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------|------------|------------------------|------------|
| ** **               | ** ** | **September 30,** | ** ** |
| ** **               | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Dividend yield           |       | 1.7                    | %          | 1.3 | % |
| Expected  volatility     |       | 24.3                   | %          | 24.4 | % |
| Risk-free interest  rate |       | 4.1                    | %          | 3.7 | % |
| Expected life in  years  |       | 5.7                    |       | 6.0 |   |

 

Compensation expense arising from stock option grantsas determined using the Black-Scholes fair value option model was as follows:

 
| ** **                        | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **(in thousands)**                          | ** ** | **(in thousands)**                         | ** ** |
| Stock-based  compensation expense |       | $                                           | 236        |                                       | $          | 307 |   | $ | 702 |   | $ | 755 |   |
|                                   |            |                                             |            |                                            |            |  |  |  |  |  |  |  |  |

 

A combined summary of shares authorized and availablefor issuance under the SOP, the DOP and ESPP as of September 30, 2005, wasas follows:

 
| ** **                      | ** ** | **SOP**            | ** ** | **DOP** | ** ** | **ESPP** | ** ** | **Total** | ** ** |
|---------------------------------|------------|--------------------|------------|---------|------------|----------|------------|-----------|------------|
| ** **                      | ** ** | **(in thousands)** | ** ** |
| Shares  authorized for issuance |       | 3,031              |       | 666     |       | 1,197    |       | 4,894     |       |
| Shares available  for issuance  |       | 988                |       | 300     |       | 875      |       | 2,163     |       |

 

Following is a combined summary of changes in thestatus of the SOP, the DOP and warrants during the nine months ended September 30,2005:

 
| ** **                              | ** ** | ** **         | ** ** | **Weighted** | ** ** |
|-----------------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                              | ** ** | ** **         | ** ** | **Average**  | ** ** |
| ** **                              | ** ** | **Stock Options**  | ** ** | **Exercise** | ** ** |
| ** **                              | ** ** | **and Warrants**   | ** ** | **Price**    | ** ** |
| ** **                              | ** ** | **(in thousands)** | ** ** |
| Outstanding at December 31,  2004  |       | 2,776              |       | $            | 8.03       |   |
| Granted                                 |       | 309                |       | 11.59        |       |
| Exercised                               |       | (461               | )          | 6.59         |       |
| Forfeited                               |       | (79                | )          | 11.70        |       |
| Outstanding at September 30,  2005 |       | 2,545              |       | $            | 8.64       |   |
|                                    |       |               |       |         |       |
| Exercisable at September 30,  2005 |       | 1,564              |       | $            | 7.14       |   |

 

7

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The following table summarizes information about stockoptions and warrants outstanding at September 30, 2005:

 
| ** **                    | ** ** | **Options and Warrants  Outstanding**                 | ** ** | **Options and Warrants  Exercisable**                         | ** ** |
|-------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding  at  September 30,  2005** | ** ** | **Weighted  Average  Remaining  Contractual  Life  in Years** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable  at  September 30,  2005** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| ** **                    | ** ** | **(in thousands)**                                    | ** ** | ** **                                                    | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| $                             | 1.50       |                                                  | $          | 3.75                                                          |       | 128 |   | 1.1 |   | $ | 3.18 |   | 128 |   | $ | 3.18 |   |
| 3.76                          |       | 7.50                                                  |       | 728                                                           |       | 3.0 |   | 5.67 |   | 670 |   | 5.53 |   |
| 7.51                          |       | 11.25                                                 |       | 1,093                                                         |       | 3.8 |   | 8.98 |   | 667 |   | 8.66 |   |
| 11.26                         |       | 15.00                                                 |       | 596                                                           |       | 5.8 |   | 12.81 |   | 99 |   | 12.94 |   |
| $                             | 1.50       |                                                  | $          | 15.00                                                         |       | 2,545 |   | 3.9 |   | $ | 8.64 |   | 1,564 |   | $ | 7.14 |   |

 

***EmployeeStock Purchase Plan:***We have a stockholder-approved ESPPthat allows eligible employees to purchase our common stock through payrolldeductions of up to 10% of their salary (not to exceed $25,000 per year). Thepurchase price of the stock is 90% of the lower of the share price ascalculated at the beginning and end of each three-month offering period. Underthe ESPP, we issued 7,032 and 18,630 shares to employees during the three andnine months ended September 30, 2005, respectively. At September 30,2005, 1,197,000 shares had been authorized for issuance under the ESPP andapproximately 875,000 shares remain available for issuance.

 

***Note 4. – Post Retirement Benefits***

 

The Company has anon-qualified supplemental executive retirement plan (“SERP”) for certain keyexecutive officers.  The following tablesets forth the components of the net periodic benefit costs for the SERP:

 
| ** **                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                 | ** ** | **(in thousands)**                         | ** ** | **(in thousands)**                        | ** ** |
| Service cost               |       | $                                          | 16         |                                      | $          | 20 |   | $ | 48 |   | $ | 44 |   |
| Interest cost              |       | 20                                         |       | 25                                        |       | 60 |   | 57 |   |
| Recognized  actuarial loss |       | 22                                         |       | 28                                        |       | 66 |   | 64 |   |
|                       |       | $                                          | 58         |                                      | $          | 73 |   | $ | 174 |   | $ | 165 |   |

 

***Note 5. – Operating Segments***

 

Southwest has tworeportable segments: the Utility Group and the Services Group.  We have not changed the basis of presentationor measurement of segment profit or loss from that reported in our 2004 AnnualReport.

 

The Utility Group owns aregulated water utility in California, regulated water and wastewater utilitiesin New Mexico, Oklahoma and Texas, and a wastewater utility in Alabama whoserates are determined through an agreement with county authorities.  Revenues result from the production anddistribution of water and the collection and treatment of sewage forresidential, business, industrial and public authority customers.  State, federal and local agencies issueregulations regarding standards of water quality, safety, environmental andother matters which affect these operations. The rates our regulated utilitysubsidiaries charge for water and wastewater services are established by state orcounty authorities.

 

The Services Groupoperates and manages water and wastewater treatment facilities owned by cities,public agencies, municipal utility districts, private entities andinvestor-owned utilities (including Utility Group affiliates). Revenues areearned by providing operations and maintenance services under contracts withthese clients.  The Services Group alsoprovides construction management and utility billing services. In June 2005,we sold our submetering subsidiary which provided utility billing andcollection services for multi-family residential properties such as apartmentbuildings and which was previously recorded as a part of the Services Group(see Note 9).

 

8

----

 

The tables below presentinformation about the operations of each reported segment for the three andnine months ended September 30, 2005 and 2004: 

 
| ** **                                                        | ** ** | **Utility Group**  | ** ** | **Services  Group  (1) (3)** | ** ** | **Total  Segments  Information** | ** ** | **Corporate and  Other (2)** | ** **  | **Total  Consolidated  Information** | ** ** |
|-------------------------------------------------------------------|------------|--------------------|------------|-----------------------------------|------------|----------------------------------|------------|------------------------------|-------------|--------------------------------------|------------|
| ** **                                                        | ** ** | **(in thousands)** | ** ** |
| **For the Three Months Ended September 30,  2005**           |       |               |       |                              |       |                             |       |                         |        |                                 |       |
| **Total revenues (1)**                                            | ** ** | **$**              | **23,300** | ** **                        | **$**      | **31,368**                       | ** ** | **$**                        | **54,668**  | ** **                           | **$**      | **—** | ** ** | **$** | **54,668** | ** ** |
| **Segment operating income**                                      | ** ** | **$**              | **8,564**  | ** **                        | **$**      | **434**                          | ** ** | **$**                        | **8,998**   | ** **                           | **$**      | **(2,868** | **)** | **$** | **6,130** | ** ** |
| **Interest expense**                                              | ** ** | **(1,020**         | **)**      | **(398**                          | **)**      | **(1,418**                       | **)**      | **(233**                     | **)**       | **(1,651**                           | **)**      |
| **Interest income**                                               | ** ** | **10**             | ** ** | **71**                            | ** ** | **81**                           | ** ** | **38**                       | ** **  | **119**                              | ** ** |
| **Other income (expense)**                                        | ** ** | **(30**            | **)**      | **35**                            | ** ** | **5**                            | ** ** | **22**                       | ** **  | **27**                               | ** ** |
| **Income (loss) from continuing operations before  income taxes** | ** ** | **$**              | **7,524**  | ** **                        | **$**      | **142**                          | ** ** | **$**                        | **7,666**   | ** **                           | **$**      | **(3,041** | **)** | **$** | **4,625** | ** ** |
| ** **                                                        | ** ** | ** **         | ** ** | ** **                        | ** ** | ** **                       | ** ** | ** **                   | ** **  | ** **                           | ** ** |
| **For the Three Months Ended September 30,  2004**           |       |               |       |                              |       |                             |       |                         |        |                                 |       |
| Total revenues (1)                                                |       | $                  | 22,422     |                              | $          | 30,231                           |       | $                            | 52,653      |                                 | $          | — |   | $ | 52,653 |   |
| Segment operating income (loss)                                   |       | $                  | 7,176      |                              | $          | 387                              |       | $                            | 7,563       |                                 | $          | (2,511 | ) | $ | 5,052 |   |
| Interest expense                                                  |       | (1,081             | )          | (428                              | )          | (1,509                           | )          | 63                           |        | (1,446                               | )          |
| Interest income                                                   |       | 444                |       | 93                                |       | 537                              |       | 7                            |        | 544                                  |       |
| Other income (expense)                                            |       | (25                | )          | (124                              | )          | (149                             | )          | 14                           |        | (135                                 | )          |
| Income (loss) from continuing operations before  income taxes     |       | $                  | 6,514      |                              | $          | (72                              | )          | $                            | 6,442       |                                 | $          | (2,427 | ) | $ | 4,015 |   |
|                                                              |       |               |       |                              |       |                             |       |                         |        |                                 |       |
| ** **                                                        | ** ** | **Utility Group**  | ** ** | **Services  Group  (1) (3)** | ** ** | **Total  Segments  Information** | ** ** | **Corporate and  Other (2)** | ** **  | **Total  Consolidated  Information** | ** ** |
| ** **                                                        | ** ** | **(in thousands)** | ** ** |
| **For the Nine Months Ended September 30,  2005**            |       |               |       |                              |       |                             |       |                         |        |                                 |       |
| **Total revenues (1)**                                            | ** ** | **$**              | **59,054** | ** **                        | **$**      | **92,127**                       | ** ** | **$**                        | **151,181** | ** **                           | **$**      | **—** | ** ** | **$** | **151,181** | ** ** |
| **Segment operating income**                                      | ** ** | **$**              | **20,237** | ** **                        | **$**      | **3,311**                        | ** ** | **$**                        | **23,548**  | ** **                           | **$**      | **(9,444** | **)** | **$** | **14,104** | ** ** |
| **Interest expense**                                              | ** ** | **(3,357**         | **)**      | **(1,394**                        | **)**      | **(4,751**                       | **)**      | **(500**                     | **)**       | **(5,251**                           | **)**      |
| **Interest income**                                               | ** ** | **32**             | ** ** | **260**                           | ** ** | **292**                          | ** ** | **40**                       | ** **  | **332**                              | ** ** |
| **Other income (expense)**                                        | ** ** | **(84**            | **)**      | **93**                            | ** ** | **9**                            | ** ** | **10**                       | ** **  | **19**                               | ** ** |
| **Income (loss) from continuing operations before  income taxes** | ** ** | **$**              | **16,828** | ** **                        | **$**      | **2,270**                        | ** ** | **$**                        | **19,098**  | ** **                           | **$**      | **(9,894** | **)** | **$** | **9,204** | ** ** |
| ** **                                                        | ** ** | ** **         | ** ** | ** **                        | ** ** | ** **                       | ** ** | ** **                   | ** **  | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **For the Nine Months Ended September 30,  2004**            |       |               |       |                              |       |                             |       |                         |        |                                 |       |
| Total revenues (1)                                                |       | $                  | 52,062     |                              | $          | 82,032                           |       | $                            | 134,094     |                                 | $          | — |   | $ | 134,094 |   |
| Segment operating income (loss)                                   |       | $                  | 17,852     |                              | $          | (416                             | )          | $                            | 17,436      |                                 | $          | (7,134 | ) | $ | 10,302 |   |
| Interest expense                                                  |       | (2,218             | )          | (1,310                            | )          | (3,528                           | )          | 157                          |        | (3,371                               | )          |
| Interest income                                                   |       | 537                |       | 284                               |       | 821                              |       | 34                           |        | 855                                  |       |
| Other income (expense)                                            |       | (79                | )          | (202                              | )          | (281                             | )          | 10                           |        | (271                                 | )          |
| Income (loss) from continuing operations before  income taxes     |       | $                  | 16,092     |                              | $          | (1,644                           | )          | $                            | 14,448      |                                 | $          | (6,933 | ) | $ | 7,515 |   |

 

----

(1)          In addition to servicesprovided to external customers, certain companies in our Services Group provideconstruction, operations, and maintenance services to companies in our UtilityGroup. In accordance with SFAS No. 71, *Accountingfor the Effects of Certain Types of Regulation*, the Company does noteliminate the intersegment profit on sales to affiliated utilities when the salesprice is reasonable and it is probable that, through the rate making process,future revenue approximately equal to the sales price will result from theregulated affiliate’s use of the services. Intersegment revenue was approximately $7.9 million and $5.4million for the three months ended September 30, 2005 and 2004,respectively.  Intersegment revenue wasapproximately $22.4 million and $10.3 million for the nine months ended September 30,2005 and 2004, respectively.

 

(2)          “Corporate and Other” consists primarily of costs that includeheadquarters expenses and any corporate functional departments whose costs arenot allocated to reportable segments.

 

(3)          Services Group amounts have been adjusted to reflect the discontinuedoperations from the sale of our submetering subsidiary as discussed in Note 9.

 

9

----

 

The following table presents information about theidentifiable assets of each reported segment as of September 30, 2005 and December 31,2004:

 
| ** **           | ** ** | **September 30, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------|------------|-----------------------------|-------------|----------------------------|------------|
| ** **           | ** ** | **(in thousands)**          | ** **  |
| Utility Group        | ** ** | **$**                       | **355,226** |                       | $          | 322,521 |   |
| Services Group       | ** ** | **60,201**                  |        | 54,467                     |       |
| Corporate and  Other | ** ** | **10,362**                  |        | 27,821                     |       |
| Consolidated         | ** ** | **$**                       | **425,789** |                       | $          | 404,809 |   |

 

***Note 6. – Seasonality and Weather***

 

As ourbusinesses are affected by weather, therefore the results of operations for onequarter do not indicate results to be expected in another quarter.

 

OurUtility Group water operations are seasonal, as rainfall and weather conditionsaffect water consumption.  The second andthird quarters of each year typically account for the highest volume of waterconsumption when weather tends to be hot and dry and a significant part of ourwater sales are for outside usage such as landscape and pools.  Drought conditions may result in lowerrevenue due to consumer conservation efforts and a shortage of water. Droughtconditions may also result in increased water costs to us, which couldadversely affect our profitability. Conversely, unusually wet conditions mayresult in decreased customer demand, lower revenues and lower profit.

 

Whileour Services Group operations are not as seasonal, they are subject to theeffects of weather. Heavy rainfall or storm conditions may limit our ability toperform certain billable work such as pipeline maintenance, manholerehabilitation, construction and other outdoor services. Severe weatherconditions may also result in additional labor and material costs as we meetthe terms of our operations and maintenance contracts. Depending on the specificcontractual terms, this additional work may be billable to certainclients.  A significant portion of therevenues by our Texas subsidiaries are earned under time and materialscontracts in which revenues are affected by weather and rainfall.

 

***Note 7. – Commitments, Contingencies and Restrictions***

 

*Commitments Under AcquisitionAgreements*

 

We own 90% of the outstanding common stock ofOperations Technologies, Inc. (“OpTech”). We have the right to acquire theremaining 10% of OpTech beginning in August 2006 based on a formularelating to the profitability of OpTech. The minority owner has the option tosell the remaining 10% of OpTech to the Company using the same formula.  However, the selling price cannot be less than$1 million.

 

We have an 80% interest in Windermere Utility Company(“Windermere”) in Texas. We have the right to acquire the remaining 20%ownership in Windermere for a purchase price of $6 million payable in Southwest’scommon stock at any time when the market value of our common stock increases to$12.96 per share (as adjusted for stock splits and dividends).  This right has not been exercised bySWWC.  The minority owner of Windermerehas the right to put the remaining 20% to us beginning in October 2005 forup to approximately 860,000 shares of Southwest’s common stock, but no fewerthan 463,000 shares both adjusted for stock splits and dividends, depending onthe prevailing stock price, with a value not to exceed $6 million. The minorityowner has notified us of his intent to exercise his right to put the remaining20% to us in exchange for common stock in accordance with the terms of ouragreement.

 

*Commitments Under DivestitureAgreements*

 

As part of the agreement to sell our submeteringsubsidiary (see Note 9), we were required to calculate a working capitaladjustment, adjust for the net loss of customers and complete a transmitterreplacement program.  These items wereestimated and recorded as liabilities in the 2nd quarter of2005.  Adjustments to the sales pricearising from these items are to be paid or collected through an escrow accountof approximately $1.2 million that was established and recorded in othercurrent assets at the close of the transaction in June 2005.  As of September 30, 2005, we haveaccrued for all expected expenses.  Theescrow account will be closed in March 2006 and any amounts remaining ondeposit at that time will be remitted to us.

 

10

----

 

*CommitmentsUnder Long-term Service Contracts*

 

In September 2002, we won a bid to facilitate theengineering and construction of a reverse osmosis water treatment system in SanJuan Capistrano, California, for the Capistrano Valley Water District (“CVWD”).The project included the drilling of several new wells and the development ofassociated water lines. We entered into subcontractor agreements with anengineering firm and a large construction firm to fulfill significantobligations of this contract.

 

During construction of the CVWD plant, we receivedpayments upon completion of construction phases. Construction of the plantcommenced in December 2002 and was substantially completed as of September 30,2005. The plant became primarily operational in 2004 and the Company nowoperates and maintains the facility under a separate 20-year operations andmaintenance contract.

 

In January 2003,we obtained an unsecured line of credit facility from a commercial bank thatwas used to issue a $3.4 million standby letter of credit as collateralfor performance under a contract to design and construct the CVWD plant. Thisstandby letter of credit was in force for the construction period of theproject.  On April 1, 2005, thestandby letter of credit was transferred to the New Credit Facility (see Note10) and the prior line of credit was cancelled.

 

As part of the financing of this project, the CVWDissued insured municipal bonds. We entered into an agreement with the bondinsurer to guarantee our performance under the CVWD contract, subject tocertain liability limits to the bond insurer in the event of a default. Suchliability limits will not exceed an amount equal to $6.0 million duringthe construction period of the project, and afterwards, during the 20-yearoperation of the facility, the liability limits will not exceed an amount equalto $4.0 million plus an amount no greater than the replacement cost of thereverse osmosis filtration unit within the facility, estimated to beapproximately $1.5 million.

 

*Legal Proceedings*

 

Southwest and a subsidiary were named as defendants inseveral lawsuits alleging various injuries as a result of water contaminationin the San Gabriel Valley Main Basin. The California Supreme Court has ruledthat the plaintiffs cannot challenge the adequacy of the water qualitystandards established by California Department of Health Services and theUnited States Environmental Protection Agency (“EPA”) but can sue us if theycan prove that we served water that did not meet those standards. In August 2004a trial court dismissed the case against us, finding that there was no evidencethat we violated any water quality standards. The plaintiffs appealed the dismissal to the Court of Appeals for theState of California, Second Appellate District, where the matter is pending. Todate, liability insurance carriers have absorbed the costs of defense of thelawsuits.

 

On May 5, 2005, oneof the Company’s operating subsidiaries received a subpoena to provide recordsto a grand jury.  The requested records relate to the operations of theSan Simeon wastewater treatment plant in California for the period January 2002to present.  The facility was also served with search warrants executed bythe EPA.  The Company’s subsidiary has operated this facility since September 2004. The Company is cooperating with the investigation and is also performing itsown internal investigation.

 

On May 18, 2005, theEPA executed a search warrant at one of the Company’s operating subsidiaries inTexas.  The search warrant sought information relating to the subsidiary’slaboratory operations.  The Company is cooperating with the investigationand is also performing its own internal investigation.

 

SouthwestWater Company and its subsidiaries are subject to litigation arising in theordinary course of operations. We believe the ultimate resolution of allmatters that have been brought to our attention will not materially adverselyaffect our consolidated financial position, results of operations or cashflows.

 

*GroundwaterSettlement*

 

One of the water sources for our California waterutility has been affected by the presence of certain groundwater contaminants.These contaminants consist mainly of chemicals disposed of by variousindustrial companies in the 1940s and 1950s. In 2001 and 2002, thiscontamination necessitated the removal from service of a number of our wells,and we purchased replacement water at a cost substantially higher than the costof water pumped from our own wells.

 

As a result of this contamination, under the termsof an agreement with the responsible parties, we have received payments fromthese parties, and we expect to continue to receive payments until completionof remediation or until our production capacities have been restored.  These payments represent the incremental costof purchasing water over the cost that would have been incurred by us to pumpwater from our wells.  Our agreement withthe responsible parties provided for ongoing reimbursement of our excess watercosts and, as such, we bill and collect reimbursements monthly.  These monthly reimbursements are recorded asa reduction to

 

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operating expenses-utility group.  During the nine months ended September 30,2005 and 2004, these reimbursements were approximately $2.3 million and $2.8million, respectively.

 

The settlement agreement also provides forcontributions by the responsible parties to construct new wells and to developadditional interconnections with nearby water sources. Funds from thesettlement agreement will also be used to develop long-term solutions that willpotentially enable us to use our own less costly groundwater supplies in thefuture.  These contributions, recorded ascontributions in aid of construction (“CIAC”), were approximately $0.1 millionand approximately $0.4 million for the nine months ended September 30,2005 and 2004, respectively.

 

***Note8. – Acquisitions***

 

In March 2005,we completed the acquisition of a contract operations company located in ShelbyCounty, Alabama.  The aggregate purchaseprice was approximately $2.5 million, of which $0.7 million was deferred, plusliabilities we assumed in the amount of approximately $1.2 million.  We incurred transactions cost ofapproximately $0.2 million.

 

In September 2005,we completed the acquisition of a wastewater system located in Shelby County,Alabama.  The aggregate purchase priceand related transaction costs were approximately $8.5 million and $0.1 million,respectively.

 

The acquisitions wereasset purchases and the assets acquired and liabilities assumed have beenrecorded at their estimated fair values. The difference between the total purchase price and the fair value ofthe net assets acquired of approximately $0.9 million was recorded asgoodwill.  The purchase price allocationsare preliminary and may change upon the completion of the final valuations ofthe net assets acquired.

 

***Note 9. – Discontinued Operations***

 

In June 2005, we completed the sale of our submeteringsubsidiary that provided utility billing and collection services formulti-family residential properties in our Services Group.  The sales price was approximately $12.0million.  We received approximately $10.8million in cash and approximately $1.2 million of the sales price was placed intoan escrow account and is included in other current assets in the accompanyingconsolidated financial statements.  Aspart of the sale, we provided certain representations and warranties that arecustomary in sales transactions and committed to a specified level of workingcapital of the subsidiary as of the closing date.  We expect to receive the escrow balance inMarch 2006.  We utilized the net proceedsfrom the sale of approximately $10.8 million (less transaction costs of $1.0million) to subsequently repay our bank lines of credit.  The sale of our sub-metering subsidiary willnot affect the operations of our remaining operating subsidiaries.

 

In the second quarter werecorded a loss from discontinued operations (net of income tax benefit ofapproximately $0.7 million) of approximately $1.2 million and a loss on sale ofstock of approximately $3.7 million (net of income tax benefit of approximately$0.3 million).

 

***Note 10. - Debt Obligations***

 

In April 2005,we established the New Credit Facility. The New Credit Facility provides for a $100 million revolving creditfacility, which includes a $40 million letter of credit subfacility and a $10million swingline subfacility.  The New Credit Facility contains customarycovenants, as well as customary events of default.  Certain of our subsidiaries have guaranteedour obligation to repay borrowings under the New Credit Facility.

 

Loansunder the New Credit Facility (other than swingline loans) will bear interestat a rate equal to (i) a Eurodollar rate plus the applicable margin (asdefined in the New Credit Facility), or (ii) a base rate (as defined)minus the applicable margin.  At September 30,2005, we had approximately $27 million of outstanding borrowings under our NewCredit Facility and the adjusted average borrowing rate was approximately4.8%.  The New Credit Facility replacedour lines of credit which had provided for up to $50 million of borrowings andwe used the New Credit Facility to repay amounts outstanding under those linesof credit.  As of September 30,2005, we were in compliance with all applicable covenants under the New CreditFacility.

 

In January 2003,we received a $3.4 million line of credit with one of our commercial banks thatwe used to issue a standby letter of credit in that amount as collateral forperformance under a contract to design and construct the CVWD plant.  On April 1, 2005, the standby letter ofcredit was transferred to the New Credit Facility, and the separate line ofcredit was cancelled.

 

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In September, 2005 weentered into a $20 million, 26-year loan with a commercial bank at a fixed rateof 6.1% per annum that is partially offset by an annual patronage payment ofapproximately 0.5%.  The note requiresinterest only payments until maturity at June 30, 2031, at which time aballoon payment for the face amount of the note is due.  The funds wereused to reduce our borrowing under our credit facility and to give usadditional flexibility to invest in future capital projects.

 

***Note 11. –Effects of Hurricanes Katrina and Rita***

 

Hurricanes Katrina andRita affected the Gulf Coast region of the United States during the thirdquarter of 2005 causing significant damage. Our Services Group provides contract operations and maintenance servicesto clients in Mississippi and Texas, among other states.

 

The water and wastewaterinfrastructure for five clients we service in Mississippi was disabled byKatrina.  The contracts with our clientsprovide that we can incur and bill additional expenses during an emergency situationto restore water supply and wastewater treatment services to customers.  In addition, our clients requested we assistwith the removal of debris to enable access for emergency vehicles andresidents.  We incurred approximately$622,000 of overtime labor costs and emergency out-of-pocket operating expensesrelated to these emergency recovery efforts. These costs were reflected as operating expenses in the third quarter of2005.  We have billed (or will bill in certaincases) our clients approximately $536,000 to $700,000 for these emergencyservices and we are assisting our clients in requesting reimbursement from theFederal Emergency Management Agency (“FEMA”) pursuant to guidelines establishedin FEMA’s *Applicant Handbook*.  We recognized revenues of $500,000 based onthe revenue recognition criteria set forth in Staff Accounting Bulletin No. 104,*Revenue Recognition*with respect tothese costs.  Additional revenues, ifany, resulting from billings to our clients beyond $500,000 will be recognizedif and when collection is reasonable assured. The $500,000 we have billed for these emergency services is reflected intrade accounts receivable as of September 30, 2005.

 

We also incurred $64,000of costs related to preparing for Hurricane Rita, principally temporaryinfrastructure relocation expenses. These costs were recorded as an operating expense during the thirdquarter of 2005 and are not reimbursable by FEMA or recoverable throughinsurance.

 

***Note12. - Adoption of Share-Based Payment (SFAS 123R)***

 

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 123 (revised December 2004), Share-Based Payment (“SFAS 123R”). This Statement is a revision of SFAS No. 123.  SFAS 123R establishesstandards for the accounting for transactions in which an entity exchanges itsequity instruments for goods or services.  SFAS 123R is effective for theCompany as of the beginning of the first annual reporting period that beginsafter June 15, 2005.  The Company has already adopted SFAS No. 123,and management believes the impact of the adoption of SFAS 123R on the Company’sconsolidated financial statements will not be material.

 

***Note 13. – Subsequent Event***

 

Asdescribed in Note 7, we have an 80% interest in Windermere Utility Company (“Windermere”)in Texas. We have the right to acquire the remaining 20% ownership inWindermere for a purchase price of $6 million payable in Southwest’s commonstock at any time when the market value of our common stock increases to $12.96per share (as adjusted for stock splits and dividends).  This right has not been exercised bySWWC.  The minority owner of Windermerehas the right to put the remaining 20% to us beginning in October 2005 forshares of Southwest’s common stock, adjusted for stock splits and dividends,depending on the prevailing stock price, with a value not to exceed $6 million.The minority owner has notified us of his intent to exercise his right to putthe remaining 20% to us in exchange for common stock in accordance with theterms of our agreement.  We anticipateissuing approximately 465,000 shares of common stock to the minority owner.

 

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***Item2: Management’s Discussion and Analysis of Financial Condition and Results ofOperations***

 

*The information in this discussion containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended and Section 21E of the SecuritiesExchange Act of 1934, as amended (the”34 Act”). Such statements are based uponcurrent expectations that involve risks and uncertainties including those set forth under “RiskFactors” in this report and under “Business-Risk Factors” in our 2004 AnnualReport**.  Factors that could affect forward-looking statements relating to theresolution of the material weakness with respect to internal controls discussedin Item 9A of the 2004 Annual Report include, among other things: the Company’sability to design and maintain policies and procedures which enable the Companyto avoid any recurrence of the matters which gave rise to the material weaknessand the Company’s ability to identify and retain qualified and experiencedfinancial personnel.*  *Any statements contained hereinthat are not statements of historical facts may be deemed to be forward-lookingstatements. For example, words such as “may”, “will”, “should”, “estimates”, “predicts”,“potential”, “continue”, “strategy”, “believes”, “expects”, “anticipates”, “plans”,“intends”, and similar expressions are intended to identify forward-lookingstatements. Our actual results and the timing of certain events may differsignificantly from the results discussed in the forward-looking statements. Weundertake no obligation to publicly update or revise any forward-lookingstatements to reflect current or future events or circumstances.*

 

The following discussion should be read in conjunction withthe accompanying unaudited condensed consolidated financial statements andrelated notes thereto and the consolidated financial statements and the notesthereto contained in our 2004 Annual Report.

 

**Overview**

 

Southwest Water Companyand subsidiaries (“Southwest,” “we,” “us,” “our” or the “Company,” unless thecontext otherwise requires) provide a broad range of water and wastewaterservices including water production, treatment and distribution; wastewatercollection and treatment; utility billing and collection; utilityinfrastructure construction management; and public works services. We provideservices to more than two million people. Our business is segmented into twooperating groups: our Utility Group and our Services Group.

 

The Utility Group owns aregulated water utility in California, regulated water and wastewater utilitiesin New Mexico, Oklahoma and Texas, and a wastewater utility in Alabama whose ratesare determined through an agreement with county authorities.  Various governmental agencies issueregulations regarding standards of water quality, safety, environmental andother matters which affect these operations, as well as establish the rates thatwe can charge for our water and wastewater services.

 

Our Services Groupoperates our contract service businesses in which we operate and maintain watersupply and wastewater facilities owned by cities, public agencies, municipalutility districts, private entities and investor-owned utilities (includingUtility Group affiliates) primarily in Alabama, California, Colorado, Georgia,Mississippi, New Jersey, New Mexico, South Dakota and Texas. While state andfederal agencies issue regulations regarding standards of water quality,safety, environmental and other matters which affect these operations, ourServices Group prices are not subject to regulation. We also provided utilitybilling and collection services.

 

In July 2004,we acquired a Texas regulated water and wastewater utility consisting of acollection of 87 rural water systems and 11 wastewater systems servingapproximately 21,000 water connections and 3,500 wastewater connections fromTecon Water Holdings, L.P. for approximately $66 million, and renamed theutility Monarch Utilities, Inc. (“Monarch”).

 

In March 2005,we completed the acquisition of the assets of a contract operations companylocated in Shelby County, Alabama.  Theaggregate purchase price was approximately $2.5 million, of which $0.7 millionwas deferred, plus liabilities we assumed in the amount of approximately $1.2million.  We incurred transactions costof approximately $0.2 million.

 

In June 2005, wecompleted the sale of our submetering subsidiary that provided utility billingand collection services for multi-family residential properties.  The sale price was approximately $12.0million.  We received approximately $10.8million in cash, and approximately $1.2 million of the sales price was placedinto an escrow account.  We incurredtransaction costs of approximately $1.0 million to complete the sale and ournet proceeds on the sale of our submetering subsidiary were approximately $9.8million.

 

In the second quarter of 2005, we recorded a lossfrom discontinued operations (net of income tax benefit of approximately $0.7million) of approximately $1.2 million and a loss on sale of stock ofapproximately $3.7 million (net of income tax benefit of approximately $0.3million) in connection with the sale of our submetering subsidiary.

 

In September 2005,we completed the acquisition of a wastewater system located in Shelby County,Alabama.  The aggregate purchase priceand related transaction costs were approximately $8.5 million and $0.1 millionrespectively.

 

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**Results of Operations**

 

A summary of ourconsolidated results for continuing operations for the three and nine monthsended September 30, 2005 and 2004 is as follows:

 
| ** **                                                 | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                 | ** ** | ** **                                | ** ** | **% of**                                 | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                                                 | ** ** | **2005**                                  | ** ** | **Revenue**                              | ** ** | **2004** | ** ** | **Revenue** | ** ** | **2005** | ** ** | **Revenue** | ** ** | **2004** | ** ** | **Revenue** | ** ** |
| ** **                                                 | ** ** | **($ amounts in millions)**          | ** ** |
| **Revenues:**                                              |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Utility group                                              |       | $                                         | 23.3       |                                     | 43         |   | $ | 22.4 |   | 43 |   | $ | 59.1 |   | 39 |   | $ | 52.1 |   | 39 |   |
| Services group                                             |       | 31.4                                      |       | 57                                       |       | 30.2 |   | 57 |   | 92.1 |   | 61 |   | 82.0 |   | 61 |   |
|                                                       |       | 54.7                                      |       | 100                                      |       | 52.6 |   | 100 |   | 151.2 |   | 100 |   | 134.1 |   | 100 |   |
|                                                       |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Expenses:**                                              |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating expenses - utility group                         |       | 12.8                                      |       | 23                                       |       | 13.7 |   | 26 |   | 33.5 |   | 22 |   | 30.0 |   | 22 |   |
| Operating expenses - services group                        |       | 28.0                                      |       | 51                                       |       | 27.0 |   | 50 |   | 80.6 |   | 53 |   | 74.8 |   | 56 |   |
| Selling, general and administrative expenses               |       | 7.7                                       |       | 14                                       |       | 6.9 |   | 13 |   | 23.0 |   | 15 |   | 19.0 |   | 14 |   |
|                                                       |       | 48.5                                      |       | 88                                       |       | 47.6 |   | 89 |   | 137.1 |   | 90 |   | 123.8 |   | 92 |   |
| **Operating Income**                                       |       | 6.2                                       |       | 12                                       |       | 5.0 |   | 11 |   | 14.1 |   | 10 |   | 10.3 |   | 8 |   |
| ** **                                                 |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Other Income (Expense):**                                |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest expense                                           |       | (1.7                                      | )          | (3                                       | )          | (1.4 | ) | (3 | ) | (5.3 | ) | (4 | ) | (3.4 | ) | (3 | ) |
| Interest income                                            |       | 0.2                                       |       | —                                   |       | 0.5 |   | 1 |   | 0.3 |   | — |   | 0.9 |   | 1 |   |
| Other                                                      |       | —                                    |       | —                                   |       | (0.1 | ) | — |   | — |   | — |   | (0.3 | ) | — |   |
|                                                       |       | (1.5                                      | )          | (3                                       | )          | (1.0 | ) | (2 | ) | (5.0 | ) | (4 | ) | (2.8 | ) | (2 | ) |
|                                                       |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Income from Continuing Operations before Income  Taxes** |       | 4.7                                       |       | 9                                        |       | 4.0 |   | 9 |   | 9.1 |   | 6 |   | 7.5 |   | 6 |   |
| **Income Tax Provision**                                   |       | 1.6                                       |       | 3                                        |       | 1.5 |   | 3 |   | 3.3 |   | 2 |   | 2.8 |   | 2 |   |
| **Income from Continuing Operations**                      |       | $                                         | 3.1        |                                     | 6          |   | $ | 2.5 |   | 6 |   | $ | 5.8 |   | 4 |   | $ | 4.7 |   | 4 |   |

 

**Effects of Hurricanes Katrina and Rita**

 

Hurricanes Katrina andRita affected the Gulf Coast region of the United States during the thirdquarter of 2005 causing significant damage. Our Services Group provides contract operations and maintenance servicesto clients in Mississippi and Texas, among other states.

 

The water and wastewaterinfrastructure for five clients we service in Mississippi was disabled byKatrina.  The contracts with our clientsprovide that we can incur and bill additional expenses during an emergencysituation to restore water supply and wastewater treatment services tocustomers.  In addition, our clientsrequested we assist with the removal of debris to enable access for emergency vehiclesand residents.  We incurred approximately$622,000 of overtime labor costs and emergency out-of-pocket operating expensesrelated to these emergency recovery efforts. These costs were reflected as operating expenses in the third quarter of2005.  We have billed (or will bill incertain cases) our clients approximately $536,000 to $700,000 for theseemergency services and we are assisting our clients in requesting reimbursementfrom the Federal Emergency Management Agency (“FEMA”) pursuant to guidelinesestablished in FEMA’s *Applicant Handbook*.  We recognized revenues of $500,000 based onthe revenue recognition criteria set forth in Staff Accounting Bulletin No. 104,*Revenue Recognition*with respect tothese costs.  Additional revenues, ifany, resulting from billings to our clients beyond $500,000 will be recognizedif and when collection is reasonably assured. The $500,000 we have billed for these emergency services is reflected intrade accounts receivable as of September 30, 2005.

 

We also incurredapproximately $64,000 of costs related to preparing for Hurricane Rita,principally temporary infrastructure relocation expenses.  These costs were recorded as an operatingexpense during the third quarter of 2005 and are not reimbursable by FEMA or recoverablethrough insurance.

 

**Adoption of Share-BasedPayment (SFAS 123R)**

 

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 123 (revised December 2004), *Share-Based Payment* (“SFAS 123R”).  This Statementis a revision of SFAS No. 123.  SFAS 123R establishes standards forthe accounting for transactions in which an entity exchanges its equityinstruments for goods or services.  SFAS 123R is effective for the Companyas of the beginning of the first annual reporting period that begins after June 15,2005.  The

 

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Companyhas already adopted SFAS No. 123, and management believes the impact ofthe adoption of SFAS 123R on the Company’s consolidated financial statementswill not be material.

 

**Discussion of Resultsof Operations for Three Months Ended September 30, 2005 and 2004**

 

**Revenues**

 

**Utility Group**

 

UtilityGroup revenues are derived from the production and distribution of water and thecollection and treatment of sewage for residential, industrial and commercialuse. Our Utility Group results of operations are seasonal, as rainfall andweather conditions affect water consumption. In our service areas, the second and third quarters of each yeartypically account for the highest volume of water consumption when weathertends to be hot and dry. Drought conditions may result in lower revenue due toconsumer conservation efforts and a shortage of water. Drought conditions mayalso result in increased water costs to us, which could adversely affect ourprofitability. Conversely, unusually wet conditions may result in decreasedcustomer demand, lower revenues and lower profit in our Utility Groupoperations.   

 

Revenuesin the Utility Group increased approximately $0.9 million, or 4%, to $23.3million during the three months ended September 30, 2005, from $22.4 millionduring the same period of the prior year. The increase in Utility Group revenuewas primarily due to the following:

 

1.     A $0.8 millionincrease in revenues attributable to Monarch Utility which we acquired in mid-July 2004.

2.     An increase of$0.3 million due to higher volume and increased number of connections severd byour New Mexico and other Texas utilites.

3.     An increase inrates of approximately $0.3 million at our California utility.  

4.     These increaseswere partially offset by a decrease in our California utility revenues of $0.5million due to lower water consumption as a result of cooler temperatures andsomewhat higher rainfall versus the prior year.

 

**ServicesGroup**

 

Services Group revenuesrepresent fees earned for water and wastewater facility operations andmaintenance (O&M) services, equipment maintenance and repair, sewerpipeline cleaning, construction management services, state-certified water andwastewater laboratory analysis and public works. Revenues for the three monthsended September 30, 2005 increased approximately $1.2 million, or 4%, to $31.4million from $30.2 million during the same period of the prior year.  

 

The increase in ServicesGroup revenues was primarily due to the following:

 

1.     A $1.9 millionincrease in revenue associated with contract operations, primarily thoseperformed for our Utility Group, as well as increased project work.  Of this increase approximately $0.5 millionis billable work associated with Hurricane Katrina.  See “Effects of Hurricanes Katrina and Rita”at beginning of Management Discussion and Analysis.

2.     A $1.4 millionincrease due to the recent acquisition of contract operations in Alabama and a$0.2 million increase from revenues generated by a laboratory we acquired inthe latter part of 2004.

3.     These revenue increaseswere partially offset by a decrease of approximately $2.3 million inconstruction-related revenues for the reverse osmosis plant, which had been underconstruction since 2003 and was substantially completed as of September 30,2005.

 

**Expenses**

 

**Operating expenses – Utility Group**

 

Operating expenses–Utility Group represent the costsof purchasing and producing water, treating wastewater, salaries, wages andemployee benefits, facilities costs, power and electricity, supplies andequipment, repairs and maintenance, professional fees and other costs.Operating expenses for our Utility Group decreased $0.9 million, or 7%, to$12.8 million during the three months ended September 30, 2005, from $13.7million during the comparable period of 2004. The decrease in operating expenses was primarily due to reduced operatingexpenses of $0.7 million at our California utility associated with lower water consumptionas a result of cooler temperatures and somewhat higher rainfall versus theprior year.  The lower consumptionenabled us to reduce the amount of water purchased from outside sources, whichis generally at prices higher than the cost of water pumped from our own wells.  

 

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Operating expenses–UtilityGroup, as a percentage of related revenues represented approximately 55% and 61%of revenues from utility operations for the three months ended September 30,2005 and 2004, respectively.  Thedecrease was primarily due to a decrease in operating expenses related tohigher capitalized overhead, lower property taxes and repairs and maintenancein our California utility combined with increased revenues from the mid-July 2004acquisition of Monarch Utility.

 

**Operatingexpenses – Services Group**

 

Operatingexpenses–services group include salaries, wages, employee benefits, projectcosts, fleet expenses, facilities costs, supplies and equipment, repairs andmaintenance and professional fees. Operating expenses–services group increased approximately $1.0 million,or 4%, to $28.0 million during the three months ended September 30, 2005from $27.0 million during the same period of 2004.  The increase in operating expense–servicesgroup was due primarily to the following:

 

1.     Anincrease in operating expenses of $1.1 million resulting from the recentacquisition of contract operations in Alabama and a $0.6 million increasegenerated by a laboratory we acquired in the latter part of 2004.

2.     Anincrease of $0.9 million associated with contract operations, primarily thoseperformed for our Utility Group, as well as increased project work.  

3.     Anincrease of $0.7 million of costs and expenses stemming from Hurricanes Katrinaand Rita related to equipment losses, emergency supplies and temporaryinfrastructure relocation expenses.  See “Effectsof Hurricanes Katrina and Rita” at beginning of Management Discussion andAnalysis.

4.     These increaseswere partially offset by a decrease of approximately $2.3 million inconstruction work related to the reverse osmosis plant, which has been underconstruction since 2003 and was substantially completed as of September 30,2005.

 

Operating expenses – ServicesGroup, as a percentage of the revenues from the related operations remainedconstant at 89% for the three months ended September 30, 2005 compared to thesame period of 2004.   

 

**Selling,general and administrative expenses**

 

Selling, general andadministrative expenses consist mainly of personnel, facilities, insurance andprofessional services costs, which support our sales, marketing, humanresources, finance and administration functions.  Selling, general and administrative expensesincreased $0.8 million, or 12%, to $7.7 million for the three months ended September 30,2005 compared to $6.9 million during the same period of 2004.  Selling, general and administrative expenses increasedto 14% of revenues for the three months ended September 30, 2005 from 13%for the three months ended September 30, 2004.  The increase in selling, general andadministrative expenses was primarily due to an increase of $0.6 millionattributable to the acquisitions of Monarch Utility, contract operations inAlabama and laboratory service in Texas. 

 

**OtherIncome (Expense)**

 

**Interest Expense**

 

Interestexpense increased approximately $0.3 million, or 24%, during the three monthsended September 30, 2005 compared to the same period in 2004.  The major components of interest expense areas follows:

 
| ** **                                             | ** ** | **For the Three Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                                 | ** ** |
| Interest expense  - convertible subordinate debentures | ** ** | **$**                                              | **289**    |   | $ | 327 |   |
| Interest expense  - bank lines of credit               | ** ** | **496**                                            |       | 322 |   |
| Interest expense  - mortgage bonds and bank term loan  | ** ** | **906**                                            |       | 889 |   |
| Interest expense  - other                              | ** ** | **387**                                            |       | 85 |   |
| Total interest  expense before capitalized interest    | ** ** | **2,078**                                          |       | 1,623 |   |
| Capitalized  interest                                  | ** ** | **(427**                                           | **)**      | (177 | ) |
| Total interest  expense                                | ** ** | **$**                                              | **1,651**  |   | $ | 1,446 |   |

 

The increase in totalinterest expense is primarily due to an increase in our long-term debt andborrowing on our bank lines of credit resulting from acquisitions and capitalspending.  This was partially offset byincreased capitalization of interest as a result of increased capitalspending.  Our average balances of interest-bearingdebt outstanding were approximately $124 million and $114

 

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million for the threemonths ended September 30, 2005 and 2004, respectively.  In addition, our effective weighted averageborrowing rate increased to 6.5% during the three months ended September 30,2005 from 6.3% during the three months ended September 30, 2004.  

 

**Provision for Income Taxes**

 

Our effectiveconsolidated income tax rates on combined continuing and discontinuedoperations for the three months ended September 30, 2005 and 2004 wereapproximately 35% and 37%, respectively.

 

**Discussion of Resultsof Operations for Nine Months Ended September 30, 2005 and 2004**

 

**Revenues**

 

**Utility Group**

 

Revenuesin the Utility Group increased approximately $7.0 million, or 13%, to $59.1million during the nine months ended September 30, 2005, from $52.1 millionduring the same period of the prior year. The increase in Utility Group revenuewas primarily due to the following:

 

1.     An approximate $8.3million increase in revenues attributable to Monarch Utility which we acquiredin mid-July 2004.

2.     An increase inrevenues from our New Mexico and Texas utilities of $0.8 million primarily dueto increased connections.

3.     The aboveincreases were partially offset by a decrease in revenues of our Californiautility of $2.8 million due to lower consumption as a result of coolertemperatures and higher rainfall versus the prior year partially offset by anincrease in rates of approximately $0.7 million.

 

**ServicesGroup**

 

Revenues for the ninemonths ended September 30, 2005 increased approximately $10.1 million, or 12%,to $92.1 million from $82.0 million during the same period of the prior year. 

 

The increase in ServicesGroup revenues was primarily due to the following:

 

1.     An approximate $12.8million increase in revenues associated with contract operations, primarilythose performed for our Utility Group, as well as increased construction work.  Of this increase approximately $0.5 million isfor billable work associated with Hurricane Katrina.  See “Effects of Hurricanes Katrina and Rita”at beginning of Management Discussion and Analysis.  The increased project work is also a resultof approximately 60% less rainfall in southern Texas versus the first ninemonths of 2004. 

2.     A $1.4 millionincrease due to the acquisition of a laboratory and a $2.2 million increase dueto the acquisition of contract operations in Alabama.

3.     These revenueincreases were partially offset by a decrease of $6.3 million in constructionwork related to the reverse osmosis plant which has been under constructionsince 2003 and was substantially completed as of September 30, 2005.

 

**Expenses**

 

**Operating expenses – Utility Group**

 

Operating expenses for our Utility Group increased $3.5 million,or 12%, to $33.5 million during the nine months ended September 30, 2005,from $30.0 million during the comparable period of 2004.  The increase in operating expenses wasprimarily due to the following:

 

1.     Anincrease of operating expenses of approximately $5.6 million attributable toMonarch which was acquired in mid-July 2004.

2.     Thisincrease was offset in part by reduced operating expenses of $2.0 million atour California utility due to lower production as a result of above averagerainfall during the first half of the year. 

 

Operating expenses—UtilityGroup, as a percentage of related revenues represented approximately 57% and 58%of revenues from utility operations for the nine months ended September 30,2005 and 2004, respectively.  

 

18

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**Operatingexpenses – Services Group**

 

Operatingexpenses–services group increased approximately $5.8 million, or 8%, to $80.6million during the nine months ended September 30, 2005 from $74.8 millionduring the same period of 2004.  Theincrease in operating expense–services group was due to the following:  

 

1.     Anincrease of operating expenses of approximately $3.6 million as a result of therecent acquisition of contract operations and a laboratory services in thelatter part of 2004.

2.     An increase ofapproximately $7.8 million associated with contract operations, primarily thoseperformed for our Utility Group, as well as increased project work.  The increased expense is also a result of increasedstaffing and fleet expense related to additional contract work, some of whichwas delayed from 2004.  The staffingincrease resulted in higher salary and wage expenses as well as benefits andother related costs.  

3.     An increase of approximately$0.7 million of costs and expenses stemming from Hurricanes Katrina and Ritarelated to equipment losses, emergency supplies and temporary infrastructurerelocation expenses which we believe will not be reimbursable by FEMA.  See “Effects of Hurricanes Katrina and Rita”at beginning of Management Discussion and Analysis.

4.     These increaseswere partially offset by a decrease of approximately $6.3 million inconstruction work related to the reverse osmosis plant, which has been underconstruction since 2003 and was substantially completed as of September 30,2005.

 

Operating expenses – ServicesGroup, as a percentage of the related revenues, decreased to 88% for the ninemonths ended September 30, 2005, compared to 91% for the same period of2004.   The decrease was due to lower2004 revenues as a result of higher rainfall relative to the expenses foradditional construction, operating and maintenance work.

 

**Selling,general and administrative expenses**

 

Selling, general andadministrative expenses increased $4.0 million, or 21%, to $23.0 million forthe nine months ended September 30, 2005 compared to $19.0 million duringthe same period of 2004.  Selling, generaland administrative expenses increased to 15% of revenues for the nine monthsended September 30, 2005 from 14% during the nine months ended September 30,2004.  The increase in selling,general and administrative expenses was primarily due to the following: 

 

1.     An increase inaudit fees of $0.4 million, legal fees of $0.3 million, as well as an increaseof $0.7 million in outside services, most of which is attributable to ourefforts to prepare for and comply with the Sarbanes-Oxley Act of 2002associated with our 2004 year end efforts.

2.     An increase of$1.4 million primarily attributable to the Monarch acquisition which occurredin mid-July 2004.

3.     A $1.2 millionincrease in costs compared to the prior period related to salaries and employeebenefits as a result of increases in headcount to support our revenue trends.

 

**OtherIncome (Expense)**

 

**Interest Expense**

 

Interestexpense increased approximately $1.9 million, or 56%, during the nine monthsended September 30, 2005 compared to the same period in 2004.  The major components of interest expense areas follows:

 
| ** **                                             | ** ** | **For the Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                             | ** ** | **September 30,**        | ** ** |
| ** **                                             | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| ** **                                             | ** ** | **(in thousands)**            | ** ** |
| Interest expense  - convertible subordinate debentures | ** ** | **$**                         | **880**    |   | $ | 968 |   |
| Interest expense  - bank lines of credit               | ** ** | **1,372**                     |       | 734 |   |
| Interest expense  - mortgage bonds and bank term loan  | ** ** | **2,985**                     |       | 1,874 |   |
| Interest expense  - other                              | ** ** | **523**                       |       | 185 |   |
| Total interest  expense before capitalized interest    | ** ** | **5,760**                     |       | 3,761 |   |
| Capitalized  interest                                  | ** ** | **(509**                      | **)**      | (390 | ) |
| Total interest  expense                                | ** ** | **$**                         | **5,251**  |   | $ | 3,371 |   |

 

The increase in totalinterest expense is primarily due to an increase in our long-term debt andborrowings on our bank lines of credit due to acquisitions and capital spending.This was offset in part by lower interest payments on our debentures asdebenture holders

 

19

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have converted these debtinstruments into common stock and increased capitalization of interest as aresult of our capital spending.  Ouraverage balances of interest bearing debt outstanding were approximately $128million and $77 million for the nine months ended September 30, 2005 and2004, respectively. In addition, our effective weighted average borrowing rate increasedto 6.4% during the nine months ended September 30, 2005 from 6.1% duringthe nine months ended September 30, 2004. 

 

**Provision for Income Taxes**

 

Our effectiveconsolidated income tax rates on combined continuing and discontinuedoperations for the nine months ended September 30, 2005 and 2004 wereapproximately 35% and 37%, respectively.

 

During the nine months endedSeptember 30, 2005 we recognized a capital loss of approximately $4.0million for income tax purposes upon the sale of our submetering subsidiary.  We will be able to carry back the capitalloss to the prior three years and partially offset it against capital gains ofapproximately $0.9 million realized during those years.  As a result, we recognized an income taxbenefit of approximately $0.3 million during the second quarter of 2005,resulting in a net loss of approximately $3.7 million on sale of thissubsidiary.

 

The remaining capitalloss of approximately $3.1 million may be carried forward for a period of up to15 years and offset against future capital gains, if any, which may be realizedduring those years. No income tax benefit has been recorded in 2005 for thiscapital loss carryforward.

 

**Liquidity and Capital Resources**

 

Our corporate objectiveswith respect to liquidity and capital resources are to:  (i) generate sufficient operating cashto provide for dividends, principal and interest requirements on ourindebtedness, capital improvements, and taxes; (ii) obtain externalfinancing for long-term capital improvements and acquisitions; (iii) use ourcredit facilities to manage seasonal cash needs; and (iv) maintainapproximately equal levels of debt and equity. 

 

Our statements of cashflows are summarized as follows:

 
| ** **                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **(in thousands)**                        | ** ** |
| Net cash  provided by continuing operating activities | ** ** | **$**                                     | **17,946** |   | $ | 726 |   |
| Net cash used in  investing activities                | ** ** | **(36,714**                               | **)**      | (66,088 | ) |
| Net proceeds  from sale of discontinued operations    | ** ** | **9,852**                                 |       | — |   |
| Net cash  provided by financing activities            | ** ** | **14,279**                                |       | 66,449 |   |
| Net increase in  cash and cash equivalents            | ** ** | **$**                                     | **5,363**  |   | $ | 1,087 |   |

 

*CashFlows From Continuing Operating Activities*

 

Cash and cash equivalentsincreased by approximately $5.4 million for the nine months ended September 30,2005, as compared to $1.1 million in 2004. The increase in 2005 cash and cash equivalents was due to strong cashflow from our operating activities which was significantly higher than lastyear due to:

 

•      acquisitions,

•      increasedcustomer connections,

•      increasedclient contracts, and

•      increasedrevenues on our existing contract operations.

 

For further discussion onoperating revenues and expenses see Results of Operations.

 

20

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*CashFlows from Investing Activities*

 

Our investing activitiesfocus on capital spending related to expansion, replacement and renovation ofour water and wastewater systems of approximately $26.0 million withsignificant spending occurring in our Texas and California utilities versusprior year spending of $16.0 million.  

 

Contributions in Aid ofConstruction (“CIAC”) represent contributions in the form of cash, services orproperty received from developers, governmental agencies, municipalities orindividuals for the purpose of constructing utility plant. Our capital spendingon our water and wastewater systems has benefited from contributions fromdevelopers to aid in construction of these facilities of approximately $2.8million as compared to approximately $2.6 million from the same period lastyear.  

 

The following tablesummarizes property, plant and equipment additions for each of the first ninemonths in 2005 and 2004.

 

 
| ** **                                        | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                        | ** ** | **(in thousands)**                        | ** ** |
|                                              |       |                                      |       |   |   |
| Company-financed  additions                       | ** ** | **$**                                     | **23,069** |   | $ | 12,984 |   |
| Capital  improvement reimbursements               | ** ** | **144**                                   |       | 386 |   |
| Contributions  paid for by developers             | ** ** | **2,842**                                 |       | 2,593 |   |
| Total property  additions paid in cash            | ** ** | **26,055**                                |       | 15,963 |   |
| Property  contributed by developers (noncash)     | ** ** | **2,248**                                 |       | 5,394 |   |
| Total additions  to property, plant and equipment | ** ** | **$**                                     | **28,303** |   | $ | 21,357 |   |

 

Cash payments foracquisitions during the first nine months of 2005 and 2004 included:

 

•      $2.6million in 2005 in cash for the purchase of Alabama contract operations, 

•      $8.5million in 2005 in cash for the purchase of an Alabama utility company, 

•      $2.9million in 2004 to acquire the remaining minority interest in our submeteringsubsidiary which was sold in June 2005, and

•      $46.7million in 2004 to acquire Monarch, one of our Texas utilities.

 

*CashFlows from the Sale of Discontinued Operations*

 

The increase ofapproximately $9.8 million in net proceeds from sale of our submeteringsubsidiary improved our cash position.  In June 2005, we completed the sale ofour submetering subsidiary inour services segment for approximately $12.0 million.  We received approximately $10.8 million incash and approximately $1.2 million of the sales price was placed into anescrow account.  We incurred transactioncosts of approximately $1.0 million to complete the sale and our net proceedson the sale of submetering subsidiary were approximately $9.8 million.  The cash from the sale was subsequently usedto pay down our bank lines of credit in our New Credit Facility.  

 

*CashFlows from Financing Activities*

 

Our financing activitiesinvolved the following significnat events during the first nine months of 2005as follows:

 

•      Net borrowings on ourrevolving lines of credit in 2005 of approximately $4.0 million.  

•      Ournet cash provided by financing activities increased through additionalborrowings of long term debt of $20.0 million. This was partially offset by repayments on our long term debt ofapproximately $16.4 million.  

•      Salesof stock of approximately $4.5 million.

 

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Our financing activitiesinvolved the following significant events during the first nine months of 2004as follows:

 

•      Net borrowings on ourrevolving lines of credit of approximately $25.7 million.  

•      Apublic offering of approximately 1.6 million shares of our common stock in March 2004,which generated net proceeds of approximately $20.5 million.

•      Apublic offering of approximately 1.8 million shares of our common stock in August 2004,which generated net proceeds of approximately $20.7 million.

 

Common stockholders mayelect to participate in our Amended and Restated Dividend Reinvestment andStock Purchase Plan (“DSPP”), which gives them the option of receiving theirdividends in either cash or common stock at a 5% discount from current marketvalue.  This plan also permits optionalcash purchases of stock at current market values of up to $10,000 perstockholder each month. Our cash position benefited by approximately $7.6million as we experienced significant activity in direct stock purchase activityof approximately $4.5 million and primarily stock option exercises whichcontributed approximately $3.1 million.  

 

During 2005, we paiddividends totaling approximately $3.0 million. Our quarterly dividend rate iscurrently $0.05 per common share.  

 

Aggregate borrowingsunder our revolving lines of credit were approximately $27.0 million as of September 30,2005, an increase of approximately $4.0 million since December 31, 2004,primarily used for capital expenditures. Our total borrowing availability underthe New Credit Facility was approximately $69.1 million as of September 30,2005.

 

We entered into a new 5-yearcredit facility with a syndicate of banks in April 2005, which providesfor a $100 million revolving credit facility. In April 2005, we used a portion of our borrowings from the NewCredit Facility to repay amounts outstanding, and to extinguish, our lines ofcredit and certain other indebtedness.

 

As part of implementing the New Credit Facility thefollowing actions were taken to reduce interest expense:

 

1)     Redeemed$4.0 million of our New Mexico bonds on April 4, 2005,

2)     Redeemednotes payable of approximately $2.5 million on April 29, 2005,

3)     Repaymentof a term loan for one of our Texas utilities in the amount of approximately$8.8 million on April 1, 2005, and

4)     Repaida revolving credit facility for our New Mexico Utility in the amount of approximately$3.8 million on April 1, 2005.

 

Our capital resources areused for debt service on our bonds and debentures and are also influenced byinvestments we make in new business ventures, including the acquisition ofcompanies and contract operations. We have historically generated reasonablystable operating cash flows. 

 

Weexpect to spend approximately $9.0 million for cash capital expenditures forthe remainder of 2005, primarily for utility property, plant and equipment.  We plan to fund those expenditures with cashflow from operations, borrowings under our New Credit Facility, long term debtfinancing and other sources.

 

At September 30, 2005, we had working capital ofapproximately $11.8 million including available cash and cash-equivalentbalances of approximately $6.8 million (excluding restricted cashbalances).  

 

We have an effective registration statement on filewith the Securities and Exchange Commission (“SEC”).  Approximately $6 million remainsavailable for issuance of securities as of September 30, 2005 under thisregistration statement. We may offer these securities for sale at any time andfrom time to time.

 

**Off-Balance Sheet Arrangements**

 

We do not have any material off-balance sheetarrangements other than leases that have been classified as operating leases inaccordance with accounting principles generally accepted in the United States (“USGAAP”).

 

**DebtObligations**

 

Following is a summary ofour debt obligations and commitments due in the remaining three months of 2005and in the specified periods thereafter. Amounts represent the expected cash principal payments related to ourlong-term debt.

 

22

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| ** **                          | ** ** | ** **         | ** ** | **Years Ending December 31,** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|--------------------|------------|------------------------------------|------------|------------|------------|
| ** **                          | ** ** | ** **         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | **2009 and** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **2005 (1)**       | ** ** | **2006**                           | ** ** | **2007**   | ** ** | **2008** | ** ** | **thereafter** | ** ** | **Total** | ** ** |
| ** **                          | ** ** | **(in thousands)** | ** ** |
| Long-term debt                      |       |               |       |                               |       |       |       |   |   |   |   |   |   |
| Bank lines of credit                |       | $                  | —     |                               | $          | —     |       | $ | — |   | $ | — |   | $ | 27,000 |   | $ | 27,000 |   |
| Bank term loans                     |       | 238                |       | 946                                |       | 938        |       | 931 |   | 31,649 |   | 34,702 |   |
| Economic  development revenue bonds |       | 95                 |       | 100                                |       | 105        |       | 115 |   | 1,810 |   | 2,225 |   |
| Mortgage bonds                      |       | —             |       | 8,000                              |       | —     |       | — |   | 35,000 |   | 43,000 |   |
| Convertible  subordinate debentures |       | —             |       | —                             |       | —     |       | — |   | 16,842 |   | 16,842 |   |
| Notes payable                       |       | 7                  |       | 397                                |       | 420        |       | 1,598 |   | — |   | 2,422 |   |
|                                |       | $                  | 340        |                               | $          | 9,443      |       | $ | 1,463 |   | $ | 2,644 |   | $ | 112,301 |   | $ | 126,191 |   |

 

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(1) Representsprincipal payments to be made the remainder of the year.

 

We have $8.0 million of7.61% first mortgage bonds maturing on October 20, 2006.  We are exploring various alternatives withrespect to funding this redemption obligation including refinancing theobligation through the sale of new mortgage bonds or funding the obligationwith borrowings under the New Credit Facility.

 

In April 2005,we entered into the New Credit Facility. The New Credit Facility provides for a $100 million revolving creditfacility, which includes a $40 million letter of credit subfacility and a $10million swingline subfacility.  The New Credit Facility contains customarycovenants, as well as customary events of default.  Certain of our subsidiaries have guaranteedour obligation to repay borrowings under the New Credit Facility.  

 

Loansunder the New Credit Facility (other than swingline loans) bear interest at arate equal to (i) LIBOR plus the applicable margin (as provided for in theNew Credit Facility), or (ii) a base rate (as defined) minus theapplicable margin.  At September 30,2005, we had $27.0 million of outstanding borrowings under our New CreditFacility and the adjusted average borrowing rate was approximately 4.8%.  The New Credit Facility replaced our existinglines of credit which had provided for up to $50.0 million of borrowings and weused the New Credit Facility to repay amounts outstanding under those lines ofcredit.  As of September 30, 2005,we were in compliance with all applicable covenants under our outstanding lineof credit agreements.

 

In January 2003,we received a $3.4 million line of credit from one of our commercial banks thatwe used to issue a standby letter of credit in that amount as collateral forperformance under a contract to design and construct the CVWD plant.  On April 1, 2005, the standby letter ofcredit was transferred to the New Credit Facility and the standby line ofcredit was cancelled.

 

Inaddition to the foregoing, the indentures governing the first mortgage bondsfor our California and New Mexico utilities allow for the issuance ofapproximately $65.0 million of first mortgage bonds at these utilities as of September 30,2005.  

 

Weanticipate that our available credit facility borrowing capacity, cash flowsgenerated from operations, long-term debt financing and other sources will besufficient to fund our activities during the next 12 months; however, wecannot guarantee that will be the case. If we needed additional financing and were unable to obtain it, ourcapital spending and any future acquisitions would be delayed, reduced, oreliminated.

 

**Critical Accounting Policies**

 

Our consolidated financial statements are prepared inaccordance with US GAAP. These accounting principles require us to make certainestimates, judgments and assumptions. We believe that the estimates, judgmentsand assumptions are reasonable based upon information available to us at thetime that these estimates, judgments and assumptions are made. These estimates,judgments and assumptions can affect the reported amounts of assets andliabilities as of the date of the financial statements, as well as the reportedamounts of revenues and expenses during the periods presented. To the extentthere are material differences between these estimates, judgments orassumptions and actual results, our financial statements will be affected. Thesignificant accounting policies that we believe are important to fullyunderstanding and evaluating our reported financial results include the following:

 

•      Revenuerecognition,

•      Valuationof long-lived and intangible assets,

•      Accountingfor regulated businesses,

•      Stock-basedcompensation, and

•      Deferredcosts.

 

23

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Our senior management has reviewed these criticalaccounting policies and related disclosures with the audit committee of theBoard of Directors. 

 

**Revenuerecognition**

 

Water utility revenues are recognized when water isdelivered to customers. At the end of an accounting period, estimated amountsfor unbilled revenues are accrued for water usage since the previous billingperiod. 

 

Revenues for contract operations are recognized andbilled at the end of the month based on a monthly fee to provide a specificlevel of service as outlined in each individual contract. We generally bill foradditional services provided beyond the scope of the base contract on atime-and-materials basis as such services are rendered. 

 

Revenues for construction projects are recorded usingthe percentage-of-completion method of accounting. The percentage-of-completionmethod recognizes revenue and income as work progresses on a project based onthe expected total project costs and the expected total project revenues. Thismethod is based on an estimate of the revenue and income earned to date, lessthe revenue and income recognized in earlier periods. If management anticipateswe will ultimately suffer a loss on a construction project, the entireestimated loss is recorded in the period such a determination is made. 

 

If a contract involves the provision of a singleproduct or service, revenue is generally recognized when the product or serviceis provided and the amount becomes billable. If services are provided evenlyduring the contract term but service billings are irregular, revenue isrecognized on a straight-line basis over the contract term. 

 

Certain non-refundable activation fees in ournon-regulated wholesale water operations are accounted for on a completedcontract basis and subsequently deferred and recognized over the expectedperiod of performance.

 

If a contract involves the provision of multipleproducts or services (elements), total estimated contract revenue is allocatedto each element based on the relative fair value of each service, provided theservices qualify for separation under Emerging Issues Task Force (“EITF”) 00-21,*Accounting for Revenue Arrangements withMultiple Deliverables*. The amount of revenue allocated to eachservice is limited to the amount that is not contingent upon the delivery ofanother element in the future. Revenue is then recognized for each element asdescribed above for single-element contracts, except revenue recognized on astraight-line basis for a non-construction service will not exceed amountscurrently billable unless the excess revenue is recoverable from the clientupon any contract termination event. If the amount of revenue allocated to aconstruction service is less than its relative fair value, costs to deliversuch service, limited to the difference between allocated revenue and therelative fair value, are deferred and amortized over the contract term. Iftotal construction service costs are estimated to exceed the relative fairvalue for the construction service contained in a multiple-element arrangement,then a provision for the estimated loss is made in the period in which the lossfirst becomes apparent. 

 

**Valuationof long-lived and intangible assets**

 

In accordance with SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets,*we assess intangible assets and other long-livedassets, excluding goodwill, for recoverability whenever events or changes incircumstances indicate that their carrying value may not be recoverable throughthe estimated undiscounted future cash flows resulting from the use of theassets. If we determine that the carrying value of intangible assets or otherlong-lived assets may not be recoverable, we measure impairment by using theprojected discounted cash-flow method in accordance with Statement No. 144.

 

We have made acquisitions in the past that resulted inrecording goodwill and intangible assets. In September 2001, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 142,*Goodwill and Other Intangible Assets.*SFASNo. 142 requires that goodwill and intangible assets with indefiniteuseful lives are not amortized, but instead are tested for impairment at leastannually. For intangible assets with finite useful lives, SFAS No. 142requires amortization over their estimated useful lives. SFAS No. 142became effective for fiscal years beginning after December 15, 2001. Weevaluate goodwill impairment, at least annually, using discounted cash flowmethodologies, transaction values for comparable companies, and other valuationtechniques for our reporting units with significant goodwill balances.  Our reporting units, generally subsidiariesone level below operating segments, constitute separate businesses for which wemaintain discrete financial information that is regularly reviewed by segment andchief operating decision maker.  Therewere no impairment charges to goodwill as of September 30, 2005 and noevents have occurred that indicated diminution in the value of recordedgoodwill. 

 

Under the provisions of SFAS No. 141, *Business Combinations*, we have identifiedintangible assets apart from goodwill such as contract costs and accountlists.  These intangible assets areamortized over their estimated useful lives ranging from four to eight years.  

 

24

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**Accountingfor regulated businesses**

 

Our regulated businesses, which include our utilitiesin Alabama, California, New Mexico, Oklahoma and Texas, are required to beaccounted for under the provisions of SFAS No. 71, *Accounting for the Effects of Certain Types ofRegulation,* which specifies certain revenue, expense and balancesheet treatment as required by each state’s regulatory authority. Each stateauthority establishes rates which are intended to permit each utility torecover its costs and earn a reasonable rate of return. 

 

Our Services Group hascontracted with our utilities in Alabama, Oklahoma, New Mexico and Texas toperform operating services, maintenance, construction work, and to managecapital projects.  In accordance withSFAS No. 71, our Services Group recognizes profit on sales to regulatedaffiliates and does not eliminate the intercompany profit when the sales priceis reasonable and it is probable that, through the rate making process, futurerevenue approximately equal to the sales price will result from the regulatedaffiliate’s use of the services. However, all revenue in excess of profits is eliminated.  Accordingly, the intercompany profit forconstruction as well as operations and maintenance services provided to UtilityGroup affiliates has not been eliminated in the accompanying consolidatedfinancial statements.  Based upon ourServices Group’s experience of providing operations and maintenance services inmore than 400 contracts with unaffiliated customers, and a history of regulatorapproval of the construction service fees charged by the Services Group toutility affiliates, we believe that the contract sales prices between ourServices Group and our Texas and New Mexico utilities are reasonable and thatit is probable that the price of these services will be recovered in therate-making process.

 

**Stock-based Compensation**

 

In 2002, we adopted the fair value recognitionprovisions of SFAS No. 123, *Accountingfor Stock-Based Compensation*, which requires valuation of stock optionsissued based upon an option pricing model and recognition of this value as anexpense over the period in which the options vest. In accordance with theprovisions of SFAS No. 148, we elected to recognize stock-basedcompensation using the retroactive restatement method. Under this change inaccounting method, we restated our accompanying consolidated financialstatements for periods prior to 2002 to reflect stock-based compensationexpense under a fair value based accounting method for all options granted,modified or settled in fiscal years beginning after December 15, 1994. 

 

We use the Black-Scholes option valuation model toestimate the fair value of our stock options. This option valuation model wasdeveloped for use in estimating the fair value of traded options that do nothave vesting restrictions and that are fully transferable. Option valuationmodels require subjective assumptions such as the expected future volatility ofthe stock price. Because the stock options we grant have characteristics thatare significantly different from those of traded options, and because changesin the subjective input assumptions can materially affect the calculatedresults, in management’s opinion, the stock option valuation models, includingBlack-Scholes, may not necessarily provide an exact measure of the fair valueof employee stock options. 

 

**DeferredCosts**

 

We defer and subsequently amortize certain directcontract acquisition costs related to activities that enable the provision ofcontracted services to our customers. Deferred contract acquisition costs areamortized on a straight-line basis over the remaining original contract termunless revenue patterns indicate a more accelerated method is appropriate. Therecoverability of all long-lived assets associated with a particular contract,including deferred contract costs, is analyzed on a periodic basis. If weconclude that long-lived assets are impaired, an impairment loss is recognizedfor the amount by which the carrying value of the long-lived assets exceeds thefair value of those assets. 

 

**RISKFACTORS**

 

Thefollowing factors, which are described more fully in our 2004 Annual Report,represent risks and uncertainties that could cause actual results to differmaterially from our historical experience and our present expectations orprojections. Factors that could affect forward-looking statements relating tothe resolution of the material weakness with respect to internal controlsdiscussed in Item 4 below and Item 9A of our 2004 Annual Report, include amongother things: our ability to identify and retain qualified and experiencedfinancial personnel and our ability to design and maintain policies andprocedures which enable us to avoid any recurrence of the matters which gaverise to the material weakness.   See “Risk Factors” in our 2004 Annual Reportfor further disclosure related to risk factors.

 

**Risks Related to Our Business**

 

***Risk Factors thataffect our Utility Group operations***

 

•      *Weather conditions can affect the financial results of our UtilityGroup.  *

 

25

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•      *Changes in the regulatory environment, including restrictions on rateswe are allowed to charge customers, may adversely affect our results ofoperations.  Changes in policies allowingour Services Group to provide services to our regulated utilities, at fairmarket values, may adversely impact our operating results.*

 

•      *We may discover additional contamination of our water sources which mayadversely affect our operations.  We maynot recover costs incurred or revenues lost due to such contamination fromresponsible parties or from rate payers.*

 

•      *We own assets in areas subject to natural disasters or that may be thetarget of terrorist activities.*

 

•      *We are subject to regulatory and environmental risksand we may not be able to provide an adequate supply of water to our customers.*

 

•      *We need access to capital to continue to invest inour utility assets.*

 

•      *We may be limited in our ability to mitigate water costs related tonon-paying customers due to environmental considerations*.

 

***Risk factors thataffect our Services Group operations***

 

•      *We operate in a competitive market with low operatingmargins.*

 

•      *Our revenue growth depends on our ability to enterinto new, and maintain our existing, operating contracts with cities, agenciesand municipal utility districts.*

 

•      *Our business depends on trained, qualified employees.*

 

•      *Events such as heavy rain, hurricanes, tornadoes andfloods may adversely affect our results of operations.*

 

•      *Our Services Group’s contracts have certainperformance risks.*

 

•      *Services Group contracts for the design andconstruction of water and wastewater facilities may expose us to certaincompletion and performance risks.*

 

•      *We use third party equipment and subcontractors.*

 

•      *Our Services Group is subject to environmental andwater quality risks.*

 

•      *We operate a large fleet of vehicles that couldexpose us to liabilities.*

 

•      *Our operating costs may rise faster than ourrevenues.*

 

•      *Our operating contracts may be canceled, reducing ourrevenues and backlog. Also we may not secure new construction and constructionmanagement projects on a consistent basis, leading to fluctuations in revenuesand backlog.*

 

**Risks Related to Our Common Stock**

 

•      *We are a holding company that depends on cash flowfrom our subsidiaries to meet our obligations.*

 

•      *Our outstanding indebtedness may adversely affect ourfinancial condition and the value of our common stock.*

 

•      *The market price of our shares of common stock couldbe volatile.*

 

•      *Our results could fall below the expectations of market analysts orinvestors. *

 

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•      *We may issue additional shares of our common stock.*

 

**Other Risk Factors**

 

•      *Our capital resources may restrict our ability to operateand expand our business.*

 

•      *If we continue to grow, we may fail to effectivelymanage our growth or we may fail to effectively manage the growth we haveexperienced.*

 

•      *Our business may be affected by the general economicconditions of real estate development in the United States.*

 

•      *We are subject to debt covenants.*

 

•      *Rating agencies may downgrade our debt.*

 

•      *We are subject to increasing costs of producingproducts and services.*

 

•      *Our operations are subject to certain risks due totheir locations.*

 

•      *Internal control weaknesses could have an adverseeffect on us.  We may not be able toremediate the material weakness noted in the 2004 Annual Report in a timelymanner.*

 

•      *The United States Environmental Protection Agencyclosely regulates many of our businesses and we must comply with its rules andregulations.*

 

•      *We rely on a number of complex business systems thatcould malfunction.*

 

•      *We retain certain risks not covered by our insurancepolicies.*

 

***Item3. Quantitative and Qualitative Disclosures about Market Risk***

 

Thereare no material changes from our 2004 Annual Report.

 

***Item4. Controls and Procedures***

 

We maintain disclosure controls and proceduresdesigned to ensure that information required to be disclosed in our ExchangeAct reports is recorded, processed, summarized and reported within the timeperiods specified by the Securities and Exchange Commission and that suchinformation is accumulated and communicated to management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow fortimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognizes that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures. 

 

As discussed in our 2004 Annual Report, filed with theSEC on March 31, 2005, accounting errors were identified during the fourthquarter of 2004 that were caused by lack of an effective review by appropriateaccounting personnel of the accounting for certain non-routine transactions. Thetransactions involved a) purchase accounting for an acquisition, b) balancesheet classification of long-term debt, and c) accounting for a gaincontingency.  As a result of thisinternal control deficiency, there was more than a remote likelihood that theCompany’s interim or annual financial statements could have been materiallymisstated, and accordingly, such deficiency was considered a material weaknessin internal control over financial reporting as of December 31, 2004.  A material weakness is a control deficiency,or combination of control deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements would not be prevented or detected. Because of the material weakness described above, management concludedthat, as of December 31, 2004, our internal control over financialreporting was not effective.

 

We are in the process ofimplementing improvements to our internal controls to address theaforementioned material weakness.  Wehave implemented procedures in our accounting review and approval process overnon-routine transactions.  These includeimplementation of additional checklists, more timely review and accounting fornon-routine transactions and timely identification of non-routine issues withour auditors.  We have evaluatedappropriate staffing and experience levels in our corporate controllershipfunction and have hired the additional experienced personnel we feelappropriate.  In addition, during thesecond and third quarters of 2005, we have made significant progress inpreparation for complying with the Sarbanes-Oxley Act for the year end 2005.

 

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Specifically, we have 1)updated key controls and documentation since year end 2004, 2) established aSteering Committee to monitor the progress of the effectiveness of the controlsand 3) started the testing for our 2005 management testing.  Management anticipates completing the testingduring the fourth quarter and believes it will have adequate time to remediateany significant deficiencies or material weaknesses.  While we feel that management has madeprogress in improving controls and in complying with the Act for 2005, thematerial weakness identified above has not yet been rectified and will not befully rectified until we have successfully completed our year end testing.        

 

In September 2005, wediscovered that we had improperly billed several of our clients forreimbursable expenses.  We engaged legalcounsel and forensic accountants to conduct an independent investigation.  We have terminated the employee responsiblefor the improper billings and have determined such improper billings were notmaterial to our consolidated financial statements.  We have designed and implemented additionalcontrols relating to employee reimbursements. We believe the added controls will be effective in reducing thepotential for this kind of impropriety in the future.

 

Therewere no other changes in the Company’s internal control over financialreporting during the third quarter of 2005 that have materially affected, orare reasonably likely to materially affect the Company’s internal control overfinancial reporting.

 

For the quarter ended September 30, 2005, theCompany carried out an evaluation, under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures. Basedon the foregoing, the Company’s Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures werenot effective as of September 30, 2005. 

 

While we continue todevote significant resources to meeting the internal control over financialreporting requirements of the rules adopted by the SEC pursuant to Section 404of the Sarbanes-Oxley Act of 2002, we cannot assure you that the policies andprocedures we have adopted and our continued efforts will successfullyremediate the material weakness we have identified and any control deficienciesor material weaknesses that we or our outside auditors may identify before theend of our fiscal year.

 

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**PART II- OTHER INFORMATION**

 

***Item1. Legal Proceedings***

 

Southwest and a subsidiary were named as defendants inseveral lawsuits alleging various injuries as a result of water contaminationin the San Gabriel Valley Main Basin. The California Supreme Court has ruledthat the plaintiffs cannot challenge the adequacy of the water qualitystandards established by California Department of Health Services and theUnited States Environmental Protection Agency (“EPA”) but can sue us if theycan prove that we served water that did not meet those standards. In August 2004a trial court dismissed the case against us, finding that there was no evidencethat we violated any water quality standards. The plaintiffs appealed the dismissal to the Court of Appeals for the Stateof California, Second Appellate District, where the matter is pending. To date,liability insurance carriers have absorbed the costs of defense of thelawsuits. 

 

On May 5, 2005, oneof the Company’s operating subsidiaries received a subpoena to provide recordsto a grand jury.  The requested records relate to the operations of theSan Simeon wastewater treatment plant in California for the period January 2002to present.  The facility was also served with search warrants executed bythe EPA.  The Company’s subsidiary has operated this facility since September 2004. The Company is cooperating with the investigation and is also performing itsown internal investigation.  

 

On May 18, 2005, theEPA executed a search warrant at one of the Company’s operating subsidiaries inTexas.  The search warrant sought information relating to the subsidiary’slaboratory operations.  The Company is cooperating with the investigationand is also performing its own internal investigation.

 

SouthwestWater Company and its subsidiaries are subject to litigation arising in theordinary course of operations. We believe the ultimate resolution of allmatters that have been brought to our attention will not materially adverselyaffect our consolidated financial position, results of operations or cashflows.

 

***Item2.  Changes In Securities And Use OfProceeds***

 

The following table summarizes the Company’s purchasesof its common stock for the quarter ended September 30, 2005.

 
| **Period**                                            | ** ** | **Total Number  of Shares (or  Units)  Purchased****(1)** | ** ** | **Average Price  Paid per Share  (or Unit)** | ** ** | **Total Number of Shares (or  Units) Purchased as Part of  Publicly Announced Plans  or Programs** | ** ** | **Maximum Number (or Approximate  Dollar Value) of Shares (or Units)  that May Yet Be Purchased Under  the Plans or Programs** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1, 2005 – July 31, 2005           |       | N/A                                                       |       | N/A                                          |       | N/A                                                                                                     |       | N/A                                                                                                                                 |       |
|                                                  |       |                                                      |       |                                         |       |                                                                                                    |       |                                                                                                                                |       |
| August 1, 2005 – August 31, 2005       |       | 33,299                                                    |       | 13.92                                        |       | N/A                                                                                                     |       | N/A                                                                                                                                 |       |
|                                                  |       |                                                      |       |                                         |       |                                                                                                    |       |                                                                                                                                |       |
| September 1, 2005 – September 30, 2005 |       | N/A                                                       |       | N/A                                          |       | N/A                                                                                                     |       | N/A                                                                                                                                 |       |
|                                                  |       |                                                      |       |                                         |       |                                                                                                    |       |                                                                                                                                |       |
| **Total**                                             |       | 33,299                                                    |       | 13.92                                        |       | N/A                                                                                                     |       | N/A                                                                                                                                 |       |

 

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(1) All of the sharespurchased during the period were shares attested to the Company in satisfactionof the exercise price and tax withholding obligations by holders of employeestock options, who exercised options granted pursuant to the Company’s stockoption plan.

 

***Item6. Exhibits***

 
|   |   | 3.1    |   | Restated  Certificate of Incorporation of Southwest Water Company dated May 24,  2005 (incorporated by reference to the Registrants Form 10-Q for the  quarterly period ended June 30, 2005)                   |
|--------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                          |
|   |   | 10.1   |   | Amended  and Restated Dividend Reinvestment and Stock Purchase Plan dated April 8,  2005 (incorporated by reference to Registrant’s S-3/A Registration Statement  filed with the Commission on April 5, 2005). |

 

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|   |   | 10.2   |   | Credit  Agreement dated as of April 1, 2005 among the Registrant, as borrower,  the several lenders parties thereto, Bank of America, N.A., as administrative  agent, swing line lender and letter of credit issuer, Banc of America  Securities LLC and Union Bank of California, N.A., as co-lead arrangers and  co-book managers, and Union Bank of California, N.A., as syndication agent  (incorporated by reference to Registrant’s Form 8-K filed with the  Commission on April 6, 2005). |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 10.3   |   | First Amendment  to Severance Compensation Agreement, dated July 22, 2005, between  Southwest Water Company and Anton C. Garner (incorporated by reference to Exhibit 10.1  to the Registrant’s Form 8-K filed with the Commission on July 22,  2005)                                                                                                                                                                                                                                       |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 10.4   |   | Amended  and Restated Master Loan Agreement date September 12, 2005 (MLA No. RX 0936)  between Monarch Utilities I L.P. and CoBank, ACB (filed herewith)                                                                                                                                                                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 10.4.1 |   | Promissory  Note and Supplement dated May 1, 2002 (Loan No. ML0936T1)  between Tecon Water Company, L.P. (now  Monarch Utilities I L.P.) and CoBank, ACB (filed herewith)                                                                                                                                                                                                                                                                                                                                       |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 10.4.2 |   | First  Amendment to Promissory Note and Supplement dated September 12, 2005 (Loan  No. ML0936T1) between Monarch Utilities I L.P. (formerly known as Tecon Water  Company, L.P.) and CoBank, ACB (filed herewith)                                                                                                                                                                                                                                                                                                    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 10.4.3 |   | Promissory  Note and Supplement dated May 1, 2002 (Loan No. ML0936T2 between Tecon Water  Company, L.P. (now Monarch Utilities I L.P.) and CoBank, ACB (filed herewith)                                                                                                                                                                                                                                                                                                                                              |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 10.4.4 |   | First  Amendment to Promissory Note and Supplement dated September 12, 2005 (Loan  No. ML0936T2) between Monarch Utilities I L.P. (formerly known as Tecon Water  Company, L.P.) and CoBank, ACB (filed herewith)                                                                                                                                                                                                                                                                                                    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 10.4.5 |   | Promissory  Note and Supplement dated September 12, 2005 (Loan No. RX0936T3) between  Monarch Utilities I L.P. and CoBank, ACB (filed herewith)                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 31.1   |   | Certification  of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002 (filed herewith).                                                                                                                                                                                                                                                                                                 |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 31.2   |   | Certification  of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002 (filed herewith).                                                                                                                                                                                                                                                                                                 |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 32.1   |   | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed  herewith).                                                                                                                                                                                                                                                                                                                                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 32.2   |   | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed  herewith).                                                                                                                                                                                                                                                                                                                                     |

 

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**SIGNATURES**

 

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.

 
|                          | SOUTHWEST  WATER COMPANY  (Registrant)                                                                                                            |
|-------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|                          |                                                                                                                                              |
| Dated:  November 9, 2005 | /s/  CHERYL L. CLARY                                                                                                                              |   |
|                          | **Cheryl L. Clary  Chief Financial Officer  (Principal Financial Officer and duly authorized to sign this report on  behalf  of the Registrant)** |

 

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