** **

**SECURITIES AND EXCHANGE COMMISSION**Washington, D.C. 20549

**FORM 10-Q**

**(Mark One)**
| x      |   | **Quarterly report pursuant to Section 13 or 15(d)  of the Securities Exchange Act of 1934 for the quarterly period ended  September 30, 2006 or** |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | ** **                                                                                                                                         |
| o      |   | **Transition report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934 for the transition period from  to**                   |

**Commission file number 001-14431**

**American States Water Company******(Exact Name ofRegistrant as Specified in Its Charter)

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

 

**(909) 394-3600**(Registrant’s Telephone Number, Including Area Code)

**Not Applicable**(Former Name, Former Address and Former Fiscal Year, if Changed Since LastReport)

**Commission file number001-12008**

**GoldenState Water Company**(Exact Name of Registrant as Specified in Its Charter)

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

 

**(909) 394-3600**(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whetherRegistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that Registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.

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

 

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anonaccelerated file. See definition of “accelerated filer and large acceleratedfile” in Rule 12b-2 of the Exchange Act. (Check one):
| American States Water Company | Large accelerated filer o | Accelerated filer x | Nonaccelerated filer o |
|-------------------------------|---------------------------|---------------------|------------------------|
| Golden State Water Company    | Large accelerated filer o | Accelerated filer o | Nonaccelerated filer x |

 

Indicate by check mark whether the Registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act)

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

 

Asof November 8, 2006, the number of Common Shares outstanding, of AmericanStates Water Company was 17,038,477 shares.

Asof November 8, 2006, all of the 122 outstanding Common Shares of Golden StateWater Company were owned by American States Water Company.

 

----

**AMERICAN STATES WATER COMPANYandGOLDEN STATE WATER COMPANYFORM 10-Q**

### **INDEX**

|             | ** ** | ** **                                                                                                                   | ** ** | **Page(s)** |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|-------------|
| **Part I**  | ** ** | **Financial Information**                                                                                                    | ** ** | ** **  |
|        |       |                                                                                                                         |       |        |
| Item  1:    |       | Financial  Statements                                                                                                        |       |        |
|        |       | Consolidated Balance Sheets of American States Water  Company as of September 30, 2006 and December 31, 2005                 |       | 3-4         |
|        |       |                                                                                                                         |       |        |
|        |       | Consolidated Statements of Income of American States  Water Company for the Three Months Ended September 30, 2006 and 2005   |       | 5           |
|        |       |                                                                                                                         |       |        |
|        |       | Consolidated Statements of Income of American States  Water Company for the Nine Months Ended September 30, 2006 and 2005    |       | 6           |
|        |       |                                                                                                                         |       |        |
|        |       | Consolidated Statements of Cash Flow of American  States Water Company for the Nine Months Ended September 30, 2006 and 2005 |       | 7           |
|        |       |                                                                                                                         |       |        |
|        |       | Balance Sheets of Golden State Water Company as of  September 30, 2006 and December 31, 2005                                 |       | 8-9         |
|        |       |                                                                                                                         |       |        |
|        |       | Statements of Income of Golden State Water Company for  the Three Months Ended September 30, 2006 and 2005                   |       | 10          |
|        |       |                                                                                                                         |       |        |
|        |       | Statements of Income of Golden State Water Company for  the Nine Months Ended September 30, 2006 and 2005                    |       | 11          |
|        |       |                                                                                                                         |       |        |
|        |       | Statements of Cash Flow of Golden State Water Company  for the Nine Months Ended September 30, 2006 and 2005            |       | 12          |
|        |       |                                                                                                                         |       |        |
|        |       | Notes to Consolidated Financial Statements                                                                                   |       | 13          |
|        |       |                                                                                                                         |       |        |
| Item 2:     |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                  |       | 30          |
|        |       |                                                                                                                         |       |        |
| Item 3:     |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                  |       | 48          |
|        |       |                                                                                                                         |       |        |
| Item 4:     |       | Controls and Procedures                                                                                                      |       | 49          |
|        |       |                                                                                                                         |       |        |
| **Part II** | ** ** | **Other Information**                                                                                                        | ** ** | ** **  |
|        |       |                                                                                                                         |       |        |
| Item  1:    |       | Legal  Proceedings                                                                                                           |       | 50          |
|        |       |                                                                                                                         |       |        |
| Item  1A:   |       | Risk  Factors                                                                                                                |       | 50          |
|        |       |                                                                                                                         |       |        |
| Item 2:     |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                 |       | 50          |
|        |       |                                                                                                                         |       |        |
| Item 3:     |       | Defaults Upon Senior Securities                                                                                              |       | 50          |
|        |       |                                                                                                                         |       |        |
| Item 4:     |       | Submission of Matters to a Vote of Security Holders                                                                          |       | 50          |
|        |       |                                                                                                                         |       |        |
| Item  5:    |       | Other  Information                                                                                                           |       | 51          |
|        |       |                                                                                                                         |       |        |
| Item 6:     |       | Exhibits                                                                                                                     |       | 51          |
|        |       |                                                                                                                         |       |        |
|        |       | Signatures                                                                                                                   |       | 52          |

 

1

----

**PART I**

**Item 1. Financial Statements**

 

**General**

The basic financial statements included herein have beenprepared by Registrant, without audit, pursuant to the rules and regulations ofthe Securities and Exchange Commission.

 

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

 

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

 

FilingFormat

 

Thisquarterly report on Form 10-Q is a combined report being filed by two separateRegistrants: American States Water Company (hereinafter “AWR”) and Golden StateWater Company (hereinafter “GSWC”) (formerly known as Southern California WaterCompany). For more information, please see Note 1 to the Notes to ConsolidatedFinancial Statements and the heading entitled General in Item 2 - Management’sDiscussion and Analysis of Financial Condition and Results of Operations.References in this report to “Registrant” are to AWR and GSWC collectively,unless otherwise specified. GSWC makes no representations as to the informationcontained in this report relating to AWR and its subsidiaries, other than GSWC.

 

**Forward-Looking Information**

 

Certain matters discussedin this report (including the documents incorporated herein by reference) areforward-looking statements intended to qualify for the “safe harbor” fromliability established by the Private Securities Litigation Reform Act of 1995.These forward-looking statements can generally be identified as such becausethe context of the statement will include words such as Registrant “believes,”“anticipates,” “expects” or words of similar import. Similarly, statements thatdescribe Registrant’s future plans, objectives, estimates or goals are alsoforward-looking statements. Such statements address future events andconditions concerning capital expenditures, earnings, litigation, rates, waterquality and other regulatory matters, adequacy of water supplies, GSWC’sability to recover electric, natural gas and water supply costs fromratepayers, contract operations, liquidity and capital resources, andaccounting matters. Actual results in each case could differ materially fromthose currently anticipated in such statements, by reason of factors such aschanges in utility regulation, including ongoing local, state and federalactivities; recovery of regulatory assets not yet included in rates; futureeconomic conditions, including changes in customer demand and changes in waterand energy supply costs; future climatic conditions; and legislative, legalproceedings, regulatory and other circumstances affecting anticipated revenuesand costs.

2

----

**AMERICAN STATES WATER COMPANYCONSOLIDATED BALANCE SHEETSASSETS(Unaudited)**

** **
| ***(in thousands)***                                                                                   | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Utility  Plant, at cost**                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                   |       |                         |       |                        |       |
| Water                                                                                                  |       | $                            | 899,598    |                        | $          | 869,471 |   |
| Electric                                                                                               |       | 62,197                       |       | 61,386                      |       |
|                                                                                                   |       | 961,795                      |       | 930,857                     |       |
| Less - Accumulated depreciation                                                                        |       | (280,906                     | )          | (259,915                    | )          |
|                                                                                                   |       | 680,889                      |       | 670,942                     |       |
| Construction work in progress                                                                          |       | 61,480                       |       | 42,283                      |       |
| Net utility plant                                                                                      |       | 742,369                      |       | 713,225                     |       |
|                                                                                                   |       |                         |       |                        |       |
| **Other  Property and Investments**                                                                    | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Goodwill                                                                                               |       | 11,778                       |       | 11,841                      |       |
| Other property and investments                                                                         |       | 9,697                        |       | 9,740                       |       |
| Total other property and investments                                                                   |       | 21,475                       |       | 21,581                      |       |
|                                                                                                   |       |                         |       |                        |       |
| **Current  Assets**                                                                                    | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                              |       | 6,591                        |       | 13,032                      |       |
| Accounts receivable-customers (less allowance for  doubtful accounts of $780 in 2006 and $789 in 2005) |       | 17,802                       |       | 13,341                      |       |
| Unbilled revenue                                                                                       |       | 18,762                       |       | 15,195                      |       |
| Other accounts receivable (less allowance for  doubtful accounts of $144 in 2006 and $337 in 2005)     |       | 9,923                        |       | 10,844                      |       |
| Income taxes receivable                                                                                |       | 30                           |       | 822                         |       |
| Materials and supplies, at average cost                                                                |       | 1,545                        |       | 1,421                       |       |
| Regulatory assets – current                                                                       |       | 3,233                        |       | 3,946                       |       |
| Prepayments and other current assets                                                                   |       | 1,395                        |       | 2,998                       |       |
| Unrealized gain on purchased power contracts                                                           |       | —                       |       | 3,417                       |       |
| Costs and estimated earnings in excess of billings  on uncompleted contracts                           |       | 2,231                        |       | —                      |       |
| Deferred income taxes – current                                                                   |       | 4,709                        |       | 1,692                       |       |
| Total current assets                                                                                   |       | 66,221                       |       | 66,708                      |       |
|                                                                                                   |       |                         |       |                        |       |
| **Regulatory  and Other Assets**                                                                       | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Regulatory assets                                                                                      |       | 61,288                       |       | 54,382                      |       |
| Other accounts receivable                                                                              |       | 9,148                        |       | 8,820                       |       |
| Deferred income taxes                                                                                  |       | 34                           |       | —                      |       |
| Other                                                                                                  |       | 8,173                        |       | 8,419                       |       |
| Total regulatory and other assets                                                                      |       | 78,643                       |       | 71,621                      |       |
| **Total Assets**                                                                                       |       | $                            | 908,708    |                        | $          | 873,135 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

 

3

----

**AMERICAN STATES WATER COMPANYCONSOLIDATED BALANCE SHEETSCAPITALIZATION AND LIABILITIES(Unaudited)**

 
| ***(in thousands)***                                                         | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Capitalization**                                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Common shares, no par value, no stated value                                 |       | $                            | 174,330    |                        | $          | 166,529 |   |
| Earnings reinvested in the business                                          |       | 107,311                      |       | 101,121                     |       |
| Accumulated other comprehensive loss                                         |       | (3,556                       | )          | (3,556                      | )          |
| Total common shareholders’ equity                                       |       | 278,085                      |       | 264,094                     |       |
| Long-term debt                                                               |       | 268,181                      |       | 268,405                     |       |
| Total capitalization                                                         |       | 546,266                      |       | 532,499                     |       |
|                                                                         |       |                         |       |                        |       |
| **Current  Liabilities**                                                     | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Notes payable to banks                                                       |       | 25,000                       |       | 27,000                      |       |
| Long-term debt – current                                                |       | 575                          |       | 635                         |       |
| Accounts payable                                                             |       | 23,284                       |       | 19,653                      |       |
| Income taxes payable                                                         |       | 4,392                        |       | 1,534                       |       |
| Accrued employee expenses                                                    |       | 4,428                        |       | 5,879                       |       |
| Accrued interest                                                             |       | 5,245                        |       | 2,254                       |       |
| Regulatory liabilities – current                                        |       | 4,120                        |       | 3,252                       |       |
| Deferred income taxes – current                                         |       | —                       |       | 86                          |       |
| Unrealized loss on purchased power contracts                                 |       | 2,468                        |       | —                      |       |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       | 1,910                        |       | —                      |       |
| Other                                                                        |       | 13,268                       |       | 14,952                      |       |
| Total current liabilities                                                    |       | 84,690                       |       | 75,245                      |       |
|                                                                         |       |                         |       |                        |       |
| **Other  Credits**                                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Advances for construction                                                    |       | 86,961                       |       | 85,168                      |       |
| Contributions in aid of construction – net                              |       | 86,708                       |       | 83,976                      |       |
| Deferred income taxes                                                        |       | 76,042                       |       | 69,669                      |       |
| Unamortized investment tax credits                                           |       | 2,450                        |       | 2,518                       |       |
| Accrued pension and other postretirement benefits                            |       | 14,955                       |       | 13,562                      |       |
| Regulatory liabilities                                                       |       | 571                          |       | 521                         |       |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       | 2,092                        |       | 2,207                       |       |
| Other                                                                        |       | 7,973                        |       | 7,770                       |       |
| Total other credits                                                          |       | 277,752                      |       | 265,391                     |       |
| **Commitments  and Contingencies (Note 8)**                                  |       | —                       |       | —                      |       |
| **Total  Capitalization and Liabilities**                                    |       | $                            | 908,708    |                        | $          | 873,135 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

 

4

----

**AMERICANSTATES WATER COMPANYCONSOLIDATED STATEMENTS OF INCOMEFOR THE THREE MONTHSENDED SEPTEMBER 30, 2006 AND 2005(Unaudited)**

** **

 
| ** **                                                              | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ***(in thousands, except per share amounts)*** | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| **Operating  Revenues**                                                 | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Water                                                                   |       | $                                     | 64,962     |   | $ | 60,539 |   |
| Electric                                                                |       | 6,444                                 |       | 6,544 |   |
| Other                                                                   |       | 2,335                                 |       | 1,008 |   |
| Total operating revenues                                                |       | 73,741                                |       | 68,091 |   |
|                                                                    |       |                                  |       |   |   |
| **Operating  Expenses**                                                 | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Water purchased                                                         |       | 15,066                                |       | 15,779 |   |
| Power purchased for pumping                                             |       | 3,600                                 |       | 3,252 |   |
| Groundwater production assessment                                       |       | 2,477                                 |       | 2,315 |   |
| Power purchased for resale                                              |       | 2,659                                 |       | 3,075 |   |
| Unrealized loss (gain) on purchased power contracts                     |       | 2,807                                 |       | (4,018 | ) |
| Supply cost balancing accounts                                          |       | 244                                   |       | 514 |   |
| Other operating expenses                                                |       | 6,677                                 |       | 4,850 |   |
| Administrative and general expenses                                     |       | 12,614                                |       | 10,342 |   |
| Depreciation and amortization                                           |       | 6,634                                 |       | 4,734 |   |
| Maintenance                                                             |       | 3,395                                 |       | 2,905 |   |
| Property and other taxes                                                |       | 2,656                                 |       | 2,572 |   |
| Net gain on sale of property                                            |       | (124                                  | )          | — |   |
| Total operating expenses                                                |       | 58,705                                |       | 46,320 |   |
| **Operating Income**                                                    |       | 15,036                                |       | 21,771 |   |
|                                                                    |       |                                  |       |   |   |
| Interest expense                                                        |       | (5,349                                | )          | 193 |   |
| Interest income                                                         |       | 695                                   |       | 745 |   |
|                                                                    |       |                                  |       |   |   |
| **Income  from operations before income tax expense**                   |       | 10,382                                |       | 22,709 |   |
| ** **                                                              | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Income tax  expense                                                     |       | 4,809                                 |       | 10,475 |   |
|                                                                    |       |                                  |       |   |   |
| **Net  Income**                                                         |       | $                                     | 5,573      |   | $ | 12,234 |   |
|                                                                    |       |                                  |       |   |   |
| **Weighted  Average Number of Shares Outstanding**                      |       | 17,003                                |       | 16,782 |   |
| **Basic  Earnings Per Common Share**                                    |       | $                                     | 0.32       |   | $ | 0.72 |   |
|                                                                    |       |                                  |       |   |   |
| **Weighted  Average Number of Diluted Shares**                          |       | 17,057                                |       | 16,887 |   |
| **Fully  Diluted Earnings Per Share**                                   |       | $                                     | 0.32       |   | $ | 0.72 |   |
|                                                                    |       |                                  |       |   |   |
| **Dividends Declared Per Common  Share**                                |       | $                                     | 0.225      |   | $ | 0.225 |   |

 

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

 

5

----

**AMERICANSTATES WATER COMPANYCONSOLIDATED STATEMENTS OF INCOMEFOR THE NINE MONTHSENDED SEPTEMBER 30, 2006 AND 2005(Unaudited)**

** **

 
| ** **                                                              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ***(in thousands, except per share amounts)*** | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| **Operating  Revenues**                                                 | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Water                                                                   |       | $                                    | 166,233    |   | $ | 155,611 |   |
| Electric                                                                |       | 21,816                               |       | 20,105 |   |
| Other                                                                   |       | 8,437                                |       | 2,721 |   |
| Total operating revenues                                                |       | 196,486                              |       | 178,437 |   |
|                                                                    |       |                                 |       |   |   |
| **Operating  Expenses**                                                 | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Water purchased                                                         |       | 34,326                               |       | 35,742 |   |
| Power purchased for pumping                                             |       | 7,620                                |       | 6,923 |   |
| Groundwater production assessment                                       |       | 6,799                                |       | 6,079 |   |
| Power purchased for resale                                              |       | 10,470                               |       | 9,922 |   |
| Unrealized loss (gain) on purchased power contracts                     |       | 5,886                                |       | (7,492 | ) |
| Supply cost balancing accounts                                          |       | (93                                  | )          | 1,042 |   |
| Other operating expenses                                                |       | 17,264                               |       | 15,138 |   |
| Administrative and general expenses                                     |       | 34,628                               |       | 32,456 |   |
| Depreciation and amortization                                           |       | 19,726                               |       | 16,123 |   |
| Maintenance                                                             |       | 9,113                                |       | 7,522 |   |
| Property and other taxes                                                |       | 7,674                                |       | 7,111 |   |
| Net gain on sale of property                                            |       | (124                                 | )          | — |   |
| Gain on settlement for removal of wells                                 |       | —                               |       | (760 | ) |
| Total operating expenses                                                |       | 153,289                              |       | 129,806 |   |
|                                                                    |       |                                 |       |   |   |
| **Operating  Income**                                                   |       | 43,197                               |       | 48,631 |   |
|                                                                    |       |                                 |       |   |   |
| Interest expense                                                        |       | (16,037                              | )          | (9,341 | ) |
| Interest income                                                         |       | 2,643                                |       | 801 |   |
|                                                                    |       |                                 |       |   |   |
| **Income  from operations before income tax expense**                   |       | 29,803                               |       | 40,091 |   |
| ** **                                                              | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Income tax expense                                                      |       | 12,061                               |       | 18,358 |   |
|                                                                    |       |                                 |       |   |   |
| **Net  Income**                                                         |       | $                                    | 17,742     |   | $ | 21,733 |   |
|                                                                    |       |                                 |       |   |   |
| **Weighted  Average Number of Shares Outstanding**                      |       | 16,898                               |       | 16,773 |   |
| **Basic  Earnings Per Common Share**                                    |       | $                                    | 1.03       |   | $ | 1.29 |   |
|                                                                    |       |                                 |       |   |   |
| **Weighted  Average Number of Diluted Shares**                          |       | 16,949                               |       | 16,845 |   |
| **Fully  Diluted Earnings Per Share**                                   |       | $                                    | 1.03       |   | $ | 1.29 |   |
|                                                                    |       |                                 |       |   |   |
| **Dividends Declared Per Common  Share**                                |       | $                                    | 0.675      |   | $ | 0.675 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

 

 

6

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**AMERICANSTATES WATER COMPANYCONSOLIDATED STATEMENTS OF CASH FLOWFOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005(Unaudited)**

** **

 
| ** **                                                                                       | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ***(in thousands)***                                                                        | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| **Cash Flows From Operating  Activities:**                                                       | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Net income                                                                                       |       | $                                    | 17,742     |   | $ | 21,733 |   |
| Adjustments for  non-cash items:                                                                 |       |                                 |       |   |   |
| Depreciation and  amortization                                                                   |       | 19,726                               |       | 16,123 |   |
| Provision for  doubtful accounts                                                                 |       | 538                                  |       | 311 |   |
| Deferred income  taxes, net regulatory asset for flow-through taxes, and investment tax  credits |       | 2,761                                |       | 9,453 |   |
| Unrealized loss  (gain) on purchased power contracts                                             |       | 5,886                                |       | (7,492 | ) |
| Stock-based  compensation expense                                                                |       | 427                                  |       | 110 |   |
| Other - net                                                                                      |       | 585                                  |       | (57 | ) |
| Changes in assets and  liabilities:                                                              |       |                                 |       |   |   |
| Accounts  receivable - customers                                                                 |       | (4,849                               | )          | (4,517 | ) |
| Unbilled revenue                                                                                 |       | (3,567                               | )          | (3,657 | ) |
| Other accounts  receivable                                                                       |       | 443                                  |       | (576 | ) |
| Materials and  supplies                                                                          |       | (124                                 | )          | 61 |   |
| Prepayments and  other current assets                                                            |       | 1,603                                |       | 1,884 |   |
| Regulatory  assets - supply cost balancing accounts                                              |       | (93                                  | )          | 1,042 |   |
| Other assets                                                                                     |       | (6,906                               | )          | (2,143 | ) |
| Accounts payable                                                                                 |       | 3,631                                |       | 265 |   |
| Income taxes  receivable/payable                                                                 |       | 3,650                                |       | 8,741 |   |
| Other  liabilities                                                                               |       | 4,196                                |       | 3,906 |   |
| Net cash  provided                                                                               |       | 45,649                               |       | 45,187 |   |
|                                                                                             |       |                                 |       |   |   |
| **Cash Flows From Investing  Activities:**                                                       | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Construction  expenditures                                                                       |       | (51,069                              | )          | (51,958 | ) |
| Net cash used                                                                                    |       | (51,069                              | )          | (51,958 | ) |
|                                                                                             |       |                                 |       |   |   |
| **Cash Flows From Financing  Activities:**                                                       | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Proceeds from  issuance of common shares                                                         |       | 1,625                                |       | 830 |   |
| Proceeds from  stock option exercises                                                            |       | 4,383                                |       | — |   |
| Tax benefits  from exercise of stock-based awards                                                |       | 1,142                                |       | — |   |
| Receipt of  advances for and contributions in aid of construction                                |       | 6,718                                |       | 10,350 |   |
| Refunds on  advances for construction                                                            |       | (3,072                               | )          | (3,147 | ) |
| Repayments of  long-term debt                                                                    |       | (329                                 | )          | (560 | ) |
| Net change in  notes payable to banks                                                            |       | (2,000                               | )          | 10,000 |   |
| Cash received on  financing portion of purchased power contracts                                 |       | 2,007                                |       | 2,007 |   |
| Dividend  equivalent rights paid                                                                 |       | (187                                 | )          | — |   |
| Tax benefits  from payment of dividend equivalent rights                                         |       | 80                                   |       | — |   |
| Dividends paid                                                                                   |       | (11,388                              | )          | (11,321 | ) |
| Net cash (used)  provided                                                                        |       | (1,021                               | )          | 8,159 |   |
|                                                                                             |       |                                 |       |   |   |
| **Net (decrease) increase in cash  and cash equivalents**                                        |       | (6,441                               | )          | 1,388 |   |
| **Cash and cash equivalents,  beginning of period**                                              |       | 13,032                               |       | 4,303 |   |
| **Cash and cash equivalents, end of period**                                                     |       | $                                    | 6,591      |   | $ | 5,691 |   |

* *

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

7

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**GOLDEN STATE WATER COMPANYBALANCE SHEETSASSETS(Unaudited)**

 
| ***(in thousands)***                                                                              | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Utility  Plant, at cost**                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                   |       |                         |       |                        |       |
| Water                                                                                                  |       | $                            | 848,250    |                        | $          | 819,958 |   |
| Electric                                                                                               |       | 62,196                       |       | 61,386                      |       |
|                                                                                                   |       | 910,446                      |       | 881,344                     |       |
| Less - Accumulated depreciation                                                                        |       | (266,178                     | )          | (246,649                    | )          |
|                                                                                                   |       | 644,268                      |       | 634,695                     |       |
| Construction work in progress                                                                          |       | 58,735                       |       | 38,334                      |       |
| Net utility plant                                                                                      |       | 703,003                      |       | 673,029                     |       |
|                                                                                                   |       |                         |       |                        |       |
| **Other  Property and Investments**                                                                    | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Other property and investments                                                                         |       | 7,312                        |       | 7,364                       |       |
| Total other property and investments                                                                   |       | 7,312                        |       | 7,364                       |       |
|                                                                                                   |       |                         |       |                        |       |
| **Current  Assets**                                                                                    | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                              |       | 2,657                        |       | 8,788                       |       |
| Accounts receivable-customers (less allowance for  doubtful accounts of $753 in 2006 and $765 in 2005) |       | 17,323                       |       | 12,919                      |       |
| Unbilled revenue                                                                                       |       | 18,361                       |       | 14,856                      |       |
| Inter-company receivable                                                                               |       | 258                          |       | 226                         |       |
| Other accounts receivable (less allowance for  doubtful accounts of $141 in 2006 and $334 in 2005)     |       | 2,869                        |       | 6,106                       |       |
| Materials and supplies, at average cost                                                                |       | 1,530                        |       | 1,404                       |       |
| Regulatory assets - current                                                                            |       | 3,162                        |       | 3,875                       |       |
| Prepayments and other current assets                                                                   |       | 1,238                        |       | 2,795                       |       |
| Unrealized gain on purchased power contracts                                                           |       | —                       |       | 3,417                       |       |
| Deferred income taxes - current                                                                        |       | 4,666                        |       | 1,693                       |       |
| Total current assets                                                                                   |       | 52,064                       |       | 56,079                      |       |
|                                                                                                   |       |                         |       |                        |       |
| **Regulatory  and Other Assets**                                                                       | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Regulatory assets                                                                                      |       | 61,288                       |       | 54,382                      |       |
| Other accounts receivable                                                                              |       | 9,148                        |       | 8,820                       |       |
| Other                                                                                                  |       | 7,407                        |       | 7,575                       |       |
| Total regulatory and other assets                                                                      |       | 77,843                       |       | 70,777                      |       |
|                                                                                                   |       |                         |       |                        |       |
| **Total  Assets**                                                                                      |       | $                            | 840,222    |                        | $          | 807,249 |   |

 

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

8

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**GOLDENSTATE WATER COMPANYBALANCE SHEETSCAPITALIZATION AND LIABILITIES(Unaudited)**

 
| ***(in thousands)***                         | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Capitalization**                                | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Common shares, no par value, no stated value      |       | $                            | 161,179    |                        | $          | 159,429 |   |
| Earnings reinvested in the business               |       | 104,447                      |       | 99,645                      |       |
| Accumulated other comprehensive loss              |       | (3,556                       | )          | (3,556                      | )          |
| Total common shareholder’s equity            |       | 262,070                      |       | 255,518                     |       |
| Long-term debt                                    |       | 261,316                      |       | 261,540                     |       |
| Total capitalization                              |       | 523,386                      |       | 517,058                     |       |
|                                              |       |                         |       |                        |       |
| **Current  Liabilities**                          | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Long-term debt – current                     |       | 305                          |       | 295                         |       |
| Accounts payable                                  |       | 20,430                       |       | 17,914                      |       |
| Inter-company payable                             |       | 3,488                        |       | 65                          |       |
| Income taxes payable to Parent                    |       | 7,174                        |       | 2,268                       |       |
| Accrued employee expenses                         |       | 4,063                        |       | 5,507                       |       |
| Accrued interest                                  |       | 5,179                        |       | 2,218                       |       |
| Regulatory liabilities – current             |       | 4,120                        |       | 3,252                       |       |
| Unrealized loss on purchased power contracts      |       | 2,468                        |       | —                      |       |
| Deferred income taxes – current              |       | —                       |       | 109                         |       |
| Other                                             |       | 12,772                       |       | 12,390                      |       |
| Total current liabilities                         |       | 59,999                       |       | 44,018                      |       |
|                                              |       |                         |       |                        |       |
| **Other  Credits**                                | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Advances for construction                         |       | 76,153                       |       | 74,790                      |       |
| Contributions in aid of construction - net        |       | 84,917                       |       | 83,055                      |       |
| Deferred income taxes                             |       | 71,478                       |       | 65,469                      |       |
| Unamortized investment tax credits                |       | 2,450                        |       | 2,518                       |       |
| Accrued pension and other postretirement benefits |       | 14,955                       |       | 13,562                      |       |
| Other                                             |       | 6,884                        |       | 6,779                       |       |
| Total other credits                               |       | 256,837                      |       | 246,173                     |       |
|                                              |       |                         |       |                        |       |
| **Commitments  and Contingencies (Note 8)**       |       | —                       |       | —                      |       |
|                                              |       |                         |       |                        |       |
| **Total  Capitalization and Liabilities**         |       | $                            | 840,222    |                        | $          | 807,249 |   |

 

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

9

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**GOLDENSTATE WATER COMPANYSTATEMENTS OF INCOMEFOR THE THREE MONTHSENDED SEPTEMBER 30, 2006 AND 2005(Unaudited)**

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|
| ***(in thousands)***                             | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| **Operating  Revenues**                               | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Water                                                 |       | $                                     | 62,842     |   | $ | 58,568 |   |
| Electric                                              |       | 6,443                                 |       | 6,544 |   |
| Other                                                 |       | 325                                   |       | 21 |   |
| Total operating revenues                              |       | 69,610                                |       | 65,133 |   |
|                                                  |       |                                  |       |   |   |
| **Operating  Expenses**                               | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Water purchased                                       |       | 14,696                                |       | 15,446 |   |
| Power purchased for pumping                           |       | 3,394                                 |       | 3,080 |   |
| Groundwater production assessment                     |       | 2,477                                 |       | 2,316 |   |
| Power purchased for resale                            |       | 2,659                                 |       | 3,074 |   |
| Unrealized loss (gain) on purchased power contracts   |       | 2,807                                 |       | (4,018 | ) |
| Supply cost balancing accounts                        |       | 244                                   |       | 514 |   |
| Other operating expenses                              |       | 5,528                                 |       | 4,346 |   |
| Administrative and general expenses                   |       | 10,893                                |       | 9,010 |   |
| Depreciation and amortization                         |       | 6,171                                 |       | 4,460 |   |
| Maintenance                                           |       | 3,217                                 |       | 2,830 |   |
| Property and other taxes                              |       | 2,579                                 |       | 2,481 |   |
| Net gain on sale of property                          |       | (132                                  | )          | — |   |
| Total operating expenses                              |       | 54,533                                |       | 43,539 |   |
|                                                  |       |                                  |       |   |   |
| **Operating  Income**                                 |       | 15,077                                |       | 21,594 |   |
| ** **                                            | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Interest expense                                      |       | (4,861                                | )          | 519 |   |
| Interest income                                       |       | 479                                   |       | 735 |   |
|                                                  |       |                                  |       |   |   |
| **Income  from operations before income tax expense** |       | 10,695                                |       | 22,848 |   |
| ** **                                            | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Income tax expense                                    |       | 4,943                                 |       | 10,475 |   |
|                                                  |       |                                  |       |   |   |
| **Net Income**                                        |       | $                                     | 5,752      |   | $ | 12,373 |   |

 

*Theaccompanying notes are an integral part of these financial statements*

 

10

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**GOLDENSTATE WATER COMPANYSTATEMENTS OF INCOMEFOR THE NINE MONTHSENDED SEPTEMBER 30, 2006 AND 2005(Unaudited)**

** **

 
| ** **                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------|------------|
| ***(in thousands)***                             | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| **Operating  Revenues**                               | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Water                                                 |       | $                                    | 160,282    |   | $ | 150,519 |   |
| Electric                                              |       | 21,816                               |       | 20,105 |   |
| Other                                                 |       | 3,244                                |       | 76 |   |
| Total operating revenues                              |       | 185,342                              |       | 170,700 |   |
|                                                  |       |                                 |       |   |   |
| **Operating  Expenses**                               | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Water purchased                                       |       | 33,573                               |       | 35,116 |   |
| Power purchased for pumping                           |       | 7,127                                |       | 6,537 |   |
| Groundwater production assessment                     |       | 6,799                                |       | 6,115 |   |
| Power purchased for resale                            |       | 10,470                               |       | 9,921 |   |
| Unrealized loss (gain) on purchased power contracts   |       | 5,886                                |       | (7,492 | ) |
| Supply cost balancing accounts                        |       | (93                                  | )          | 1,042 |   |
| Other operating expenses                              |       | 14,961                               |       | 13,656 |   |
| Administrative and general expenses                   |       | 29,988                               |       | 27,958 |   |
| Depreciation and amortization                         |       | 18,336                               |       | 15,290 |   |
| Maintenance                                           |       | 8,559                                |       | 7,085 |   |
| Property and other taxes                              |       | 7,372                                |       | 6,799 |   |
| Net gain on sale of property                          |       | (132                                 | )          | — |   |
| Total operating expenses                              |       | 142,846                              |       | 122,027 |   |
|                                                  |       |                                 |       |   |   |
| **Operating  Income**                                 |       | 42,496                               |       | 48,673 |   |
| ** **                                            | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Interest expense                                      |       | (14,538                              | )          | (8,381 | ) |
| Interest income                                       |       | 2,203                                |       | 767 |   |
|                                                  |       |                                 |       |   |   |
| **Income  from operations before income tax expense** |       | 30,161                               |       | 41,059 |   |
| ** **                                            | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Income tax expense                                    |       | 12,305                               |       | 18,710 |   |
| **Net  Income**                                       |       | $                                    | 17,856     |   | $ | 22,349 |   |

 

*Theaccompanying notes are an integral part of these financial statements*

 

11

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**GOLDENSTATE WATER COMPANYCASH FLOW STATEMENTSFOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005(Unaudited)**

 

 
| ** **                                                                                      | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ***(in thousands)***                                                                       | ** ** | **2006**                             | ** ** | **2005** | ** ** |
| **Cash  Flows From Operating Activities:**                                                      | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Net income                                                                                      |       | $                                    | 17,856     |   | $ | 22,349 |   |
| Adjustments for  non-cash items:                                                                |       |                                 |       |   |   |
| Depreciation and amortization                                                                   |       | 18,336                               |       | 15,290 |   |
| Provision for doubtful accounts                                                                 |       | 528                                  |       | 280 |   |
| Deferred income taxes, net regulatory asset for  flow-through taxes, and investment tax credits |       | 2,452                                |       | 8,684 |   |
| Unrealized loss (gain) on purchased power contracts                                             |       | 5,886                                |       | (7,492 | ) |
| Stock-based compensation expense                                                                |       | 402                                  |       | 110 |   |
| Other – net                                                                                |       | 401                                  |       | 162 |   |
| Changes in  assets and liabilities:                                                             |       |                                 |       |   |   |
| Accounts receivable – customers                                                            |       | (4,782                               | )          | (4,397 | ) |
| Unbilled revenue                                                                                |       | (3,505                               | )          | (3,600 | ) |
| Other accounts receivable                                                                       |       | 2,759                                |       | 615 |   |
| Materials and supplies                                                                          |       | (126                                 | )          | 63 |   |
| Prepayments and other current assets                                                            |       | 1,557                                |       | 1,770 |   |
| Regulatory assets - supply cost balancing accounts                                              |       | (93                                  | )          | 1,042 |   |
| Other assets                                                                                    |       | (4,764                               | )          | (1,959 | ) |
| Accounts payable                                                                                |       | 2,516                                |       | 465 |   |
| Inter-company receivable/payable                                                                |       | 891                                  |       | 3,182 |   |
| Income taxes receivable/payable from/to Parent                                                  |       | 4,906                                |       | 7,867 |   |
| Other liabilities                                                                               |       | 2,526                                |       | 2,723 |   |
| Net cash provided                                                                               |       | 47,746                               |       | 47,154 |   |
|                                                                                            |       |                                 |       |   |   |
| **Cash  Flows From Investing Activities:**                                                      | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Construction expenditures                                                                       |       | (49,465                              | )          | (48,756 | ) |
| Net cash used                                                                                   |       | (49,465                              | )          | (48,756 | ) |
|                                                                                            |       |                                 |       |   |   |
| **Cash  Flows From Financing Activities:**                                                      | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Tax benefits from exercise of stock-based awards                                                |       | 1,131                                |       | — |   |
| Receipt of advances for and contributions in aid of  construction                               |       | 5,798                                |       | 8,745 |   |
| Refunds on advances for construction                                                            |       | (2,591                               | )          | (2,801 | ) |
| Repayments of long-term debt                                                                    |       | (259                                 | )          | (222 | ) |
| Net change in inter-company borrowings                                                          |       | 2,500                                |       | 7,300 |   |
| Cash received on financing portion of purchased  power contracts                                |       | 2,007                                |       | 2,007 |   |
| Dividend equivalent rights paid                                                                 |       | (171                                 | )          | — |   |
| Tax benefits from payment of dividend equivalent  rights                                        |       | 73                                   |       | — |   |
| Dividends paid                                                                                  |       | (12,900                              | )          | (12,000 | ) |
| Net cash (used) provided                                                                        |       | (4,412                               | )          | 3,029 |   |
|                                                                                            |       |                                 |       |   |   |
| **Net  (decrease) increase in cash and cash equivalents**                                       |       | (6,131                               | )          | 1,427 |   |
| **Cash  and cash equivalents, beginning of period**                                             |       | 8,788                                |       | 2,702 |   |
| **Cash and cash equivalents, end  of period**                                                   |       | $                                    | 2,657      |   | $ | 4,129 |   |

 

*Theaccompanying notes are an integral part of these financial statements*

 

 

12

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**AMERICAN STATES WATER COMPANYANDGOLDEN STATE WATER COMPANYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

** **

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

 

General / Nature ofOperations: American States Water Company (“AWR”) is theparent company of Golden State Water Company (“GSWC”), American States UtilityServices, Inc. (“ASUS”) (and its subsidiaries: Fort Bliss Water ServicesCompany (“FBWS”), Terrapin Utility Services, Inc. (“TUS”) and Old DominionUtility Services, Inc. (“ODUS”)), and Chaparral City Water Company (“CCWC”). Morethan 90% of AWR’s assets consist of the common stock of GSWC and its revenuesand operations are primarily those of GSWC. GSWC is a public utility engagedprincipally in the purchase, production, distribution and sale of water inCalifornia serving approximately 254,000 water customers. GSWC also distributeselectricity in several California mountain communities serving approximately23,000 electric customers. The California Public Utilities Commission (“CPUC”)regulates GSWC’s water and electric businesses, including properties, rates,services, facilities and other matters. CCWCis a public utility regulated by the Arizona Corporation Commission(“ACC”) serving approximately 13,000customers in the town of Fountain Hills, Arizona and a portion of the City ofScottsdale, Arizona. ASUS performs water-related services and operationson a contract basis. There is no direct regulatory oversight by either the CPUCor the ACC of the operation or rates of the contracted services provided byASUS and its wholly owned subsidiaries or by AWR.

 

FBWS operates the waterand wastewater systems at Fort Bliss located near El Paso, Texas pursuant tothe terms of a 50-year contract with the U.S. Government. FBWS holds acertificate of convenience and necessity from the Texas Commission onEnvironmental Quality (“TCEQ”). TUS took over the operation and maintenance ofthe water and wastewater systems at Andrews Air Force Base in Maryland onFebruary 1, 2006 and commenced operation of these systems on that date pursuantto the terms of a 50-year contract with the U.S. Government. On December 14,2005, the Maryland Public Service Commission determined it was in the publicinterest and consistent with public convenience and necessity to conditionallyapprove the right of TUS to operate in accordance with the terms and conditionsof the contract with the U.S. Government. ODUS assumed the operation andmaintenance of the wastewater systems at Fort Lee in Virginia on February 23,2006 and the water and wastewater systems at Fort Eustis, Fort Monroe and FortStory in Virginia on April 3, 2006 and commenced operation and maintenance ofthese systems on those dates pursuant to the terms of 50-year contracts withthe U.S. Government. The Virginia State Corporation Commission exercisesjurisdiction over ODUS as a public service company.

 

Basis of Presentation: The consolidated financial statements of AWR include the accounts of AWR and its subsidiaries, all of which are wholly owned. These financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. Inter-company transactions and balances have been eliminated in the AWR consolidated financial statements. The consolidated financial statements included herein have been prepared by Registrant, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America for annual financial statements have been condensed or omitted pursuant to such rules and regulations. The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments, consisting of normal recurring items and estimates necessary for a fair statement of the results for the interim periods, have been made. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements, and the notes thereto, included in the Form 10-K for the year ended December 31, 2005 filed with the SEC. Certain prior-period amounts were reclassified to conform to the September 30, 2006 financial statement presentation.

13

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GSWC’s Related Party Transactions: GSWC and other subsidiaries provide and receive various services to and from their parent, AWR, and among themselves. In addition, AWR has an $85 million syndicated credit facility. AWR borrows under this facility and provides funds to its subsidiaries, including GSWC, in support of their operations. Amounts owed to AWR for borrowings under this facility represent the majority of GSWC’s inter-company payables on GSWC’s balance sheets as of September 30, 2006 and December 31, 2005. The interest rate charged to GSWC is sufficient to cover AWR’s interest cost under the credit facility. GSWC also allocates certain corporate office administrative and general costs to its affiliates using agreed upon allocation factors.

 

New Accounting Pronouncements:  Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “*Share-Based Payment*,” which requires the recognition of compensation expense related to the fair value of stock-based compensation awards. See Note 6 for further details.  

 

In March 2006, the FASB Emerging Issues Task Force (“EITF”) issued EITF No. 06-03, *“How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)”*, which provides clarifying guidance on how to present sales taxes in the income statement. This guidance is effective for periods beginning after December 15, 2006, with early application of the guidance permitted. Registrant is currently assessing the impact of the EITF on its financial statements.

 

In June 2006, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation No.48, “*Accounting for Uncertainty in IncomeTaxes: an interpretation of FASB Statement No. 109*.” ThisInterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return, and provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition. This Interpretation is effective for fiscal yearsbeginning after December 31, 2006. Registrant will implement the new guidanceeffective January 1, 2007 and is currently assessing the impact of theInterpretation on its financial statements.

In September 2006,the FASB issued SFAS No. 157, *“Fair Value Measurements”*,which defines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements. This statement is effectivefor financial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. Early adoption isencouraged, provided that Registrant has not yet issued financial statementsfor that fiscal year, including any financial statements for an interim periodwithin that fiscal year. Registrant will implement the new standard effectiveJanuary 1, 2008. Registrant is currently evaluating the impact SFAS No. 157 mayhave on its financial statements and disclosures. 

In September 2006,the FASB also issued SFAS No. 158, *Employer’sAccounting for Defined Benefit Pension and Other Postretirement Plans – anamendment of FASB Statements No. 87, 88, 106, and 132(R)*.**SFAS 158 requires that Registrant recognizethe overfunded or underfunded status of its defined benefit and retiree medicalplans as an asset or liability in its 2006 year-end balance sheet, with changesin the funded status recognized through comprehensive income in the year inwhich they occur. Registrant is currently evaluating the impact of adoptingSFAS No. 158 on its financial statements including the possible regulatoryaccounting treatment and will implement the new standard by December 31,2006.  

In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, *“Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements”*. This SAB provides guidance onthe consideration of the effects of prior year misstatements in quantifyingcurrent year misstatements for the purpose of a materiality assessment. SAB No.108 establishes an approach that requires quantification of financial statementerrors based on the effects of the error on each of the company’s financialstatements and the related financial statement disclosures.  SAB No. 108 is effective as of the end ofRegistrant’s 2006 fiscal year, allowing a one-time transitional cumulativeeffect adjustment to retained earnings as of January 1, 2006 for errorsthat were not previously deemed material, but are material under the guidancein SAB 108. Registrant is currently evaluating the impact of adopting SAB No. 108on its financial statements and will implement the new guidance by December 31,2006. Registrant believes SAB No. 108 will not have a material impact on itsresults of operations or financial position.

14

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**Note 2 —Regulatory Matters:**

 

In accordance with accounting principles forrate-regulated enterprises, Registrant records regulatory assets, whichrepresent probable future revenues associated with certain costs that will berecovered from customers through the ratemaking process, and regulatoryliabilities, which represent probable future reductions in revenues associatedwith amounts that are to be credited to customers through the ratemakingprocess. AtSeptember 30, 2006, Registrant had $8.9 million of regulatory assets notaccruing carrying costs. Of this amount, $7.3 million represents deferredincome taxes due to accelerated tax benefits previously flowed-through toratepayers, which will be included in rates concurrently with recognition ofthe associated tax expense. In addition, $1.6 million in deferred charges forrate case applications was recorded as other regulatory assets that Registrantrecovers in rates over a short period and for which no recovery of carryingcosts is earned.

 

Regulatory assets, lessregulatory liabilities, included in the consolidated balance sheets are asfollows:

 
| ***(In thousands)***                              | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **GSWC**                                               | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Supply cost balancing accounts                         |       | $                            | 16,920     |                        | $          | 19,624 |   |
| Supply cost memorandum accounts net  under-collections |       | 6,043                        |       | 3,151                       |       |
| Costs deferred for future recovery on Aerojet case     |       | 21,334                       |       | 21,109                      |       |
| Flow-through taxes, net                                |       | 7,346                        |       | 6,939                       |       |
| Electric transmission line abandonment costs           |       | 3,333                        |       | 3,428                       |       |
| Asset retirement obligations                           |       | 3,189                        |       | 2,928                       |       |
| Low income balancing accounts                          |       | 3,503                        |       | 2,846                       |       |
| General rate case memorandum accounts                  |       | —                       |       | 209                         |       |
| Refund of water rights lease revenues                  |       | (3,732                       | )          | (6,474                      | )          |
| Other regulatory assets                                |       | 2,394                        |       | 1,245                       |       |
| Total GSWC                                             |       | $                            | 60,330     |                        | $          | 55,005 |   |
| **CCWC**                                               | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Asset retirement obligations                           |       | 47                           |       | 44                          |       |
| Other regulatory assets/liabilities, net               |       | (547                         | )          | (494                        | )          |
| Total AWR                                              |       | $                            | 59,830     |                        | $          | 54,555 |   |

*** ***

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

 

***Electric SupplyCost Balancing Account*** – Electric power costs incurred by GSWC’s Bear Valley Electricdivision continue to be charged to its electric supply cost balancing account.The under-collection in the electric supply cost balancing account is $19.6million at September 30, 2006. The balance in the electric supply balancingaccount is primarily impacted by (i) a surcharge to decrease previouslyunder-collected energy costs; (ii) changes in purchased energy costs; and (iii)changes in power system delivery costs.

 

The CPUC has authorized GSWC to collect a surchargefrom its customers of 2.2¢ per kilowatt hour through August 2011, to enableGSWC to recover an under-collection of approximately $23.1 million at the endof 2001 which had been incurred during the energy crisis in late 2000 and 2001.GSWC sold 32,049,785 and 31,123,833 kilowatt hours of electricity to its BearValley Electric division customers for the three months ended September 30,2006 and 2005, respectively, and 109,125,050 and 101,438,647 kilowatt hours forthe nine months ended September 30, 2006 and 2005, respectively. As a result,the supply cost balancing account was reduced by approximately $710,000 and $689,000for the three months ended September 30, 2006 and 2005, respectively, andapproximately $2,416,000 and $2,246,000 for the nine months ended September 30,2006 and 2005, respectively. Approximately $14.3 million of theunder-collection incurred during the energy crisis in late 2000 and 2001 hasbeen recovered through this surcharge. GSWC anticipates the surcharge, based onelectricity sales, to be sufficient for it to recover the amount of theunder-collected balance incurred during the energy crisis by August 2011.

 

The purchased energy costs that are recorded in thesupply cost balancing account are subject to a price cap by terms of the 2001settlement with the CPUC. The Bear Valley Electric division of GSWC is allowedto include up to a weighted average annual energy purchase cost of $77 permegawatt-hour (“MWh”) through August 2011 in its electric supply cost balancingaccount for purchased energy costs. To the extent that the actual weightedaverage annual cost for power purchased exceeds the $77 per MWh amount, GSWCwill not be able to include these amounts in its balancing account and suchamounts will be expensed. During the three months ended September 30,

15

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2006and 2005,there was no expense over the $77 per MWh cap because of increases in GSWC’ssales of surplus energy into the spot market. During the nine months ended September30, 2006 and 2005, GSWC expensed approximately $40,400 and $6,400 for costsover $77 per MWh, respectively.

 

Charges to GSWC by Southern California Edison (“Edison”)associated with the transportation of energy over Edison’s power system and theabandonment of a transmission line upgrade have increased under Edison’s tariffto levels that exceed the amounts authorized by the CPUC in Bear ValleyElectric’s retail power rates to its customers. The incremental cost increaseto GSWC from this tariff above the amounts included in rates is $38,137 permonth. These increases have been included in the balancing account forsubsequent recovery from customers. The incoming power system delivery costs are not subject toany price caps.

 

In summary, for the three months ended September 30, 2006 and 2005,approximately $867,000 and $355,000 of over-collections, respectively, wererecorded in the electric supply cost balancing account, net of amortization ofapproximately $710,000 and $689,000, respectively.  For the nine months ended September 30, 2006and 2005, approximately $1.5 million and $1.6 million of over-collections wererecorded in the electric supply cost balancing account, respectively, net ofamortization of approximately $2.4 million and $2.2 million, respectively.

 

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

 

***WaterSupply Cost Memorandum/Balancing Accounts –***In a CPUC decision issued onJune 19, 2003 related to memorandum supply cost accounts, all water utilitiesregulated by the CPUC were required to seek review of under- and over-collections by filing an advice letter annually and the utility’s recovery ofsuch expenses has been reduced by the amount exceeding the authorized rate ofreturn. On April 13, 2006, the CPUC approved a decision eliminating theearnings test adopted in the June 2003 decision. The recent decision alsoeliminated the need to make an annual filing. Pursuant to this order,GSWC recognized a cumulative under-collection of approximately $636,000 to thesupply cost memorandum account provisions in the second quarter of 2006 for theunder-collected balances not recognized at March 31, 2006 and began recordingunder- and over- collections on a monthly basis thereafter commencing with thesecond quarter of 2006. Forthe three months ended September 30, 2006 and 2005, approximately $645,000 ofunder-collections and $130,000 of over-collections, respectively, were recordedin the water supply cost memorandum/balancing accounts, net of amortization ofapproximately $730,000 and $75,000, respectively.  For the nine months ended September 30, 2006and 2005, approximately $1.6 million and $670,000 of under-collections wererecorded in the memorandum/balancing accounts, respectively, net of amortizationof approximately $1.3 million and $367,000, respectively.

 

***CostsDeferred for Future Recovery:***

 

In 1999, GSWC sued Aerojet-General Corporation(“Aerojet”) for contaminating the Sacramento County Groundwater Basin, whichaffected certain GSWC wells. On a related matter, GSWC also filed a lawsuitagainst the State of California (the “State”). The CPUC authorized memorandumaccounts to allow for recovery, from customers, of costs incurred by GSWC inprosecuting the cases against Aerojet and the State, less any recovery from thedefendants or others.

 

On July 21, 2005, theCPUC authorized GSWC to collect approximately $21.3 million of the Aerojetlitigation memorandum account, through a rate surcharge, which will continuefor no longer than 20 years. Beginning in October 2005, new rates went intoeffect to begin amortizing the memorandum account over a 20-year period. A ratesurcharge generating approximately $328,000 and $791,000 was billed tocustomers during the three and nine months ended September 30, 2006,respectively. GSWC will keep the Aerojet memorandum account open until it isfully amortized, but no longer than 20 years. However, no costs will be addedto the memorandum account, other than on-going interest charges approved by thedecision.  Pursuant to the decision,additional interest of approximately $279,000 and $1.1 million were added tothe Aerojet litigation memorandum account during the three and nine monthsended September 30, 2006, respectively.

 

It is management’sintention to offset any settlement proceeds from Aerojet that may occurpursuant to the settlement agreement against the balance in the memorandumaccount, with the exception of an $8 million payment guaranteed by Aerojet (forcapital investments), with interest due GSWC, to be paid in full over 5 years,beginning in 2009. Pursuant to such settlement agreement, Aerojet has agreed toreimburse GSWC $17.5 million, plus interest accruing from January 1, 2004, forits past legal and expert costs. Therecovery of the $17.5 million is contingent

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 upon the issuance of land use approvals fordevelopment in a defined area within Aerojet property in Eastern SacramentoCounty and the receipt of certain fees in connectionwith such development. On April 7, 2006, GSWC filed an advice letter with theCPUC to incorporate the Westborough development into the Arden Cordova servicearea and to provide water service to that new development. The City of Folsomfiled a protest of GSWC’s advice letter on April 27, 2006. GSWC cannot predictthe outcome of the City’s protest nor the future development within Aerojet’sproperty.

 

***Refundof Water Rights Lease Revenues:***

 

In 1994, GSWC enteredinto a contract to lease to the City of Folsom, 5,000 acre-feet per year ofwater rights from the American River. GSWC included all associated revenues ina nonoperating income account. In a decision issued on March 16, 2004, the CPUCordered GSWC to refund 70 percent of the total amount of lease revenuesreceived since 1994, plus interest, to customers. Pursuant to the order,refunds of approximately $170,000 and $186,000 were provided to customersduring the three months ended September 30, 2006 and 2005, respectively, andapproximately $426,000 and $455,000 were provided to customers during the ninemonths ended September 30, 2006 and 2005, respectively. The refunds will bemade over a 9-year period which commenced in June 2004.

 

Pursuant to the March2004 CPUC order, the apportionment of any lease revenues that GSWC collectscommencing in January 2004 was to be determined by a later decision. Pendingthat later decision and beginning in the first quarter of 2004, all amountsbilled to the City of Folsom had been included in a regulatory liabilityaccount and no amounts were recognized as revenue until uncertainties aboutthis matter were resolved with the CPUC. On April 13, 2006, the CPUC authorizedGSWC to reinvest all lease revenues received from the City of Folsom sinceJanuary, 2004, inclusive of the balances in the regulatory liability accounts,in water system infrastructure and to include such investments in the rate baseupon which GSWC earns a rate of return. As a result, GSWC transferredapproximately $2.3 million of water rights lease revenues received from theCity of Folsom in 2004 and 2005 from the regulatory liability account intoother operating revenues in the first quarter of 2006. GSWC also recordedadditional other operating revenues of approximately $311,000 and $909,000reflecting water rights revenues for the three and nine months ended September 30,2006, respectively.

 

***Outside Services Memorandum Account:***

 

In April 2006, the CPUCapproved GSWC’s Region II advice letter which requested recovery of theexpenses recorded in the Outside Services Memorandum Account (“OSMA”), as ofDecember 31, 2005. The decision authorized the recovery of this memorandumaccount to record costs incurred while working with the Water ReplenishmentDistrict (“WRD”), WRD Technical Advisory Committee, Central and West BasinMunicipal Water Districts, Metropolitan Water District, West Basin WaterAssociation and Central Basin Water Association on water supply reliability andrate-related issues in Region II. GSWC incurred approximately $374,000 and$345,000 in the OSMA in 2004 and 2005, respectively. GSWC sought and receivedauthorization to amortize the cumulative total of approximately $719,000 over a12-month period through customer rates. Accordingly, GSWC recorded a regulatoryasset for this amount in April of 2006 with an offset and reduction to outsidelegal services recorded in administrative and general expenses during thesecond quarter of 2006. A surcharge went into effect in April of 2006 andaccordingly, GSWC began amortizing the OSMA account. Revenues of approximately $200,000and $304,000 were received from customers during the three and nine monthsended September 30, 2006, respectively, relating to this surcharge. GSWC alsobooked the amortization for these amounts received to its OSMA memorandumaccount; therefore, there was no net impact on earnings. The surcharge will bein place for a 12-month period from the effective date.

** **

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

** **

In accordance with the Emerging Issues Task Force(“EITF”) No. 03-06, *“Participating Securitiesand the Two-Class Method under FASB Statement No. 128”*, Registrantuses the “two-class” method of computing earnings per share (“EPS”). The“two-class” method is an earnings allocation formula that determines EPS foreach class of common stock and participating security. AWR has participatingsecurities related to stock options and restricted stock units that earndividend equivalents on an equal basis with AWR’s Common Shares (the “CommonShares”) that have been issued under AWR’s 2000 Stock Incentive Plan and 2003Non-Employee Directors Stock Plan. In applying the “two-class” method,undistributed earnings are allocated to both common shares and participatingsecurities. The following is a reconciliation of Registrant’s net income andweighted average Common Shares outstanding for calculating basic net income pershare:

17

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| ***Basic***                                                             | ** ** | **For The Three Months  Ended September 30,** | ** ** | **For The Nine Months  Ended September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ***(in thousands, except per share amounts)*** | ** ** | **2006**                                      | ** ** | **2005**                                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                                              |       | $                                             | 5,573      |                                         | $          | 12,234 |   | $ | 17,742 |   | $ | 21,733 |   |
| Less: (a) distributed  earnings to common shareholders             |       | 3,826                                         |       | 3,776                                        |       | 11,406 |   | 11,322 |   |
| distributed earnings to participating securities                        |       | 80                                            |       | —                                       |       | 234 |   | — |   |
| Undistributed  earnings                                                 |       | 1,667                                         |       | 8,458                                        |       | 6,102 |   | 10,411 |   |
|                                                                    |       |                                          |       |                                         |       |   |   |   |   |
| (b) Undistributed  earnings allocated to common                    |       | 1,633                                         |       | 8,315                                        |       | 5,980 |   | 10,235 |   |
| Undistributed  earnings allocated to participating                      |       | 34                                            |       | 143                                          |       | 122 |   | 176 |   |
|                                                                    |       |                                          |       |                                         |       |   |   |   |   |
| Total income  available to common shareholders, basic (a)+(b)           |       | $                                             | 5,459      |                                         | $          | 12,091 |   | $ | 17,386 |   | $ | 21,557 |   |
|                                                                    |       |                                          |       |                                         |       |   |   |   |   |
| Weighted average  Common Shares outstanding, basic                      |       | 17,003                                        |       | 16,782                                       |       | 16,898 |   | 16,773 |   |
| **Basic earnings per Common Share**                                     |       | $                                             | 0.32       |                                         | $          | 0.72 |   | $ | 1.03 |   | $ | 1.29 |   |

 

Diluted EPS is based upon the weighted average numberof Common Shares including both outstanding shares and shares potentiallyissuable in connection with stock options and restricted stock units grantedunder Registrant’s 2000 Stock Incentive Plan and 2003 Non-Employee DirectorsStock Plan, and net income. At September 30, 2006 and 2005 there were 603,245and 686,600 options outstanding, respectively, under these Plans. At September 30,2006 and 2005, there were also 47,629 and 30,800 restricted stock unitsoutstanding, respectively. The following is a reconciliation of Registrant’snet income and weighted average Common Shares outstanding for calculatingdiluted net income per share:

 

 
| **Diluted**                                                             | ** ** | **For The Three Months  Ended September 30,** | ** ** | **For The Nine Months  Ended September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ***(in thousands, except per share amounts)*** | ** ** | **2006**                                      | ** ** | **2005**                                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| Common  shareholders earnings, basic                                    |       | $                                             | 5,459      |                                         | $          | 12,091 |   | $ | 17,386 |   | $ | 21,557 |   |
| Undistributed  earnings for dilutive stock options (1)                  |       | —                                        |       | —                                       |       | — |   | — |   |
| Total common  shareholders earnings, diluted                            |       | $                                             | 5,459      |                                         | $          | 12,091 |   | $ | 17,386 |   | $ | 21,557 |   |
|                                                                    |       |                                          |       |                                         |       |   |   |   |   |
| Weighted average  Common Shares outstanding, basic                      |       | 17,003                                        |       | 16,782                                       |       | 16,898 |   | 16,773 |   |
| Stock-based  compensation (2)                                           |       | 54                                            |       | 105                                          |       | 51 |   | 72 |   |
| Weighted average  Common Shares outstanding, diluted                    |       | 17,057                                        |       | 16,887                                       |       | 16,949 |   | 16,845 |   |
| **Diluted earnings per Common  Share**                                  |       | $                                             | 0.32       |                                         | $          | 0.72 |   | $ | 1.03 |   | $ | 1.29 |   |

----

(1)   Undistributedearnings allocated to participating securities were not included due to theirantidilutive effect on diluted earnings per share.

(2)      Inapplying the treasury stock method of reflecting the dilutive effect ofoutstanding stock-based compensation in calculation of diluted EPS, 199,818stock options at September 30, 2006 were deemed to be outstanding in accordancewith SFAS No. 128, *“Earnings Per Share”*.All of the stock options and restricted stock units at September 30, 2005 wereincluded in the calculation of diluted EPS for the three and nine months ended September30, 2005.

 

Stockoptions of 403,427 and restricted stock units of 47,629 were outstanding at September30, 2006, but not included in the computation of diluted EPS because they wereantidilutive.

 

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

 

During the three monthsended September 30, 2006 and 2005, Registrant issued 16,168 and 9,468 CommonShares, for approximately $602,000 and $274,000, respectively, under theRegistrant’s Common Share Purchase and Dividend Reinvestment Plan (“DRP”), andthe 401(k) Plan. During the nine months ended September 30, 2006 and

18

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2005, Registrant issued 45,270and 30,153 Common Shares, for approximately $1,625,000 and $830,000,respectively, under the Registrant’s DRP and 401(k) Plan. In addition, duringthe three and nine months ended September 30, 2006, Registrant issued 42,144and 190,976 Common Shares for approximately $962,000 and $4,383,000,respectively, as a result of the exercise of stock options. No cash proceedsreceived by AWR as a result of the exercise of these stock options have beendistributed to any subsidiaries of AWR.

 

In addition, during thethree months ended September 30, 2006 and 2005, Registrant purchased 1,028 and 26,009,respectively, Common Shares on the open market under the Registrant’s DRPand 401(k) Plan, which were used to satisfy the requirements of these plans andprograms. During the nine months ended September 30, 2006 and 2005, Registrantpurchased 25,849 and 47,515, respectively, Common Shares on the open marketunder the Registrant’s DRP and 401(k) Plan, for the same reason.

 

Duringthe three months ended September 30, 2006 and 2005, AWR paid quarterlydividends to shareholders, totaling approximately $3.8 million or $0.225 pershare. During the nine months ended September 30, 2006 and 2005, AWR paidquarterly dividends to shareholders, totaling approximately $11.4 million and $11.3million, respectively, or $0.675 per share.

 

**Note 4 — Derivative Instruments:**

 

Registranthas certain block-forward purchase power contracts that are subject to SFAS No.133, *“Accounting for Derivative Instruments and HedgingActivities”*, as amended by SFAS Nos. 138 and 149. A derivativefinancial instrument or other contract derives its value from anotherinvestment or designated benchmark. SFAS No. 133 requires companies to recordderivatives on the balance sheet as assets and liabilities, and to measurethose instruments at their fair value. Certain of these contracts qualify as anexception provided under SFAS No. 133 for activities that are considered normalpurchases and normal sales. These contracts are reflected in the statements ofincome at the time of contract settlement.

 

During2002, GSWC became a party to block-forward purchase power contracts thatqualified as derivative instruments under SFAS No. 133. Contracts with PinnacleWest Capital Corporation (“PWCC”) which became effective in November 2002 havenot been designated as normal purchases and normal sales. As a result, on amonthly basis, the related asset or liability is adjusted to reflect the fairmarket value at the end of the month. For the three months ended September 30,2006 and 2005, GSWC recognized a pretax unrealized loss of approximately $2.8million and a pretax unrealized gain of approximately $4.0 million,respectively. For the nine months ended September 30, 2006 and 2005, GSWCrecognized a pretax unrealized loss of approximately $5.9 million and a pretaxunrealized gain of approximately $7.5 million, respectively. As this contractis settled, the realized gains or losses are recorded in power purchased forresale, and the unrealized gains or losses are reversed. These contracts havebeen recognized at fair market value on the balance sheets resulting in acumulative unrealized loss of approximately $2.5 million as of September 30,2006 since the inception of the contracts.

 

The market prices used to determinethe fair value for this derivative instrument were estimated based onindependent sources such as broker quotes and publications. Monthly, settlementof this contract occurs on a cash or net basis through 2006 and by physicaldelivery through 2008. Registrant has no other derivativefinancial instruments.

 

**Note 5 — Taxes:**

** **

As a regulatedutility, GSWC treats certain temporary differences as flow-throughadjustments in computing its income tax provision consistent with theincome tax approach approved by the CPUC for ratemaking purposes. Flow-through adjustmentsincrease or decrease tax expense in one period, with an offsetting decreaseor increase occurring in another period. Giving effect to these temporarydifferences as flow-through adjustments typically results in a greatervariance between the effective tax rate (“ETR”) and the statutoryfederal income tax rate in any given period than would otherwise exist ifGSWC were not required to account for its income taxes as a regulatedenterprise. During the second quarter of 2005, the recognition of the federaleffect of state taxes was adjusted to conform to the flow-through methodreflected in the tax calculation for ratemaking purposes, which partiallydefers the recognition of the effect to the subsequent tax year. This increasedincome tax expense by approximately $33,000 for the three months endedSeptember 30, 2006 and decreased income tax expense by approximately $171,000for the nine months ended September 30, 2006.  During the third quarter of 2005, AWR filed anamended tax return for 2001 with the Internal Revenue Service (“IRS”) which wassubject to IRS and Congressional Joint Committee of Taxation (“JCT”) review. Duringthe second quarter of 2006, the IRS and JCT

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reviews were completedand AWR received a refund in the amount of its original claim of $3.0 million,with interest. Consequently, in the second quarter of 2006, AWR recorded a taxbenefit of approximately $400,000, of which $351,000 was attributable to GSWC.

 

**Note 6 —Stock-Based Compensation:**

 

***Summary Description ofStock Incentive Plans***

 

AWR currently has two primary stock incentive plans foremployees and for non-employee directors: the 2000 Stock Incentive Plan (the“2000 Employee Stock Plan”) and the 2003 Non-Employee Directors Stock Plan (the“Directors Stock Plan”), more fully described below.

 

*2000 Employee Stock Plan******–***AWR adopted the 2000 Employee Stock Plan at the annualmeeting of shareholders in 2000 to provide stock-based incentive awards in theform of stock options, and restricted stock to employees as a means ofpromoting the success of the Company by attracting, retaining and aligning theinterests of employees with those of shareholders generally. The 2000 EmployeeStock Plan was amended in January 2006 to also permit the grant of restrictedstock units. There are 1,050,000 Common Shares reserved for issuance under the2000 Employee Stock Plan, approximately 277,400 of which remain available forissuance as of September 30, 2006. The 2000 Employee Stock Plan is administeredby the Compensation Committee of the Board of Directors (the “Committee”). Forstock options, the Committee determines, among other things, the date of grant,the form, term, option exercise price, vesting and exercise terms of eachoption. Stock options granted by AWR have been in the form of nonqualifiedstock options, expire ten years from the date of grant, vest over a period ofthree years and are subject to earlier termination as provided in the form ofoption agreement approved by the Committee.

 

The option price per share is determined by the Committee atthe time of grant, but may not be less than 100% of the fair market value ofCommon Shares on the date of grant. In addition, AWR may grant employeesreceiving a grant of stock options the right to receive cash dividends pursuantto the terms of a dividend equivalent rights agreement for a period of up tothree years from the date of the option grant. For restricted stock, theCommittee determines, among other things, the dividend, voting and other rightsprior to vesting and the restrictions (which may be based on performancecriteria, passage of time or other factors) imposed on the shares. Forrestricted stock units, the Committee determines, among other things, thevesting terms and form of pay-out. Each employee who receives a grant of arestricted stock unit is also generally entitled to dividend equivalents rightsin the form of additional restricted stock units until vesting of therestricted stock units. The restricted stock units are a non-voting unit ofmeasurement relative to one Common Share.

 

*Directors Stock Plan****–*** On May 20, 2003,the Board of Directors adopted the Directors Stock Plan, subject to shareholderapproval. The shareholders approved the Directors Stock Plan at the May 2004Annual Meeting. The Directors Stock Plan provides the non-employee directorswith supplemental stock-based compensation and encourages them to increasetheir stock ownership in AWR. There are 250,000 Common Shares reserved forissuance under the Directors Stock Plan, approximately 168,900 of which remainavailable for issuance as of September 30, 2006. Pursuant to the DirectorsStock Plan, non-employee directors are entitled to receive options to purchase3,000 Common Shares at each annual meeting of shareholders commencing with the2005 annual meeting of shareholders. AWR also granted options to eachnon-employee director to purchase 1,000 Common Shares at its annual shareholdermeetings in 2003 and 2004. In addition, each non-employee director with no morethan ten years of service with AWR is entitled to receive restricted stockunits at each annual meeting in an amount equal to the then current annualretainer payable by AWR to each non-employee director divided by the fairmarket value of Common Shares on the last trading day prior to the annualmeeting. All grants of stock options and restricted stock units are entitled todividend equivalent rights payable in the form of additional restricted stockunits under the terms of the Directors Stock Plan.

 

The stock options grantedunder the Directors Stock Plan are 10-year nonqualified stock options. Theexercise price of the stock options must be 100% of the fair market value ofCommon Shares on the date of grant. Stock options granted under the DirectorsStock Plan are fully vested and exercisable upon the date of grant. The restricted stock units are a non-voting unit ofmeasurement relative to one Common Share. Restrictedstock units with respect to dividend equivalent rights on stock optionscredited to the non-employee director are payable in Common Shares on theearlier of the date on which the stock option is exercised and three years fromthe date of grant of the stock option. Restricted stock units granted at eachannual meeting of shareholders and restricted stock units with respect todividend equivalent rights with respect thereto are payable solely inCommon Shares on the 

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date that the participantterminates service as a director. Restrictedstock units credited to each non-employeedirector’s account are at all times fully vested and non-forfeitable.

*** ***

***Change in AccountingPrinciple***

 

Priorto January 1, 2006, Registrant accounted for share-based compensation toemployees in accordance with Accounting Principles Board Opinion (“APB”)No. 25, “*Accounting for Stock Issued to Employees*,”and related interpretations. Registrant also followed the disclosurerequirements of SFAS No. 123, “*Accounting for Stock-BasedCompensation*”, as amended by SFAS No. 148, “*Accountingfor Stock-Based Compensation—Transition and Disclosure*”. Except forcosts related to restricted stock units and restricted stock granted todirectors and employees, no stock-based compensation cost was recognized in netincome.

 

EffectiveJanuary 1, 2006, the Company adopted the provisions of SFAS No. 123(R), “*Share-Based Payment*,” which requires the recognition ofcompensation expense related to the fair value of stock-based compensationawards. Under the provisions of SFAS No. 123(R), share-based compensationcost is measured by the Registrant at the grant date, based on the calculatedfair value of the award, and is recognized as an expense over the employee’srequisite service period (generally the vesting period of the equity grant).Registrant elected to adopt the modified prospective transition method asprovided by SFAS No. 123(R). Accordingly, financial statement amounts forthe prior periods presented in this Form 10-Q have not been restated toreflect the fair value method of expensing share-based compensation.

 

***Effect of Stock-Based Compensation on Net Income***

 

Priorto January 1, 2006, Registrant had previously adopted the “disclosure-only”provisions of SFAS No. 123, as amended by SFAS No. 148. Had Registrantaccounted for stock-based compensation plans using the fair value basedaccounting method described by SFAS No. 123 for the periods prior tofiscal year 2006, Registrant’s net income and earnings per share for the threeand nine months ended September 30, 2005 would have been changed to the proforma amounts indicated below:

 
| ***(dollars in thousands, except EPS)***                                          | ** ** | **Three Months  Ended  September 30,  2005** | ** ** | **Nine Months  Ended  September 30,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| Net income, as reported                                                                               |       | $                                                      | 12,234     |                                                  | $          | 21,733 |   |
| Add: Stock-based compensation expense included in  reported net income, net of tax                    |       | 7                                                      |       | 64                                                    |       |
| Less: Stock-based compensation expense determined under  the fair-value accounting method, net of tax |       | (10                                                    | )          | (682                                                  | )          |
|  Pro forma                                                                                       |       | $                                                      | 12,231     |                                                  | $          | 21,115 |   |
|                                                                                                  |       |                                                   |       |                                                  |       |
| Basic earnings per share:                                                                             |       |                                                   |       |                                                  |       |
| As reported                                                                                           |       | $                                                      | 0.72       |                                                  | $          | 1.29 |   |
| Pro forma                                                                                             |       | $                                                      | 0.72       |                                                  | $          | 1.25 |   |
|                                                                                                  |       |                                                   |       |                                                  |       |
| Diluted earnings per share:                                                                           |       |                                                   |       |                                                  |       |
| As reported                                                                                           |       | $                                                      | 0.72       |                                                  | $          | 1.29 |   |
| Pro forma                                                                                             |       | $                                                      | 0.72       |                                                  | $          | 1.25 |   |

 

There were no material differences between theconsolidated 2005 pro forma disclosures for AWR and the 2005 pro formadisclosures for GSWC.

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Thefollowing table presents share-based compensation expenses for the three and ninemonths ended September 30, 2006 and 2005 and included in administrative andgeneral expenses in AWR and GSWC’s statements of income resulting from stockoptions, restricted stock and restricted stock units:

 
| ** **                                                                 | ** ** | **AWR**                               | ** ** | **GSWC**                             | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                 | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
| ***(in thousands)***                                                  | ** ** | **2006**                              | ** ** | **2005**                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Stock-based compensation related to:                                       |       |                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock options granted to employees and directors                           |       | $                                     | 60         |                                 | $          | — |   | $ | 279 |   | $ | — |   | $ | 54 |   | $ | — |   | $ | 263 |   | $ | — |   |
| Restricted stock units granted to employees                                |       | 42                                    |       | —                               |       | 120 |   | — |   | 38 |   | — |   | 111 |   | — |   |
| Restricted stock units granted to directors                                |       | —                                |       | 12                                   |       | 28 |   | 110 |   | — |   | 12 |   | 28 |   | 110 |   |
| Stock-based compensation recognized in the income  statement, before taxes |       | $                                     | 102        |                                 | $          | 12 |   | $ | 427 |   | $ | 110 |   | $ | 92 |   | $ | 12 |   | $ | 402 |   | $ | 110 |   |
| Income tax benefit                                                         |       | (41                                   | )          | (5                                   | )          | (171 | ) | (46 | ) | (37 | ) | (5 | ) | (161 | ) | (46 | ) |
| Total stock-based  compensation after income taxes                         |       | $                                     | 61         |                                 | $          | 7 |   | $ | 256 |   | $ | 64 |   | $ | 55 |   | $ | 7 |   | $ | 241 |   | $ | 64 |   |

 

 

Compensation costcapitalized as part of utility plant for the three and nine months ended September30, 2006 was approximately $38,000 and $166,000, respectively. In addition,pursuant to SFAS No. 123(R), dividend equivalent rights paid in cash in theamount of approximately $187,000 and $171,000 for AWR and GSWC, respectively,for the nine months ended September 30, 2006 were recognized as a reduction toretained earnings, net of tax benefit of approximately $80,000 and $73,000,respectively.

 

Withthe adoption of SFAS No. 123(R), Registrant elected to amortize stock-basedcompensation for awards granted on or after the adoption of SFAS No. 123(R) onJanuary 1, 2006 on a straight-line basis over the requisite (vesting) periodfor the entire award. Registrant did not recognize compensation expense foremployee share-based awards for the three and nine months ended September 30,2005, when the exercise price of Registrant’s employee stock awards equaled themarket price of the underlying stock on the date of grant. Registrant didrecognize compensation expense under APB No. 25 relating to restricted stockunits granted to directors. Non-vested stock options granted to employees priorto January 1, 2006 have terms that provide for the continuation of vesting upontermination of employment. Accordingly, these awards were deemed to be grantedfor past services from an accounting standpoint and any measured compensationcost was recognized in full in the pro forma disclosures at the date of grant.Therefore, upon implementation of SFAS No. 123(R), there was no remainingcompensation cost to be recognized for these options granted prior to, but notyet vested as of January 1, 2006.

 

***Valuation of Stock Options***

 

Registrant estimated the fair valueof stock options granted during the three and nine months ended September 30,2006 and 2005 using the Black-Scholes valuation model. Key input assumptionsused to estimate the fair value of stock options include the exercise price ofthe award, the expected option term, the expected volatility of theRegistrant’s stock over the option’s expected term, the risk-free interest rateover the option’s expected term, and the Registrant’s expected annual dividendyield. Registrant believes that the valuation technique and the approachutilized to develop the underlying assumptions are appropriate in calculatingthe fair values of Registrant’s stock options granted during the three and ninemonths ended September 30, 2006 and 2005. Estimates of fair value are notintended to predict actual future events or the value ultimately realized bypersons who receive equity awards. The fair value of stock units and restrictedstock was determined based on the closing trading price of Common Shares on thegrant date.

 

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Thefair value of each option grant during the three and nine months ended September30, 2006 and 2005 was estimated on the grant date using the Black-Scholesoption-pricing model with the following assumptions:

 

|                                               | ** ** | **2006**        | ** **     | **2005** | ** ** |
|-----------------------------------------------|------------|-----------------|----------------|----------|------------|
| Weighted-average fair value of option granted |       | $               | 8.01 -  $10.46 |     | $5.63      |   |
| Risk-free  interest rate                      |       | 4.40% - 5.02%   |           | 3.93%    |       |
| Expected  annual dividend yield               |       | 2.77% - 3.08%   |           | 3.68%    |       |
| Expected  volatility factor                   |       | 24.90% - 26.43% |           | 26.23%   |       |
| Expected option term (in years)               |       | 6               |           | 7        |       |
|                                               |            |                 |                |          |            |  |

 

* *

*Summaryof key assumptions****–***Therisk-free interest rate for periods equal to the expected term of the shareoption was based on the U.S. Treasury yield curve in effect at the time ofgrant. Dividend yield reflects the current dividend rate at the date of grant.The stock volatility for each grant is measured using the weighted average ofhistorical monthly and daily price changes of the Common Shares over the mostrecent period equal to the expected option life of the grant. For the three andnine months ended September 30, 2006, the option term was determined using thesimplified method for estimating expected option life, which qualify as“plain-vanilla” options and is derived from the average midpoint betweenvesting and the contractual term, as described in SEC’s SAB No. 107, “*Share-Based Payment*.” As permitted by SFAS No. 123(R),underlying assumptions used for stock options granted prior to January 1, 2005were retained.

 

SFAS No. 123(R) requires entities to estimate the number offorfeitures expected to occur and record expense based upon the number ofawards expected to vest. Prior to adoption, the Company accounted forforfeitures as they occurred as permitted under previous accounting standards. Thecumulative effect of adopting the change in estimating forfeitures was notmaterial to the Company’s financial statements for the nine months ended September30, 2006.

 

*Stock Options****–***A summary ofstock option activity as of September 30, 2006, and changes during the ninemonths ended September 30, 2006, is presented below:

 
| ** **                                | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|--------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------|------------|
| Options outstanding at January 1, 2006    |       | 684,304                     |       | $                                          | 24.31      |                                                        |       |                                |       |   |
| Granted                                   |       | 109,917                     |       | 34.85                                      |       |                                                        |       |                                |       |
| Exercised                                 |       | (190,976                    | )          | 22.95                                      |       |                                                        |       |                                |       |
| Forfeited or expired                      |       | —                      |       | —                                     |       |                                                        |       |                                |       |
| Options outstanding at September 30, 2006 |       | 603,245                     |       | $                                          | 26.66      |                                                        | 7.45       |                                | $          | 6,993,336 |   |
| Options exercisable at September 30, 2006 |       | 345,296                     |       | $                                          | 25.15      |                                                        | 6.66       |                                | $          | 4,523,945 |   |

 

The weighted-averagegrant-date fair value of options granted by Registrant during the nine monthsended September 30, 2006 was $8.34. There were no options granted during thethree months ended September 30, 2006.  Theaggregate intrinsic value in the table above represents the total pretaxintrinsic value (i.e., the difference between the closing price of the CommonShares on the last trading day of the third quarter of 2006 and the exerciseprice, times the number of shares) that would have been received by the optionholders had all option holders exercised their option on September 30, 2006. Thisamount changes if the fair market value of the Common Shares changes. The totalintrinsic value of options exercised during the three and nine months ended September30, 2006 was approximately $602,000 and $2,803,000, respectively. During thethree and nine months ended September 30, 2006, Registrant receivedapproximately $962,000 and $4,383,000, respectively, in cash proceeds from theexercise of its stock options and realized approximately $245,000 and $1,142,000,respectively, of tax benefit for the tax deduction from awards exercised. As ofSeptember 30, 2006, approximately $530,000 of total unrecognized compensationcost related to outstanding stock options is expected to be recognized over a remainingperiod of 2.34 years.

 

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*Restricted Stock and Stock Units****–*****A summary of the status of Registrant’s outstandingrestricted stock units to employees and directors as of September 30, 2006, andchanges during the nine months ended September 30, 2006, is presented below:

 
| ** **                                   | ** ** | **Number of  Restricted Share  Units** | ** ** | **Weighted Average  Grant-Date Value** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| Restricted share units at January 1, 2006    |       | 31,166                                           |       | $                                                | 25.02      |   |
| Granted                                      |       | 17,065                                           |       | 34.37                                            |       |
| Vested                                       |       | (602                                             | )          | 26.68                                            |       |
| Forfeited                                    |       | —                                           |       | —                                           |       |
| Restricted share units at September 30, 2006 |       | 47,629                                           |       | $                                                | 28.34      |   |

 

 

Asof September 30, 2006, there was approximately $330,000 of total unrecognizedcompensation cost related to restricted stock units granted under Registrant’semployee and director’s stock plans. That cost is expected to be recognizedover a remaining period of 2.34 years.

 

AWR has no restricted stock outstanding as of September 30,2006.

** **

**Note 7 — Employee Benefit Plans:**

 

Thecomponents of net periodic benefit costs, before allocation to the overheadpool, for Registrant’s pension plan, postretirement benefits plan, andSupplemental Executive Retirement Plan (“SERP”) for the three and nine months endedSeptember 30, 2006 and 2005 are as follows:

 
| ** **                                     | ** ** | **For The Three Months Ended September 30,  2006 and 2005** | ** ** |
|------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Pension Benefits**                                        | ** ** | **Other  Postretirement  Benefits** | ** ** | **SERP** | ** ** |
| ***(dollars in thousands)***         | ** ** | **2006**                                                    | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Components  of Net Periodic Benefits Cost:** | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service Cost                                   |       | $                                                           | 963        |   | $ | 933 |   | $ | 107 |   | $ | 109 |   | $ | 55 |   | $ | 32 |   |
| Interest Cost                                  |       | 1,170                                                       |       | 1,088 |   | 155 |   | 151 |   | 36 |   | 28 |   |
| Expected Return  on Plan Assets                |       | (990                                                        | )          | (922 | ) | (50 | ) | (74 | ) | — |   | — |   |
| Amortization of  Transition                    |       | —                                                      |       | — |   | 105 |   | 105 |   | — |   | — |   |
| Amortization of  Prior Service Cost            |       | 41                                                          |       | 41 |   | (50 | ) | (50 | ) | 39 |   | 38 |   |
| Amortization of  Actuarial Loss (Gain)         |       | 291                                                         |       | 313 |   | 37 |   | 41 |   | (5 | ) | (10 | ) |
| Net Periodic  Pension Cost                     |       | $                                                           | 1,475      |   | $ | 1,453 |   | $ | 304 |   | $ | 282 |   | $ | 125 |   | $ | 88 |   |

 

 
| ** **                                     | ** ** | **For The Nine Months Ended September 30,  2006 and 2005** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Pension  Benefits**                                      | ** ** | **Other  Postretirement  Benefits** | ** ** | **SERP** | ** ** |
| ***(dollars in thousands)***         | ** ** | **2006**                                                   | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Components  of Net Periodic Benefits Cost:** | ** ** | ** **                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service Cost                                   |       | $                                                          | 2,889      |   | $ | 2,799 |   | $ | 321 |   | $ | 327 |   | $ | 165 |   | $ | 96 |   |
| Interest Cost                                  |       | 3,510                                                      |       | 3,264 |   | 465 |   | 453 |   | 108 |   | 84 |   |
| Expected Return  on Plan Assets                |       | (2,970                                                     | )          | (2,766 | ) | (150 | ) | (222 | ) | — |   | — |   |
| Amortization of  Transition                    |       | —                                                     |       | — |   | 315 |   | 315 |   | — |   | — |   |
| Amortization of  Prior Service Cost            |       | 123                                                        |       | 123 |   | (150 | ) | (150 | ) | 117 |   | 114 |   |
| Amortization of  Actuarial Loss (Gain)         |       | 873                                                        |       | 939 |   | 111 |   | 123 |   | (15 | ) | (30 | ) |
| Net Periodic  Pension Cost                     |       | $                                                          | 4,425      |   | $ | 4,359 |   | $ | 912 |   | $ | 846 |   | $ | 375 |   | $ | 264 |   |

 

 

Registrant contributed approximately$4,414,000 to the pension plan during the third quarter of 2006.  Registrant expects to contributeapproximately $795,000 to the postretirement benefit plan by the end of 2006. 

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In August 2006, the Board of Directorsapproved an amendment to the SERP for executive officers of the Company. Underthe SERP, the formula for calculating benefits was revised to provide that thebenefit is calculated based on 2% of compensation per year of credited servicebefore 2006 and 3% of compensation per year of credited service after 2005 upto a combined maximum of 60% of compensation, except that participants who wereemployed with the Company on January 1, 2006 are entitled to receive thegreater of the benefit calculated under the new formula or the benefitcalculated under the previous formula. The Board’s approval of the new SERPformula is subject to the receipt of a confirming example, showing the effectof the change on an executive officer. The effect of this change on the 2006 net periodic benefit cost is notmaterial.

**Note 8 — Contingencies:**

 

***WaterQuality-Related Litigation:***

In1997, GSWC was named as a defendant in nineteen lawsuits that alleged that GSWCand other water utilities delivered unsafe water to their customers in the SanGabriel Valley and Pomona Valley areas of Los Angeles County. Plaintiffs inthese actions sought damages, including general, special, and punitive damages,as well as attorney’s fees on certain causes of action, costs of suit, andother unspecified relief.  On August 4,2004, GSWC was dismissed from all nineteen Los Angeles County cases. The Courtfound GSWC did not violate established water quality standards and dismissedthe cases after allowing reasonable time and opportunity for the plaintiffs toprove otherwise. GSWC has long asserted that it provides water within thestandards established by the health authorities. On September 21, 2004, GSWCreceived notice that several plaintiffs filed an appeal to the trial court’sorder to dismiss GSWC. Briefs and reply briefs on the appeal have been filed.On February 7, 2006, the Second Appellate District in which the briefs werefiled moved the California Supreme Court to transfer the appeal to the FirstAppellate District, the District in which prior appeals regarding these caseshad been heard. GSWC is unable to predict the outcome of this appeal.

GSWC is subject to self-insured retention (deductible)provisions in its applicable insurance policies and has either expensed theself-insured amounts or has reserved against payment of these amounts asappropriate. GSWC’s various insurance carriers have, to date, providedreimbursement for much of the costs incurred above the self-insured amounts fordefense against these lawsuits, subject to a reservation of rights. Inaddition, the CPUC has issued certain decisions, which authorize GSWC toestablish a memorandum account to accumulate costs for future recovery.

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

A key ruling of the court was that the waterpurveyors, including GSWC, by virtue of their ownership of wells contaminatedwith hazardous chemicals are themselves PRPs under the ComprehensiveEnvironmental Response, Compensation, and Liability Act (“CERCLA”).

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

On August 29, 2003, theUS Environmental Protection Agency (“EPA”) issued Unilateral AdministrativeOrders (“UAO”) against 41 parties deemed responsible for polluting thegroundwater in that portion of the San Gabriel Valley from which two of GSWC’simpacted wells draw water. GSWC was not named as a party to the UAO. The UAOrequires that these parties remediate the contamination. The judge in theFederal lawsuit has appointed a special master to oversee mandatory settlementdiscussions between the PRPs and the Water Entities. EPA is also conductingsettlement discussions with several PRPs regarding the UAO. The Water Entitiesand EPA 

25

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are working tocoordinate their settlement discussions under the special master in order toarrive at a complete resolution of all issues affecting the Federal lawsuitsand the UAO. Registrant is presently unable to predict the ultimate outcome ofthese settlement discussions.

 

Registrant is unable to predict anestimate of the loss, if any, resulting from any of these litigations oradministrative proceedings.

 

***Condemnation of Properties:***

 

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

 

Although the City of Claremont, California located inGSWC’s Region III, has not initiated the formal condemnation process pursuantto California law, the City has expressed various concerns to GSWC about therates charged by GSWC and the effectiveness of the CPUC’s rate settingprocedures. The City hired a consultant to perform an appraisal of the value ofRegistrant’s water system serving the City. The value was estimated in 2004 bythe consultant at $40 - $45 million. GSWC disagrees with the City’s valuationassessment. As of September 30, 2006, management believes that the fair marketvalue of the system exceeds the $37.0 million recorded net book value and alsoexceeds the consultant’s estimates of the Claremont water system.

 

On April 12, 2005, the Town Council of the Town ofApple Valley located in GSWC’s Region III, voted 5-0 to authorize Town staff toprepare a Request for Proposal for an evaluation of the feasibility andestimated cost of and a timeframe for the potential takeover of GSWC’s AppleValley water systems as well as the water systems of another utility servingthe Town. On April 11, 2006 the Town Council unanimously decided to moveforward with efforts to acquire all the water systems serving the Town, basedon a study authorized by the Town Council. On July 25, 2006, the Town Councilvoted 4-0 to defer any further consideration of a takeover pending preparationby Town staff of financing options and costs to residents of anyacquisition.  No time frame was set forstaff to report back to the Council.  GSWChas not received any formal notice from the Town of its intention to condemnthe Registrant’s Apple Valley water systems. Management will vigorously representRegistrant’s interests in any condemnation proceeding to ensure that theCompany receives full value for assets that become subject to condemnation. Asof September 30, 2006, management believes that the fair market value of GSWC’ssystem exceeds the recorded net book value of the Apple Valley water systems.

 

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

 

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

 

In 1997, the Santa Maria Valley Water ConservationDistrict (“plaintiff”) filed a lawsuit against multiple defendants, includingGSWC, the City of Santa Maria, and several other public water purveyors. Theplaintiff’s lawsuit seeks an adjudication of the Santa MariaGroundwater Basin.  A settlement of thelawsuit has been reached, subject to CPUC approval. The settlement, among otherthings, if approved, would preserve GSWC’s historical pumping rights and securesupplemental water rights for use in case of drought or other reductions in thenatural yield of the Basin. There are also a small number of nonsettlingparties, and the case is going forward as to these parties. The stipulation, ifapproved, would preserve GSWC’s position with the settling parties independentof the outcome of the case as it moves forward with the nonsettling parties. GSWCcannot predict the outcome of the case as to the nonsettling parties.

 

As of September 30, 2006, GSWC has incurred costs ofapproximately $6.3 million in defending its rights in the Santa MariaBasin, including legal and expert witness fees, which have been recorded inUtility Plant for rate recovery.  However,as stated earlier, the stipulation between the parties requires GSWC to go tothe CPUC to seek recovery of these costs that have been incurred by GSWC inthis lawsuit.  In February 2006, GSWCfiled with the CPUC for recovery of these costs. Management believes that therecovery of these costs through rates is probable. 

26

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***Air Quality Management District:***

 

In 1998, the South CoastAir Quality Management District (“AQMD”) issued a permit to GSWC for theinstallation and use of air stripping equipment at one of GSWC’s groundwatertreatment systems in its Region II service area.   In 2005, the AQMD conducted an inspection ofthis facility and issued a Notice of Violation (“NOV”) for exceeding the amountof groundwater permitted to be treated by the treatment system during calendaryear 2004.  Since receiving the NOV,changes in GSWC procedures have prevented additional violations at thefacility.  The AQMD could assess penaltiesassociated with an NOV that can range from $10,000 up to $75,000 per day ofviolation.  GSWC estimates that it was inviolation approximately 180 days in 2004. GSWC has met with AQMD to ensure future compliance and resolve the NOV.  As part of this, GSWC also promptly submittedan application to amend the permit as an amendment may have been necessary forcontinued operation of the subject air stripping equipment.

 

The AQMD has recentlyrecommended that GSWC be allowed to pursue a Supplemental Environmental Program(“SEP”) as part of the settlement of the NOV. A SEP typically involves capitalexpenditures resulting in a change of process, equipment, material, or indirectsource reduction for the purposes of eliminating or reducing air contaminantemissions.  As part of going forward withits permit amendment application, GSWS would amend its current application toalso include the addition of additional controls to the facility to reduceemissions.  The penalties which GSWC hasbeen informed might be assessed, could likely be reduced or avoided through thesettlement of this matter based on the possible funding of a SEP.  In October 2006, GSWC submitted initialcapital cost estimates to the AQMD for the installation and operation ofgranular activated carbon filters at the facility as a proposed SEP which wouldeliminate the use of the air stripping equipment.  Initial discussions indicate that AQMD staffhas favorably received GSWC’s proposal and if approved, it could result in theimposition of only a nominal monetary penalty. However, until further notice from the AQMD on the proposed SEP, GSWCcannot reasonably estimate the amount of penalties which might beassessed.  

 

***OtherLitigation:***

 

An officer of the Company has asserted a potentialclaim against the Company for retaliation against the officer and others inconnection with alleged discriminatory conduct by the Company and its Board ofDirectors. Although management believes that the allegations are without meritand intends to vigorously defend against them, the Company retained an independentinvestigator to review the allegations and investigate the facts. Based upon theresults of such investigation, the Company does not believe, but can give noassurance, that the ultimate resolution of this matter will have a materialadverse effect on its financial position, results of operations, or cash flows.

 

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

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** **

**Note 9 — Business Segments:**

 

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

 
| ** **                             | ** ** | **As of and for The Three Months Ended September 30, 2006** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                                      | ** ** | **CCWC** | ** ** | ** ** | ** ** | **Consolidated** | ** ** |
| ***(dollars in thousands)*** | ** ** | **Water**                                                                                                     | ** ** | **Electric** | ** ** | **Water** | ** ** | **Other*** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                             | 63,166     | (1) | $ | 6,444 |   | $ | 2,120 |   | $ | 2,011 |   | $ | 73,741 |   |
| Operating income  (loss)               |       | 17,780                                                                                                        |       | (2,703 | )(2) | 301 |   | (342 | ) | 15,036 |   |
| Interest  expense, net                 |       | 3,975                                                                                                         |       | 407 |   | 113 |   | 159 |   | 4,654 |   |
| Identifiable  assets                   |       | 661,847                                                                                                       |       | 41,156 |   | 38,521 |   | 845 |   | 742,369 |   |
| Depreciation and  amortization expense |       | 5,717                                                                                                         |       | 454 |   | 420 |   | 43 |   | 6,634 |   |
| Capital additions                      |       | 16,044                                                                                                        |       | 305 |   | 509 |   | 89 |   | 16,947 |   |
|                                        |            |                                                                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                        | ** ** | **As of and for The Three Months Ended September 30, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| *** ***                           | ** ** | **GSWC**                                                                                                      | ** ** | **CCWC** | ** ** | ** ** | ** ** | **Consolidated** | ** ** |
| ***(dollars in thousands)*** | ** ** | **Water**                                                                                                     | ** ** | **Electric** | ** ** | **Water** | ** ** | **Other*** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                             | 58,589     | (1) | $ | 6,544 |   | $ | 1,971 |   | $ | 987 |   | $ | 68,091 |   |
| Operating income  (loss)               |       | 16,700                                                                                                        |       | 4,894 | (2) | 322 |   | (145 | ) | 21,771 |   |
| Interest  expense, net                 |       | (1,587                                                                                                        | )          | 333 |   | 114 |   | 202 |   | (938 | ) |
| Identifiable  assets                   |       | 620,844                                                                                                       |       | 39,680 |   | 37,028 |   | 678 |   | 698,230 |   |
| Depreciation and  amortization expense |       | 3,948                                                                                                         |       | 512 |   | 263 |   | 11 |   | 4,734 |   |
| Capital additions                      |       | 15,031                                                                                                        |       | 288 |   | 805 |   |   |   | 16,124 |   |
|                                        |            |                                                                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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*             *Includes amounts from AWR and ASUS and its subsidiaries’ contracted operations(including FBWS, ODUS and TUS for the three months ended September 30, 2006 andFBWS for the three months ended September 30, 2005.)*

(1)      For the threemonths ended September 30, 2006, it includes $325,000 of GSWC other operatingrevenues, $311,000 of which reflects water rights lease revenues received fromthe City of Folsom (Note 2). For the three months ended September 30, 2005, italso includes $21,000 of GSWC other operating revenues.

(2)      Includes $2,807,000and ($4,018,000) unrealized loss (gain) on purchased power contracts for thethree months ended September 30, 2006 and 2005, respectively.

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| ** **                             | ** ** | **As of and for The Nine Months Ended  September 30, 2006** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                    | ** ** | **CCWC** | ** ** | ** ** | ** ** | **Consolidated** | ** ** |
| ***(dollars in thousands)***           | ** ** | **Water**                                                   | ** ** | **Electric** | ** ** | **Water** | ** ** | **Other*** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                           | 163,526    | (3) | $ | 21,816 |   | $ | 5,951 |   | $ | 5,193 |   | $ | 196,486 |   |
| Operating income  (loss)               |       | 46,380                                                      |       | (3,884 | )(4) | 1,026 |   | (325 | ) | 43,197 |   |
| Interest  expense, net                 |       | 11,339                                                      |       | 996 |   | 377 |   | 682 |   | 13,394 |   |
| Identifiable  assets                   |       | 661,847                                                     |       | 41,156 |   | 38,521 |   | 845 |   | 742,369 |   |
| Depreciation and  amortization expense |       | 16,806                                                      |       | 1,530 |   | 1,258 |   | 132 |   | 19,726 |   |
| Capital additions                      |       | 47,784                                                      |       | 1,681 |   | 1,313 |   | 291 |   | 51,069 |   |
|                                        |            |                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 
| ** **                             | ** ** | **As of and for The Nine Months Ended  September 30, 2005** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSCW**                                                    | ** ** | **CCWC** | ** ** | ** ** | ** ** | ** ** | ** ** | **Consolidated** | ** ** |
| ***(dollars in thousands)***           | ** ** | **Water**                                                   | ** ** | **Electric** | ** ** | **Water** | ** ** | **Other*** | ** ** | **Eliminations** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                           | 150,595    | (3) | $ | 20,105 |   | $ | 5,068 |   | $ | 2,704 |   | $ | (35 | ) | $ | 178,437 |   |
| Operating income  (loss)               |       | 39,439                                                      |       | 9,234 | (4) | 1,586 |   | (1,628 | ) |   |   | 48,631 |   |
| Interest  expense, net                 |       | 6,632                                                       |       | 982 |   | 325 |   | 601 |   |   |   | 8,540 |   |
| Identifiable  assets                   |       | 620,844                                                     |       | 39,680 |   | 37,028 |   | 678 |   |   |   | 698,230 |   |
| Depreciation and  amortization expense |       | 13,771                                                      |       | 1,519 |   | 788 |   | 45 |   |   |   | 16,123 |   |
| Capital additions                      |       | 47,108                                                      |       | 1,648 |   | 2,843 |   | 359 |   |   |   | 51,958 |   |
|                                        |            |                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

*             *Includes amounts from AWR and ASUS and its subsidiaries’ contracted operations(including FBWS, ODUS and TUS for the nine months ended September 30, 2006 andFBWS for the nine months ended September 30, 2005.)*

(3)      Forthe nine months ended September 30, 2006, it also includes $3,244,000 of GSWCother operating revenues, $3,190,000 of which reflects water rights leaserevenues received from the City of Folsom (Note 2). For the nine months ended September30, 2005, it also includes $76,000 of GSWC other operating revenues.

(4)      Includes$5,886,000 and ($7,492,000) unrealized loss (gain) on purchased power contractsfor the nine months ended September 30, 2006 and 2005, respectively.

 

 

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**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

# **General**

 

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

 

GSWC is a Californiapublic utility company engaged principally in the purchase, production anddistribution of water. GSWC also distributes electricity in one customerservice area. GSWC is regulated by the California Public Utilities Commission(“CPUC”) and was incorporated as a California corporation on December 31, 1929.GSWC is organized into one electric customer service area and three waterservice regions operating within 75 communities in 10 counties in the State ofCalifornia and provides water service in 21 customer service areas. Region Iconsists of 7 customer service areas in northern and central California; RegionII consists of 4 customer service areas located in Los Angeles County; andRegion III consists of 10 customer service areas in eastern Los Angeles County,Orange, San Bernardino and Imperial counties. GSWC also provides electricservice to the City of Big Bear Lake and surrounding areas in San BernardinoCounty through its Bear Valley Electric Service division.

 

GSWC served 254,063 water customers and 23,177 electriccustomers at September 30, 2006, or a total of 277,240 customers, compared with275,706 total customers at September 30, 2005. GSWC’s utility operationsexhibit seasonal trends. Although GSWC’s water utility operations have adiversified customer base, residential and commercial customers account for themajority of GSWC’s water sales and revenues. Revenues derived from commercialand residential water customers accounted for approximately 89.6% of total water revenues for the three months ended September 30, 2006, as compared to 90.2% for the three months ended September 30,2005. Revenues derived from commercial and residential watercustomers accounted for approximately 88.5% of total water revenues for the nine months ended September 30, 2006, as compared to 88.8% for the nine months ended September 30,2005.

 

CCWC is an Arizona public utility company serving 13,294customers as of September 30, 2006, compared with 12,959 customers at September30, 2005. Located in the town of Fountain Hills, Arizona and a portion of theCity of Scottsdale, Arizona, the majority of CCWC’s customers are residential.The Arizona Corporation Commission (“ACC”) regulates CCWC.

 

ASUS contracts, either directly or throughwholly-owned subsidiaries, with various municipalities, the U.S. Government andprivate entities to provide water and wastewater services, including billingand meter reading, water marketing and the operation and maintenance of waterand wastewater systems. On October 1, 2004, ASUS commenced operation of thewater and wastewater systems at Fort Bliss located near El Paso, Texas, throughFBWS, pursuant to the terms of a 50 year contract with the U.S. Government.ASUS commenced operation and maintenance of the water and wastewater systems atAndrews Air Force Base in Maryland on February 1, 2006 through TUS pursuant tothe terms of a 50 year contract. ASUS commenced operation and maintenance ofthe wastewater systems at Fort Lee in Virginia through ODUS on February 23,2006 pursuant to the terms of a 50 year contract. ASUS also commenced operationof the water and wastewater systems at Fort Eustis, Fort Story and Fort Monroein Virginia through ODUS on April 3, 2006 pursuant to the terms of a 50 yearcontract. These contracts are each subject to termination for convenience bythe U.S. Government. The contract price for each of these contracts is subjectto re-determination two years after commencement of operations and every threeyears thereafter to the extent provided in each of the contracts. Prices arealso subject to equitable adjustment based upon changes in circumstances andchanges in wages and fringe benefits to the extent provided in each of thecontracts.

 

ASUS and GSWC have beenpursuing an opportunity to provide retail water services within the servicearea of the Natomas Central Mutual Water Company (“Natomas”). Natomas is aCalifornia mutual water company which currently provides water service to itsshareholders, primarily for agricultural irrigation in portions of Sacramentoand Sutter counties in northern California. GSWC filed a Certificate of Public Convenience and Necessity applicationin May 2006, as mentioned below. 

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In August 2004, Natomasgranted ASUS the exclusive right to market water that has become “temporarilysurplus” that may arise under water rights permits and contracts owned orcontrolled by it, to third parties outside the Natomas service area. On January31, 2006, ASUS entered into a water purchase agreement to acquire 5,000acre-feet of permanent Sacramento River water diversion rights from Natomas. Pursuantto the terms of this agreement, Natomas will sell, transfer and convey to ASUS,in perpetuity, water rights and entitlements to divert from the SacramentoRiver up to 5,000 acre-feet of water per year, subject to certain regulatoryapprovals. Terms of the acquisition, among other things, include a base priceof $2,500 per acre-foot of water, with payments contingent on meeting specificmilestones and events over a 10-year period. Natomas will pay to ASUS acommission of 16% of the sale price over the same 10-year period under anexisting agreement between the two companies. At the same time that the water purchaseagreement was completed, Natomas and ASUS also entered into a settlementagreement that released Natomas from previously established reimbursementobligations under existing agreements. ASUS may use this 5,000 acre-feet ofwater rights acquired from Natomas to engage in transactional opportunities withdevelopers or water purveyors.

 

GSWC has also enteredinto a water transfer agreement with Natomas for 30,000 acre-feet of water tobe used exclusively by GSWC to serve Sutter County, California. Additionally,GSWC filed for a Certificate of Public Convenience and Necessity with the CPUCon May 31, 2006 to provide retail water service in a portion of Sutter County,California.  CPUC review of theapplication is pending, subject to completion of an environmental assessment. Inaddition, both agreements are subject to and become effective upon variousregulatory approvals.****

 

**Overview**

 

Registrant’s revenues, income, and cash flows areearned primarily through delivering potable water to homes and businesses.Rates charged to customers of GSWC and CCWC are determined by either the CPUCor ACC. These rates are intended to allow recovery of operating costs and afair rate of return on capital. Factors recently affecting our financialperformance include the process and timing of setting rates charged to customers;our ability to recover, and the process for recovering, the costs of water andelectricity in rates; weather; the impact of increased water quality standardson the cost of operations and capital expenditures; pressures on water supplycaused by population growth, more stringent water quality standards,deterioration in water quality and water supply from a variety of causes;capital expenditures needed to upgrade water systems and increased costs andrisks associated with litigation relating to water quality and water supply,including suits initiated by Registrant to protect its water supply.

 

For the three months ended September 30, 2006, netincome was $5.6 million compared to $12.2 million for the same period in 2005,a decrease of 54.4%.  Basic and dilutedearnings per share for the third quarter of 2006 were $0.32 when compared tothe $0.72 for the third quarter of 2005. Two factors contributed to the significant decrease in net income: firstthere was the favorable CPUC decision on July 21, 2005 regarding the Aerojetmatter which added about $4.3 million to net income in July 2005 orapproximately $0.25 per share with no similar gain in 2006; and second, due todecreasing energy prices, the pretax unrealized loss on purchased powercontracts of $2.8 million decreased net income by $0.10 per share during thethird quarter of 2006 in contrast to a pretax unrealized gain of $4.0 millionwhich increased net income by $0.14 per share for the same period of 2005.  Offsetting these decreases were higher revenuesdue to increases in customer rates and consumption, partially offset by higheroperating expenses.

 

For the nine months ended September 30, 2006, netincome was $17.7 million compared to $21.7 million for the same period in 2005,a decrease of 18.4%.  Basic and dilutedearnings per share for the nine months ended September 30, 2006 were $1.03,compared to $1.29 for the same period of 2005. Similar to the quarterlyresults, the decrease in earnings per share was primarily due to decreasingenergy prices which resulted in a pretax unrealized loss on purchased powercontracts of $5.9 million or a $0.21 per share decrease to net income duringthe third quarter of 2006, in contrast to a pretax unrealized gain of $7.5million which increased net income by $0.26 per share for the same period of2005.  In addition, there was thefavorable CPUC decision on July 21, 2005 regarding the Aerojet matter whichadded about $4.3 million to net income in July 2005 or approximately $0.25 pershare.  Offsetting these 2006 decreaseswas another favorable decision issued by the CPUC in April 2006 regardingGSWC’s water rights lease revenues received from the City of Folsom, increasedrates approved by the CPUC and ACC, and an increase in water consumption overthe prior period, partially offset by higher operating expenses.

 

Registrant plans to continue to seek additional rateincreases in future years to recover operating and supply costs and receivereasonable returns on invested capital. Capital expenditures in future yearsare expected to remain 

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atmuch higher levels than depreciation expense. Cash solely from operations isnot expected to be sufficient to fund Registrant’s needs for capitalexpenditures, dividends, investments in the contract business and other cash needs.Registrant expects to fund these needs through a combination of debt and commonshare offerings in the next five years.

 

Unless specifically noted, the following discussionand analysis provides information on AWR’s consolidated operations and assets.For the three and nine months ended September 30, 2006 and 2005, there isgenerally no material difference between the consolidated operations and assetsof AWR and the operations and assets of GSWC. However, where necessary, thefollowing discussion and analysis includes references specifically to AWR’sother subsidiaries — CCWC and ASUS and its subsidiaries.

 

***Consolidated Results ofOperations — Three Months Ended September 30, 2006 and 2005 (dollars inthousand)***

 
| ** **                                          | ** ** | **3 MOS  ENDED  9/30/2006** | ** ** | **3 MOS  ENDED  9/30/2005** | ** ** | **$  CHANGE** | ** ** | **%  CHANGE** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|---------------|------------|---------------|------------|
| OPERATING  REVENUES                                 |       |                             |       |                             |       |          |       |          |       |
| Water                                               |       | $                                | 64,962     |                             | $          | 60,539        |       | $             | 4,423      |   | 7.3 | % |
| Electric                                            |       | 6,444                            |       | 6,544                            |       | (100          | )          | -1.5          | %          |
| Other                                               |       | 2,335                            |       | 1,008                            |       | 1,327         |       | 131.6         | %          |
| Total operating revenues                            |       | 73,741                           |       | 68,091                           |       | 5,650         |       | 8.3           | %          |
| OPERATING EXPENSES                                  |       |                             |       |                             |       |          |       |          |       |
| Water purchased                                     |       | 15,066                           |       | 15,779                           |       | (713          | )          | -4.5          | %          |
| Power purchased for pumping                         |       | 3,600                            |       | 3,252                            |       | 348           |       | 10.7          | %          |
| Groundwater production assessment                   |       | 2,477                            |       | 2,315                            |       | 162           |       | 7.0           | %          |
| Power purchased for resale                          |       | 2,659                            |       | 3,075                            |       | (416          | )          | -13.5         | %          |
| Unrealized loss (gain) on purchased power contracts |       | 2,807                            |       | (4,018                           | )          | 6,825         |       | -169.9        | %          |
| Supply cost balancing accounts                      |       | 244                              |       | 514                              |       | (270          | )          | -52.5         | %          |
| Other operating expenses                            |       | 6,677                            |       | 4,850                            |       | 1,827         |       | 37.7          | %          |
| Administrative and general expenses                 |       | 12,614                           |       | 10,342                           |       | 2,272         |       | 22.0          | %          |
| Depreciation and amortization                       |       | 6,634                            |       | 4,734                            |       | 1,900         |       | 40.1          | %          |
| Maintenance                                         |       | 3,395                            |       | 2,905                            |       | 490           |       | 16.9          | %          |
| Property and other taxes                            |       | 2,656                            |       | 2,572                            |       | 84            |       | 3.3           | %          |
| Net gain on sale of property                        |       | (124                             | )          | -                                |       | 124           |       | 100.0         | %          |
| Total operating expenses                            |       | 58,705                           |       | 46,320                           |       | 12,385        |       | 26.7          | %          |
| OPERATING INCOME                                    |       | 15,036                           |       | 21,771                           |       | (6,735        | )          | -30.9         | %          |
| Interest expense                                    |       | (5,349                           | )          | 193                              |       | 5,542         |       | 2871.5        | %          |
| Interest income                                     |       | 695                              |       | 745                              |       | (50           | )          | -6.7          | %          |
| INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE    |       | 10,382                           |       | 22,709                           |       | (12,327       | )          | -54.3         | %          |
| Income tax expense                                  |       | 4,809                            |       | 10,475                           |       | (5,666        | )          | -54.1         | %          |
| NET INCOME                                          |       | $                                | 5,573      |                             | $          | 12,234        |       | $             | (6,661     | ) | -54.4 | % |

 

 

Net income for the third quarter ended September 30,2006 decreased by 54.4% to $5.6 million, equivalent to $0.32 per common shareon both a basic and fully diluted basis, compared to $12.2 million or $0.72 pershare for the three months ended September 30, 2005. Significantly impactingthe comparability in the results of the two periods are the following two items:

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·                    A favorable decision issued by theCPUC on July 21, 2005 regarding the Aerojet memorandum account which addedabout $4.3 million to net income in July 2005 or approximately $0.25 per share.GSWC was authorized to collect the balance of the Aerojet litigation memorandumaccount of approximately $21.3 million, through a rate surcharge, which willcontinue for no longer than 20 years.  Asa result of this decision, in July 2005 GSWC recorded an increase ofapproximately $6.2 million to the Aerojet regulatory asset to includepreviously expensed carrying and other costs, and recorded a correspondingpre-tax gain.  In addition, GSWC wasordered to restore to the appropriate plant accounts, those amounts that havebeen reimbursed by Aerojet pursuant to the settlement. This resulted in GSWCrecording an approximate $1.0 million decrease to depreciation expense duringthe third quarter of 2005.  There were nosimilar entries during the third quarter of 2006.  The following is a summary of the impact onthe results of operations for the three months ended September 30, 2005resulting from this decision: 

 

| Operating Expenses                        | ** ** | ** **                          | ** ** | **Amount** | ** ** |
|------------------------------------------------|------------|-------------------------------------|------------|------------|------------|
| ** **                                     | ** ** | **Increase / (Decrease)** | ** ** |
| Power purchased for resale                     |       | ($31,230                            | )          |
| Other operating expenses                       |       | (459,415                            | )          |
| Administrative and general expenses            |       | (16,963                             | )          |
| Depreciation and amortization                  |       | (992,232                            | )          |
| Total pre-tax  impact to operating expenses    |       | (1,499,840                          | )          |
|                                           |       |                                |       |
| **Interest**                                   | ** ** | ** **                          | ** ** |
| Interest expense                               |       | (5,084,551                          | )          |
| Interest income                                |       | (607,083                            | )          |
| Total net  interest charges                    |       | (5,691,634                          | )          |
|                                           |       |                                |       |
| Total pre-tax  impact to results of operations |       | $                                   | 7,191,474  |       |
| Impact to taxes on income                      |       | 2,930,238                           |       |
| Total impact to  net income                    |       | $                                   | 4,261,236  |       |
|                                           |       |                                |       |
| Impact to Basic  Earnings per Share            |       | $                                   | 0.25       |       |
| Impact to Diluted  Earnings per Share          |       | $                                   | 0.25       |       |

 

·                  Therewas a pretax unrealized loss on purchased power contracts in 2006 due todecreasing energy prices versus a pretax unrealized gain on purchased powercontracts in 2005. The cumulative unrealized loss on purchased power contractsdecreased pretax income by approximately $2.8 million, or $0.10 per share, forthe three months ended September 30, 2006, as compared to a cumulativeunrealized gain on purchased power contracts that increased pretax income by $4.0million, or $0.14 per share, for the same period in 2005.

 

Eliminating the effects of the two items discussedabove, basic and diluted earnings per share for the third quarter of 2006 wouldhave actually increased by $0.09 per share as compared to the same period lastyear, resulting primarily from higher water revenues due to increased customerrates and consumption due to warmer weather conditions, offset partially byhigher operating expenses, as further discussed below.

*** ***

***Operating Revenues***

 

For the three monthsended September 30, 2006, revenues from water operations increased by 7.3% to $65.0million, compared to $60.5 million for the three months ended September 30,2005. An increase of 1.5% in billed water consumption resulting from changes inweather conditions increased revenues by approximately $524,000. In addition, higherwater revenues reflecting rate increases since the third quarter of 2005covering almost all water customers contributed $3.6 million in increasedrevenues for the third quarter of 2006. Differences in temperature and rainfallin Registrant’s service areas impact sales of water to customers, causingfluctuations in Registrant’s revenues and earnings between comparable periods.

 

For the three months ended September 30, 2006, revenuesfrom electric operations decreased by 1.5% to $6.4 million compared to $6.5million for the three months ended September 30, 2005. The decrease primarily

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reflects lower new connection, reconnection andmiscellaneous fees charged to customers during the three months ended September30, 2006 as compared to same period in 2005. This decrease was partially offset by a slight increase in kilowatt-hour(“KWh”) usage, due to changes in weather conditions. During the thirdquarter of 2006, the Big Bear area experienced a heat wave. Temperatures ranabove normal and residential customers used more power for fans and central air,as well as the commercial customers which required more power for air coolingand freezers compared to the third quarter of 2005

 

Registrantrelies upon rate approvals by state regulatory agencies in California andArizona, in order to recover operating expenses and provide for a fair returnon invested and borrowed capital used to fund utility plant. Without adequaterate relief granted in a timely manner, revenues and earnings can be negativelyimpacted.

 

For the three months ended September 30, 2006, otheroperating revenues increased by 131.6% to $2.3 million compared to $1.0 millionfor the three months ended September 30, 2005 due primarily to $954,000 ofadditional revenues generated by ASUS from operating the water and wastewatersystems pursuant to new contracts at military bases. In addition, revenuesincreased due to a decision issued by the CPUC on April 13, 2006 enabling GSWCto record water rights lease revenues from the City of Folsom subsequent toJanuary 2004, as income. Prior to this decision, the apportionment of any leaserevenues that GSWC collected in 2004 and 2005 had been included in a regulatoryliability account and no amounts were recognized as revenues untiluncertainties about this matter were resolved. For the third quarter 2006,Registrant recorded additional water lease revenues of $311,000.

 

***Operating Expenses***

 

For the three months ended September 30, 2006, purchasedwater costs decreased by 4.5% to $15.1 million compared to $15.8 million forthe three months ended September 30, 2005. The decrease is due primarily to afavorable change in the supply mix caused by less purchased water needed toreplace contaminated groundwater supply or wells temporarily out of service in2005. For the three months ended September 30, 2006, 46.3% of Registrant’ssupply mix was purchased water as compared to 49.8% purchased water for thethree months ended September 30, 2005. During the same period last year, therewere additional purchases of water needed to replace contaminated groundwatersupply lost due to wells being removed from service resulting from waterquality issues and mechanical problems, particularly in GSWC’s Foothilldistrict. The cost of purchased water in this district decreased byapproximately $616,000 for the three months ended September 30, 2006 whencompared to the three months ended September 30, 2005 as a result of certainwells being returned to operation in 2006. 

 

For the three months ended September 30, 2006, the cost ofpower purchased for pumping increased by 10.7% to $3.6 million compared to $3.3million for the three months ended September 30, 2005 due to an increase in KWhusage by Registrant caused by higher pumping volume due to the favorable supplymix change discussed above.

 

For the three months ended September 30, 2006, groundwaterproduction assessments increased by 7.0% to $2.5 million as compared to $2.3million for the three months ended September 30, 2005 due to increases in wellproduction resulting from the supply mix change and increased consumption. Therewere also increases in assessment rates levied against groundwater production,effective July 2006. Average pump tax rates increased in GSWC’s Regions II andIII by approximately 2% and 4%, respectively.

 

Changes in the waterresource mix between water supplied from purchased sources and that suppliedfrom Registrant’s own wells can increase/decrease actual supply-related costsrelative to that approved for recovery through rates, thereby impactingearnings either negatively or positively. Registrant has the opportunity tochange the supply-related costs recovered through rates by application to theappropriate regulatory body. Registrant believes that its applications forrecovery of supply-related costs accurately reflect the water supply situationas it is known at the time. However, without additional regulatory mechanisms,it is not possible to wholly protect earnings from adverse changes in supplycosts related to unforeseen contamination or other loss of water supply.

 

For the three months ended September 30, 2006, cost ofpower purchased for resale to customers in GSWC’s Bear Valley Electric divisiondecreased by 13.5% to $2.7 million compared to $3.1 million for the threemonths ended September 30, 2005, reflecting lower costs of energy in thethird quarter of 2006 as compared to the same period of 2005 in the spotmarket. The third quarter of 2005 was characterized by high energy costs due tothe effects of hurricanes and uncertainty in the energy markets. The sameperiod in 2006, with no significant hurricane activity, saw spot market costsdecline from 2005 levels. Thisdecrease to the cost of power purchased for resale was offset partially byhigher customer demand during the third quarter of 2006.

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Unrealized loss (gain) onpurchased power contracts represents losses and gains recorded for GSWC’spurchased power agreements with Pinnacle West Capital Corporation (“PWCC”),which qualify as derivative instruments under SFAS No. 133, *“Accounting for Derivative Instruments and Hedging Activities”*.The $2.8 million pretax unrealized loss on purchased power contracts for thethree months ended September 30, 2006 is due to a decrease in the currentforward market prices since June 30, 2006. There was a $4.0 million pretaxunrealized gain on purchased power contracts for the three months ended September30, 2005. Unrealized gains and losses at Bear Valley Electric will continue toimpact earnings during the life of the contract with PWCC, which terminates in2008.

 

A decrease of $270,000during the three months ended September 30, 2006 in the provision for supplycost balancing accounts as compared to the three months ended September 30,2005 was primarily due to the recording in 2006 of a $1.4 millionunder-collection related to the 2006 year-to-date supply cost memorandumaccount resulting from the elimination of the earnings test.  This change was authorized by the CPUC inApril 2006.  This decrease was offset by:(i) an increase of $654,000 in the third quarter of 2006 related to theamortization of the water supply cost balancing accounts approved by the CPUCin August and September of 2005, and (ii) a net increase of $504,000 in the electricsupply cost balancing account resulting from the lower offset cost of power. 

 

For the three months ended September30, 2006, other operating expenses increased by 37.7% to $6.7 million comparedto $4.9 million for the three months ended September 30, 2005 due primarily to:(i) higher operating expenses of $519,000 at ODUS and TUS due to thecommencement of the operations of the water and wastewater systems pursuant tonew military contracts in Maryland and Virginia in early 2006; (ii) a$459,000 downward adjustment in July of 2005 reflecting the approval from theCPUC of previously incurred operating expenses in the Aerojet matter,previously discussed; (iii) higher chemicals and water treatment costs of$266,000 at GSWC; (iv) higher labor costs as a result of higher wages whichincreased by approximately $164,000 at GSWC; (v) an increase of $226,000 in baddebt expense at GSWC relating to miscellaneous accounts receivable balances,and (vi) a net increase of $193,000 in various other miscellaneous operatingexpenses.

 

For the three months ended September30, 2006, administrative and general expenses increased by 22.0% to $12.6million compared to $10.3 million for the three months ended September 30, 2005due to: (i) administrative and general expenses of $446,000 at ODUS and TUS dueto the commencement of the operations of the water and wastewater systemspursuant to new military contracts in Maryland and Virginia; (ii) an increaseof approximately $683,000 in various employee benefit costs including stock-basedcompensation expense of $102,000 due to the adoption of SFAS No. 123(R)effective January 1, 2006; (iii) an increase of $994,000 in outside servicesrelating primarily to tax and legal services at GSWC, and (iv) higherlabor costs as a result of higher wages which increased by approximately$118,000 at GSWC.  

 

For the three months ended September 30, 2006, depreciation andamortization expense increased by 40.1% to $6.6 million compared to $4.7million for the three months ended September 30, 2005 reflecting, among otherthings, the effects of closing approximately $100 million of additions toutility plant during 2005, depreciation on which began in January 2006. Inaddition, there was a decrease in depreciation expense in 2005 resulting fromthe favorable CPUC decision on the Aerojet matter, discussed previously, whichordered GSWC in July of 2005 to restore approximately $1.0 million to theappropriate plant accounts and decrease depreciation expense.  There was no such adjustment in 2006.Registrant anticipates that depreciation expense will continue to increase dueto Registrant’s on-going construction program at its regulated subsidiaries.Registrant believes that depreciation expense related to property additionsapproved by the appropriate regulatory agency will be recovered through waterand electric rates.

 

For the three months ended September30, 2006, maintenance expense increased by 16.9% to $3.4 million compared to$2.9 million for the three months ended September 30, 2005 due principally toan increase in required maintenance on GSWC’s wells and water supply sources. Therewere also increases in well treatment and emergency repair costs. Furthermore,there was an increase of $61,000 at ODUS and TUS due to the commencement of theoperations of the water and wastewater systems pursuant to new military contractsin Maryland and Virginia. 

 

For the three months ended September30, 2006, property and other taxes increased by 3.3% to $2.7 million comparedto $2.6 million for the three months ended September 30, 2005 reflectingadditional property taxes resulting from higher assessed values, and increasesin payroll taxes based on increased labor costs.

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For the three months ended September30, 2005, Registrant recorded a net pre-tax gain of $124,000 on the sale ofnon-utility property.  There was nosimilar gain in the same period of 2005.

 

***Interest Expense***

 

For the three months ended September30, 2006, interest expense increased by $5.5 million during the three monthsended September 30, 2006 as compared to the same period in 2005 reflectingprimarily the approval from the CPUC in July of 2005 for the recovery ofpreviously incurred and expensed interest costs totaling $5.1 million in theAerojet memorandum account, discussed previously.   In addition, theincrease also reflects increases in long-term debt interest expense of $585,000due to $40.0 million of additional private placement notes issued at GSWC inOctober 2005. Partially offsetting this increase was a decrease in short-termcash borrowings. Average bank loan balances outstanding under an AWR creditfacility for the third quarter of 2006 were approximately $26.5 million, ascompared to an average of $50.8 million during the same period of 2005. However,the decrease in short-term bank loan balances was also partially offset byhigher interest rates.

 

***Interest Income***

 

Interest income decreased by 6.7%during the three months ended September 30, 2006 as compared to the same periodin 2005 reflecting primarily the decision from the CPUC in 2005 on theAerojet matter, which resulted in the recognition of interest income totalingapproximately $607,000 earned on the $8.0 million Aerojet long-term notereceivable.  The recording of theinterest income had been deferred pending this final CPUC decision.  This decrease was offset by increases dueprimarily to: (i)interest accrued on the uncollected balance of the Aerojet litigationmemorandum account authorized by the CPUC of $279,000; (ii) interestincome totaling $173,000 earned from the U.S. Government for costs incurred oncapital upgrade projects at Andrews Air Force Base, and (iii) interest earnedon short-term cash surplus. 

 

***Income Tax Expense***

 

For the three monthsended September 30, 2006, income tax expense decreased by 54.1%to $4.8 million compared to $10.5 million for the three months endedSeptember 30, 2005 due primarily to a decrease in pretax incomeof 54.3%. The effective tax rate (“ETR”) for the threemonths ended September 30, 2006 increased slightly to 46.3% ascompared to a 46.1% ETR applicable to the three months ended September 30,2005. The variance between the ETR and the statutory tax rate is primarily theresult of differences between book and taxable income that are treated asflow-through adjustments in accordance with regulatoryrequirements. Flow-through adjustments increase or decrease tax expense inone period, with an offsetting increase or decrease occurring in anotherperiod. During thesecond quarter of 2005, the recognition of the federal effect of state taxeswas adjusted to conform to the flow-through method reflected in the taxcalculation for ratemaking purposes, which partially defers the recognition ofthe effect to the subsequent tax year. This increased income tax expense by$33,000 for the three months ended September 30, 2006.

 

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***Consolidated Results of Operations — Nine Months Ended September 30,2006 and 2005 (dollars in thousand)***

 
| ** **                                          | ** ** | **9 MOS  ENDED  9/30/2006** | ** ** | **9 MOS  ENDED  9/30/2005** | ** ** | **$  CHANGE** | ** ** | **%  CHANGE** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|---------------|------------|---------------|------------|
| OPERATING  REVENUES                                 |       |                             |       |                             |       |          |       |          |       |
| Water                                               |       | $                                | 166,233    |                             | $          | 155,611       |       | $             | 10,622     |   | 6.8 | % |
| Electric                                            |       | 21,816                           |       | 20,105                           |       | 1,711         |       | 8.5           | %          |
| Other                                               |       | 8,437                            |       | 2,721                            |       | 5,716         |       | 210.1         | %          |
| Total operating revenues                            |       | 196,486                          |       | 178,437                          |       | 18,049        |       | 10.1          | %          |
| OPERATING EXPENSES                                  |       |                             |       |                             |       |          |       |          |       |
| Water purchased                                     |       | 34,326                           |       | 35,742                           |       | (1,416        | )          | -4.0          | %          |
| Power purchased for pumping                         |       | 7,620                            |       | 6,923                            |       | 697           |       | 10.1          | %          |
| Groundwater production assessment                   |       | 6,799                            |       | 6,079                            |       | 720           |       | 11.8          | %          |
| Power purchased for resale                          |       | 10,470                           |       | 9,922                            |       | 548           |       | 5.5           | %          |
| Unrealized loss (gain) on purchased power contracts |       | 5,886                            |       | (7,492                           | )          | 13,378        |       | -178.6        | %          |
| Supply cost balancing accounts                      |       | (93                              | )          | 1,042                            |       | (1,135        | )          | -108.9        | %          |
| Other operating expenses                            |       | 17,264                           |       | 15,138                           |       | 2,126         |       | 14.0          | %          |
| Administrative and general expenses                 |       | 34,628                           |       | 32,456                           |       | 2,172         |       | 6.7           | %          |
| Depreciation and amortization                       |       | 19,726                           |       | 16,123                           |       | 3,603         |       | 22.3          | %          |
| Maintenance                                         |       | 9,113                            |       | 7,522                            |       | 1,591         |       | 21.2          | %          |
| Property and other taxes                            |       | 7,674                            |       | 7,111                            |       | 563           |       | 7.9           | %          |
| Net gain on sale of property                        |       | (124                             | )          | -                                |       | 124           |       | 100.0         | %          |
| Gain on settlement for removal of wells             |       | -                                |       | (760                             | )          | (760          | )          | -100.0        | %          |
| Total operating expenses                            |       | 153,289                          |       | 129,806                          |       | 23,483        |       | 18.1          | %          |
| OPERATING INCOME                                    |       | 43,197                           |       | 48,631                           |       | (5,434        | )          | -11.2         | %          |
| Interest expense                                    |       | (16,037                          | )          | (9,341                           | )          | 6,696         |       | 71.7          | %          |
| Interest income                                     |       | 2,643                            |       | 801                              |       | 1,842         |       | 230.0         | %          |
| INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE    |       | 29,803                           |       | 40,091                           |       | (10,288       | )          | -25.7         | %          |
| Income tax expense                                  |       | 12,061                           |       | 18,358                           |       | (6,297        | )          | -34.3         | %          |
| NET INCOME                                          |       | $                                | 17,742     |                             | $          | 21,733        |       | $             | (3,991     | ) | -18.4 | % |

 

Net income decreased by 18.4% for the nine monthsended September 30, 2006, to $17.7 million, which is equivalent to $1.03 percommon share on both a basic and fully diluted basis, compared to $21.7 millionor $1.29 per share on a basic and fully diluted basis, respectively, for the ninemonths ended September 30, 2005. Impacting the comparability in the results ofthe two periods are the following significant items:

 

·                    There was anunrealized loss on purchased power contracts in 2006 due to decreasing energyprices versus an unrealized gain on purchased power contracts in 2005. Thecumulative unrealized loss on purchased power contracts decreased pretax incomeby approximately $5.9 million, or $0.21 per share, for the nine months ended September30, 2006, as compared to a cumulative unrealized gain on purchased powercontracts that increased pretax income by $7.5 million, or $0.26 per shareincrease to income, for the same period in 2005. 

 

·                   As discussedin the quarterly results, the 2005 nine months recorded results reflects afavorable decision issued by the CPUC on July 21, 2005 regarding the Aerojetmatter which added about $4.3

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million to net income inJuly of 2005 or approximately $0.25 per share. The impact to pretax income resulted in reduced interest charges,depreciation expense and other operating expenses as discussed below.

 

·                  A decisionissued by the CPUC on April 13, 2006 regarding the treatment of GSWC’s waterrights lease revenues added about $3.2 million to pretax income for the nine monthsended September 30, 2006 or approximately $0.11 per share. In this decision,the CPUC authorized GSWC to reinvest all lease revenues since January 2004,inclusive of the balances in the regulatory liability accounts established byGSWC for this matter, in water system infrastructure. These investments will beincluded in the rate base upon which GSWC earns a rate of return. In accordancewith California law, GSWC will have 8 years in which to reinvest the proceeds.As a result, GSWC transferred about $2.3 million of water rights lease revenuesreceived from the City of Folsom in 2004 and 2005 from the regulatory liabilityaccount into other operating revenues. GSWC also recorded pretax income of $909,000reflecting water rights lease revenues for the first, second and third quartersof 2006.

 

·                  Waterrate increases contributed approximately $8.8 million to revenues, or $0.31 pershare for the nine months ended September 30, 2006. This was partially offsetby higher expenses as described below.

 

·                  Anincrease in ASUS’s pretax operating income of $1.4 million, or $0.05 per share,as compared to the same period of 2005 by operating and maintaining the waterand wastewater systems for the U.S. Government. The increases included revenuerecognized for certain special projects and reimbursement of various operatingcosts incurred during the period of transition of the operation and maintenanceof the water and wastewater systems at military bases in Maryland and Virginiaformerly owned and operated by the U.S. Government.

 

·                  A$2.4 million increase in other interest income, excluding the impact of theAerojet decision in July 2005 mentioned above, or $0.09 per share, resultingprimarily from interestaccrued on the uncollected balance of the Aerojet litigation memorandum accountauthorized by the CPUC, interest income related to a $3.0 million InternalRevenue Service refund received in May 2006, and interest income fromthe U.S. Government for costs incurred on capital upgrade projects at AndrewsAir Force Base

 

·                  Alower effective tax rate increased earnings by $0.09 per share resultingprimarily from: (i) a $400,000 tax benefit relating to a $3.0 million IRSrefund received in May 2006; and (ii) differences between book and taxableincome, which are treated as flow-through adjustments in accordance withregulatory requirements.

 

·                    Higheroperating expenses, other than those described above, which lowered 2006 netincome by an additional $0.19 per share, as more fully described below.

*** ***

***Operating Revenues***

 

For the nine months endedSeptember 30, 2006, revenues from water operations increased by 6.8% to $166.2million, compared to $155.6 million for the nine months ended September 30,2005. Higher water revenues reflect rate increases since the second quarter of2005 covering almost all water customers, which contributed $8.8 million inincreased revenues. In addition, an increase of about 2.0% in billed waterconsumption resulting from changes in weather conditions also increasedrevenues by approximately $1.8 million. Differences in temperature and rainfallin Registrant’s service areas impact sales of water to customers, causingfluctuations in Registrant’s revenues and earnings between comparable periods.

 

For the nine months ended September30, 2006, revenues from electric operations increased by 8.5% to $21.8 millioncompared to $20.1 million for the nine months ended September 30, 2005. Theincrease reflects primarily a 7.4% increase in KWh usage, due to changes inweather conditions which caused the usage of snow-making machines to increase in2006. Thecooler 2006 winter weather as compared to same period last year allowed the skiresorts (industrial customers) to remain open well into May, operating theirlifts and some snow-making in the evening hours. New rates authorized by the CPUC for the 8.4 megawatt (“MW”)natural gas-fueled generation facility also contributed to the increase. Thenew rates went into effect on April 15, 2005 and generate approximately $2.7million in additional annual revenues, subject to refund pending the CPUC’sfinal cost review.

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The new Bear Valley Electric rateshave been recognized in 2006 revenues and management believes it is probablethat the final CPUC cost review will not result in refunds to the customer.

 

Registrantrelies upon rate approvals by state regulatory agencies in California andArizona, in order to recover operating expenses and provide for a fair returnon invested and borrowed capital used to fund utility plant. Without adequaterate relief granted in a timely manner, revenues and earnings can be negativelyimpacted.

 

For the nine months ended September 30, 2006, otheroperating revenues increased by 210.1% to $8.4 million compared to $2.7 millionfor the nine months ended September 30, 2005 due primarily to a decision issuedby the CPUC on April 13, 2006 enabling GSWC to record  $3.2 million of water rights lease revenuesfrom the City of Folsom from January 2004 to September 2006. Prior to this decision,the apportionment of any lease revenues that GSWC collected in 2004 and 2005,totaling $2.3 million, had been included in a regulatory liability account andno amounts were recognized as revenues until regulatory uncertainties aboutthis matter were resolved. Registrant also recorded additional revenue of $909,000,reflecting the first, second and third quarters of the 2006 water rights leaserevenues. In addition, an increase of $2.8 million in revenues as compared tothe first nine months of 2005 reflects: (i) the recording of FBWS revenue ofapproximately $768,000 during the nine months ended September 30, 2006 based onthe percentage of completion method of accounting for contract revenuerecognition for several projects at Fort Bliss; and (ii) additional revenuestotaling $2.0 million generated from operating the water and wastewater systemsat Andrews Air Force Base which began operation on February 1, 2005, at FortEustis, Fort Monroe and Fort Story all of which began operation on April 3,2006, and the wastewater systems at Fort Lee which began operation on February23, 2006.

 

***Operating Expenses***

 

For the nine months ended September 30, 2006, purchasedwater costs decreased by 4.0% to $34.3 million compared to $35.7 million forthe nine months ended September 30, 2005. The decrease is due primarily to achange in the supply mix caused by less purchased water needed to replacegroundwater supply lost in 2005. For the nine months ended September 30, 2006,44.8% of Registrant’s supply mix was purchased water as compared to 47.2%purchased water for the nine months ended September 30, 2005. During the sameperiod last year, there were additional purchases of water needed to replacegroundwater supply, due to wells being removed from service. The wells wereremoved from service in 2005 as a result of water quality issues and mechanicalproblems, particularly in GSWC’s Foothill district. The cost of purchased waterin this district decreased by approximately $1.7 million as a result of thewells being returned to operation in 2006. This decrease was partially offsetby an increase in customer demand resulting from higher consumption andincreased water rates by purchased water suppliers.

 

For the nine months ended September30, 2006, the cost of power purchased for pumping increased by 10.1% to $7.6million compared to $6.9 million for the nine months ended September 30, 2005due to an increase in KWh usage by Registrant caused by higher customer waterdemand and an increase in pumping volume due to the supply mix change discussedabove.

 

For the nine months ended September 30, 2006, groundwaterproduction assessments increased by 11.8% to $6.8 million as compared to $6.1million for the nine months ended September 30, 2005 due to increases in wellproduction to meet higher customer demand. There were also increases inassessment rates levied against groundwater production, effective July 2005 and2006. Average pump tax rates increased in Regions II and III in July 2006 byapproximately 2% and 4%, respectively, and 5% and 20% in July 2005,respectively.

 

Changes in the waterresource mix between water supplied from purchased sources and that suppliedfrom Registrant’s own wells can increase/decrease actual supply-related costsrelative to that approved for recovery through rates, thereby impactingearnings either negatively or positively.

 

For the nine months ended September30, 2006, cost of power purchased for resale to customers in GSWC’s Bear ValleyElectric division increased by 5.5% to $10.5 million compared to $9.9 millionfor the nine months ended September 30, 2005, primarily reflecting highercustomer demand during the nine months ended September 30, 2006.

 

Unrealized loss (gain) onpurchased power contracts represents losses and gains recorded for GSWC’spurchased power agreements with PWCC, which qualify as derivative instrumentsunder SFAS No. 133, *“Accounting for DerivativeInstruments and Hedging Activities”*. The $5.9 million pretaxunrealized loss on purchased power contracts for the nine months ended September30, 2006 is due to a decrease in the current forward

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market prices sinceDecember 31, 2005. There was a $7.5 million pretax unrealized gain on purchasedpower contracts for the nine months ended September 30, 2005. Unrealized gainsand losses at Bear Valley Electric will continue to impact earnings during thelife of the contract with PWCC, which terminates in 2008.

 

A decrease of $1.1 millionduring the nine months ended September 30, 2006 in the provision for supplycost balancing accounts as compared to the nine months ended September 30, 2005was primarily due to: (i) the recording of a $247,000 refund received in May2005 from Mirant with no corresponding amount booked in the same period of2006; (ii) the recording of a $2.7 million under-collection in the second andthird quarter of 2006 related to the 2006 year-to-date supply cost memorandumaccount resulting from the elimination of the earnings test by the CPUC inApril 2006, and (iii) the recording in April 2006 of an additional $181,000under-collection for 2005’s supply cost memorandum account due to theelimination by the CPUC of the earnings test. These decreases were offset by:(i) the approval by the CPUC and recording in September 2005 of $1.3 millionunder-collection related to Region III’s 2004 supply cost memorandum account,and (ii) an increase of $884,000 in the amortization of water supply costbalancing accounts approved by the CPUC in June, August and September of 2005.

 

For the nine months ended September30, 2006, other operating expenses increased by 14.0% to $17.3 million comparedto $15.1 million for the nine months ended September 30, 2005 due primarily tohigher operating expenses of $1.2 million at ODUS and TUS due to thecommencement of operation of the water and wastewater systems at military basesin Maryland and Virginia. There was also a net increase of $1.3 million at GSWCprimarily due to: (i) a $459,000 downward adjustment in July of 2005reflecting the approval from the CPUC of previously incurred operating expensesin the Aerojet matter, previously discussed; (ii) higher chemicals and watertreatment costs of $386,000 at GSWC; (iii) approximately $292,000 of higherlabor costs as a result of higher wages at GSWC, and (iv) an increase of$248,000 in bad debt expense at GSWC relating to miscellaneous accountsreceivable balances. Theseincreases were partially offset by the increase in reimbursement of $560,000 fromthe U.S. Government and a contractor, for operating expenses incurred at FortBliss.  FBWS was separately hired by theU.S. Government as a subcontractor for certain related projects at the samebase. 

 

For the nine months ended September30, 2006, administrative and general expenses increased by 6.7% to $34.6million compared to $32.5 million for the nine months ended September 30, 2005 causedprimarily by higher administrative and general expenses of $804,000 at ODUS andTUS due to the commencement of operation of the water and wastewater systems atmilitary bases in Maryland and Virginia in early 2006.  This increase at ODUS and TUS is net of therecovery of transition period operating expenses of about $672,000 at these militarybases.  Other changes at ASUS includedecreases due to: (i) an increase of $284,000 in reimbursements by the U.S.Government of indirect costs incurred by FBWS, and (ii) lower outside servicesand other expenses at ASUS totaling $380,000. General and administrative expenses also increased by $2.0 million atGSWC primarily due to increases in: (i) pensions and benefits of $170,000 causedby actuarial assumption changes in the mortality tables, and increases ofapproximately $378,000 in various other benefit costs due primarily toincreases in medical and labor costs; (ii) stock-based compensation expense of$402,000 due to the adoption of SFAS No. 123(R) effective January 1, 2006; (iii)labor cost increases of $762,000 due to higher wages, and (iv) various otheroffice, supplies and rent expenses of $314,000. 

 

For the nine months ended September 30, 2006, depreciation and amortizationexpense increased by 22.3% to $19.7 million compared to $16.1 million for the ninemonths ended September 30, 2005 reflecting, among other things, the effects ofclosing approximately $100 million of additions to utility plant during 2005,depreciation on which began in January 2006.  In addition, there was a decrease indepreciation expense in 2005 resulting from the favorable CPUC decision on theAerojet matter, discussed previously, which ordered GSWC to restoreapproximately $1 million to the appropriate plant accounts and decreasedepreciation expense in July of 2005. There was no such adjustment in 2006. Registrant anticipates that depreciation expense will continue toincrease due to Registrant’s on-going construction program at its regulatedsubsidiaries. Registrant believes that depreciation expense related to propertyadditions approved by the appropriate regulatory agency will be recoveredthrough water and electric rates.

 

For the nine months ended September30, 2006, maintenance expense increased by 21.2% to $9.1 million compared to $7.5million for the nine months ended September 30, 2005 due principally to anincrease in required maintenance on GSWC’s wells and water supply sources atall Regions. There were also increases in well treatment and emergency repaircosts.  Furthermore, there was anincrease of: (i) $451,000 at GSWC’s electric division due to the new 8.4 MWnatural gas-fueled generation facility, and (ii) $175,000 at ODUS and TUS dueto the commencement of the operations of the water and wastewater systemspursuant to new military contracts in Maryland and Virginia. 

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For the nine months ended September30, 2006, property and other taxes increased by 7.9% to $7.7 million comparedto $7.1 million for the nine months ended September 30, 2005 reflectingadditional property taxes resulting from higher assessed values, and increasesin payroll taxes based on increased labor costs.

 

For the nine months ended September30, 2005, Registrant recorded a net pretax gain of $124,000 on the sale ofnon-utility property.  There was nosimilar gain in the same period of 2005.

 

 For the nine months ended September 30, 2005, Registrant also recorded anet pre-tax gain of $760,000 on a settlement reached with the Fountain HillsSanitary District (“FHSD”) in February 2005 for the capping of two CCWC wellsin order to facilitate FHSD’s ability to secure certain permits. Pursuant tothe settlement agreement, CCWC agreed to permanently remove from service andcap one of its wells, and cap another well which had never been used as apotable source of supply. There was no similar gain in the same period of 2006.

 

***Interest Expense***

 

For the nine months ended September30, 2006, interest expense increased $6.7 million during the nine months endedSeptember 30, 2006 as compared to the same period in 2005 reflecting primarilythe approval from the CPUC in 2005 for the recovery of previously incurred andexpensed interest costs totaling $5.1 million in the Aerojet memorandumaccount, discussed previously.   In addition, the increase also reflects increasesin long-term debt interest expense of $1.8 million primarily due to theplacement of $40.0 million of notes in October 2005 coupled with increases inshort-term bank loan interest rates. Partially offsetting this increase was adecrease in short-term cash borrowings. Average bank loan balances outstandingunder an AWR credit facility for the nine months ended September 30, 2006 wereapproximately $28.2 million, as compared to an average of $48.6 million duringthe same period of 2005. 

 

***Interest Income***

 

For the nine months ended September30, 2006, interest income increased by 230% to $2.6 million compared to$801,000 for the nine months ended September 30, 2005 due primarily to: (i) interest accrued on theuncollected balance of the Aerojet litigation memorandum account authorized bythe CPUC of $1.1 million; (ii) interest income of $381,000 related to a $3.0million Internal Revenue Service refund received in May 2006; (iii) interestincome totaling $345,000 earned from the U.S. Government for costs incurred oncapital upgrade projects at Andrews Air Force Base, and (iv) interest earned on short-term cash surplus. Theseincreases were partially offset by the recognition in July 2005 of approximately$607,000 in interest income earned on the $8.0 million Aerojet long-term notereceivable.  The recording of theinterest income had been deferred pending the final CPUC decision on theAerojet matter.  Registrant has sincebeen recording the interest income on the $8.0 million Aerojet long-term notereceivable on a monthly basis. 

 

***Income Tax Expense***

 

For the nine months endedSeptember 30, 2006, income tax expense decreased by 34.3% to $12.1million compared to $18.4 million for the nine months ended September 30,2005 due, in part, to a decrease in pretax income of 25.7%.  Inaddition, the decrease was as a result of flow-through adjustments and a refundclaim, as discussed further, below. The ETR for the nine months endedSeptember 30, 2006 decreased by approximately 5.3 percentage pointsto 40.5% as compared to a 45.8% ETR applicable to the nine months ended September 30,2005. The variance between the ETR and the statutory tax rate is primarily theresult of differences between book and taxable income that are treated asflow-through adjustments in accordance with regulatoryrequirements. Flow-through adjustments increase or decrease tax expense inone period, with an offsetting increase or decrease occurring in anotherperiod. During the second quarter of 2005, the recognition of the federaleffect of state taxes was adjusted to conform to the flow-through methodreflected in the tax calculation for ratemaking purposes, which partiallydefers the recognition of the effect to the subsequent tax year. This reducedincome tax expense by $171,000 for the nine months ended September 30,2006. During the third quarter of 2005, AWR filed an amended tax return for2001 with the Internal Revenue Service (“IRS”) which was subject to IRS andCongressional Joint Committee of Taxation (“JCT”) review. During the secondquarter of 2006, the IRS and JCT reviews were completed and AWR received arefund in the amount of its original claim of $3.0 million, with interest. Consequently,in the second quarter of 2006, AWR recorded a tax benefit of $400,000, of which$351,000 was attributable to GSWC. The refund-claim benefit contributed to 1.3 ofthe 5.3 percentage point ETR reduction referred to, above. 

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**CriticalAccounting Policies and Estimates**

 

Critical accountingpolicies and estimates are those that are important to the portrayal of AWR’sfinancial condition, results of operations and cash flows, and require the mostdifficult, subjective or complex judgments of AWR’s management. The need tomake estimates about the effect of items that are uncertain is what makes thesejudgments difficult, subjective and/or complex. Management makes subjectivejudgments about the accounting and regulatory treatment of many items. Thesejudgments are based on AWR’s historical experience, terms of existingcontracts, and AWR’s observance of trends in the industry, information providedby customers and information available from other outside sources, asappropriate. Actual results may differ from these estimates under differentassumptions or conditions.

 

Thecritical accounting policies used in the preparation of the Registrant’sfinancial statements that we believe affect the more significant judgments andestimates used in the preparation of our consolidated financial statementspresented in this report are described in *“Management’s Discussionand Analysis of Financial Condition and Results of Operations”*included in our Annual Report on Form 10-K for the year endedDecember 31, 2005. Except for the adoption of SFAS No. 123(R), *“Share-Based Payment”*, there have been no material changesto the critical accounting policies. Effective January 1, 2006, Registrantbegan accounting for employee and directors stock-based compensation costs inaccordance with SFAS No. 123(R) which requires the recognition of compensationexpense in the financial statements based on fair values of the stock awards. Registrantelected to adopt the modified prospective transition method as provided by SFASNo. 123(R) and, accordingly, financial statement amounts for the prior periodspresented in the Form 10-Q have not been restated to reflect the fair valuemethod of expensing share-based compensation. Registrant utilized theBlack-Scholes option pricing model to estimate the fair value of employee stockbased compensation at the date of grant, which requires the input of highlysubjective assumptions, including expected volatility and expected life. Further,as required under SFAS No. 123(R), Registrant now estimates forfeitures foroptions granted, which are not expected to vest. The cumulative effect ofadopting the change in estimating forfeitures is not material to Registrant’sfinancial statements for the nine months ended September 30, 2006. Changes inthese inputs and assumptions can materially affect the measure of estimatedfair value of Registrants share-based compensation. The adoption of SFAS No.123(R) did not have a material affect on Registrant’s consolidated financialposition, results of operations and cash flows for the three and nine monthsended September 30, 2006.

 

**Liquidity and Capital Resources**

 

***AWR***

 

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

 

Net cash provided by operating activities was $45.6million for the nine months ended September 30, 2006 as compared to $45.2million for the same period ended September 30, 2005. The slight increase of $0.4 millionwas primarily attributable to higher net income after adjustments for non-cashitems, which increased cash flows from operating activities by $7.5million.  This increase was offset by thetiming of cash receipts and disbursements related to working capital items, inparticular the decrease in cash flows from operating activities of $5.1 millionin income taxes receivable/payable resulting from the receipt of a $3.0 millionfederal tax refund received in May 2006 as compared to a $5.0 million federaltax refund in April 2005 as well as differences in the timing of remittingtaxes which resulted in additional taxes paid during the nine months ended September30, 2006 as compared to same period in 2005. 

 

Net cash used ininvesting activities decreased slightly to $51.1 million for the nine monthsended September 30, 2006 as compared to $52.0 million for the same period endedSeptember 30, 2005.

 

Net cash used in financingactivities was $1.0 million for the nine months ended September 30, 2006 ascompared to net cash provided by financing activities of $8.2 million for thesame period in 2005. The decrease in net cash provided by financing activitieswas primarily caused by a decrease of about $3.6 million in advances for and contributionsin aid of construction and a $12.0 million net decrease in notes payable tobanks. These decreases were offset by a $5.2 million increase in proceeds fromstock option exercises and the issuance of Common Shares under the Registrant’sCommon Share Purchase and Dividend Reinvestment Plan and 401(k) Plan. Cashflows from financing activities also increased by $1.1 million from the taxbenefits associated with the exercise of stock options.

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Registrant haspaid common dividends for 75 consecutive years. On October 27, 2006, AWR declared a regular quarterly dividendof $0.235 per Common Share. The dividend, totaling approximately $4.0million, will be paid onDecember 1, 2006 to common shareholders of record at the close of business on November10, 2006. During the nine months ended September 30, 2006 and 2005, AWR paidquarterly dividends to shareholders, totaling approximately $11.4 million or$0.675 per share and $11.3 million or $0.675 per share, respectively. AWR’sability to pay cash dividends on its Common Shares outstanding dependsprimarily upon cash flows from GSWC.  AWRpresently intends to continue paying quarterly cash dividends in the future, onMarch 1, June 1, September 1 and December 1, subject to earnings and financialcondition, regulatory requirements and such other factors as the Board ofDirectors may deem relevant.

 

In June 2005, AWRamended and restated its credit agreement which increased its borrowing limitunder this facility to $85 million and extended the maturity date to June 2010.Up to $20 million of this facility may be used for letters of credit. As of September30, 2006, an aggregate of $25.0 million in cash borrowings were included incurrent liabilities and approximately $11.2 million of letters of credit wereoutstanding under this facility. In August 2006, AWR filed a RegistrationStatement with the Securities and Exchange Commission for the sale from time totime of debt and equity securities. As of September 30, 2006, approximately $156.5million was available for issuance under this Registration Statement.

 

Registrantanticipates that interest costs will increase in future periods due topotential market interest rate increases and the need for additional externalcapital to fund its construction program. In December of 2005, S&P revisedAWR’s rating from A- negative to A- stable. S&P debt ratings range from AAA(highest rating possible) to D (obligation is in default). Securities ratingsare not recommendations to buy, sell or hold a security and are subject to changeor withdrawal at any time by the rating agency. Registrant believes that costsassociated with capital used to fund construction at its regulated subsidiarieswill continue to be recovered in water and electric rates charged to customers.

 

***GSWC***

 

Net cash provided by operating activities was $47.7million for the nine months ended September 30, 2006 as compared to $47.2million for the same period in 2005. The slight increase of $0.5 millionwas primarily attributable to higher net income after adjustments for non-cashitems, which increased cash flows from operating activities by approximately$6.5 million.  This increase was offsetby higher general rate case costs, lower tax refunds received in 2006 ascompared to the same period in 2005 as well as differences in the timing ofremitting taxes, and the timing of cash receipts and disbursements related to otherworking capital items. 

 

Net cash used in investing activities increasedslightly to $49.5 million for the nine months ended September 30, 2006 ascompared to $48.8 million for the same period in 2005.

 

Net cash used byfinancing activities was $4.4 million for the nine months ended September 30,2006 as compared to net cash provided by financing activities of $3.0 millionfor the same period in 2005. The decrease reflects a $2.9 million decrease inthe receipt of advances for and contributions in aid of construction, and a netdecrease of $4.8 million in intercompany borrowings.

 

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

 

GSWC also relies on external sources, including equityinvestments and short-term borrowings from AWR, long-term debt, contributionsin aid of construction, advances for construction and install-and-conveyadvances to fund the majority of its construction expenditures. GSWC has aRegistration Statement on file with the SEC for issuance from time to time, ofup to $100.0 million of debt securities. As of September 30, 2006, $50.0million remained for issuance under this Registration Statement, subject toregulatory approval from the CPUC for issuance of additional debt.

 

On October 11, 2005,CoBank, ACB purchased a 5.87% Senior Note due December 20, 2028 in theaggregate principal amount of $40.0 million from GSWC. The proceeds were usedto pay down GSWC’s intercompany short-term borrowings.

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In February 2005,Moody’s Investor Services (“Moody’s”) changed the rating outlook for $175million of senior unsecured debt at GSWC from A2 negative to A2 stable. Moody’sdebt ratings range from Aaa (best quality) to C (lowest quality). In December2005, S&P changed its debt rating for GSWC from A- negative to A- stable. Securitiesratings are not recommendations to buy, sell or hold a security and are subjectto change or withdrawal at any time by the rating agency.

 

***CCWC***

 

CCWC funds the majority of its operating expenses, paymentson its debt and dividends, if any, through internal operating sources orshort-term borrowings from AWR. CCWC also relies on external sources, includinglong-term debt, contributions in aid of construction, advances for constructionand install-and-convey advances, to fund the majority of its constructionexpenditures.

 

***ASUS***

 

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

 

**Contractual Obligations and Other Commitments**

 

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

 

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

 

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

 

**Regulatory Matters**

 

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

 

Rates that GSWC and CCWC are authorized to charge aredetermined by the CPUC and the ACC, respectively, in general rate cases and arederived using rate base, cost of service and cost of capital, as projected fora future test year in California and using an historical test year, asadjusted, in Arizona. Rates charged to customers vary according to customerclass and rate jurisdiction and are generally set at levels allowing forrecovery of prudently incurred costs, including a fair return on rate base.Rate base generally consists of the original cost of utility plant in service,plus certain other assets, such as working capital and inventory, lessaccumulated depreciation on utility plant in service, deferred income taxliabilities and certain other deductions.

 

GSWCis required to file a general rate case (“GRC”) application every three yearsfor each of its water rate-making areas according to a schedule established bythe CPUC. GRCs typically include an increase in year one and step increases forthe second and third years. Rates are based on a forecast of expenses andcapital investments. GRCs have a typical regulatory processing time of oneyear. In California, rates may be increased by offsets for certain expenseincreases, including but not limited to supply cost offset and balancingaccount amortization, and advice letter filings related to certain plantadditions and other operating cost increases. Offset rate increases and adviceletter filings typically have a two to four month regulatory lag.

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Neitherthe operations nor rates of AWR and ASUS are directly regulated by the CPUC orthe ACC. The CPUC and the ACC do, however, regulate certain transactions betweenGSWC and CCWC and their affiliates.

 

Theamounts charged by the subsidiaries of ASUS for water and wastewater servicesat military bases are based upon the terms of 50-year contracts with the U.S.Government. Prices will be re-determined at the end of two years aftercommencement of operations at each military base and generally every threeyears thereafter. In addition, prices may be equitably adjusted for changes inlaw, wage and benefit increases and other circumstances.

 

***RecentChanges in Rates***

 

On January12, 2006, the CPUC approved GSWC’s Region III rate case. The authorized rateincrease for 2006 was made effective January 19, 2006 and is expected toprovide GSWC additional annual revenue approximating $5.4 million in 2006 basedon a return on equity of 9.8%. For the second and the third years of thisthree-year GRC, the CPUC approved an annual increase of approximately $1.9million and $2.3 million, respectively, subject to certain earnings tests.

 

On November 14, 2005, GSWC filed advice letters withthe CPUC for step increases for Region I in an amount of approximately $0.6million and an attrition increase of approximately $5.2 million for Region II,both of which were approved and became effective on January 1, 2006.

 

***Pending Rate Changes in2006***

 

In February 2006, GSWC filed an application with theCPUC for rate increases in Region II and to cover general office expenses atthe Corporate Headquarters. In the filing, GSWC requested rate increases whichare expected to generate approximately $14.9 million in annual revenuesstarting in 2007, with additional increases of $4.7 million in 2008 and $6.9million in 2009. A decision on this application is expected in late 2006. Managementis unable to predict the ultimate outcome of this rate case.

 

***OtherRegulatory Matters***

 

*New Service TerritioryApplication*

 

GSWC has entered into awater transfer agreement with Natomas for 30,000 acre-feet of water to be usedexclusively by GSWC to serve Sutter County, California. GSWC filed for aCertificate of Public Convenience and Necessity with the CPUC on May 31, 2006to provide retail water service in a portion of Sutter County, California. CPUCreview of the application is pending, subject to completion of an environmentalassessment.

 

*Finance Application*

 

InOctober of 2006, GSWC filed with the CPUC an application requestingauthorization for it to issue, sell and deliver by publicoffering or private placement securities not exceeding $200.0 million inaggregate offering amount, said securities consisting of, but not limited to,common shares and preferred shares, bonds, debentures, medium-term notes,loans and tax exempt debt.  GSWC will usethe net proceeds to first pay down all or a portion of its then outstandingshort-term debt, fund its construction expenditures, and acquire utilityproperties.

*State-WideRate Application*

 

In September 2006,GSWC filed an application with the CPUC for authority to implement changes incertain ratemaking mechanisms and reallocation of rates within its entireservice territory in California.  The application requests authority fromthe CPUC to implement certain rate setting mechanisms, including the following:

 

·                                          Establishment of a Water QualityMemorandum Account or Water Quality Compliance Offset Account to, among otherthings, permit full recovery of costs relating to water quality compliance.

·                                          Measures to encourage and support watersupply planning and investment.

·                                          Changes to existing GSWC water shortageor emergency procedures and mandatory conservation and rationing penalties.

·                                          Establishment of an Infrastructure SystemReplacement Surcharge to encourage and support infrastructure replacementneeds.

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·                                          To eliminate disincentives to conservewater and eliminate fluctuations in revenues due to weather, the establishmentof a Water Revenue Adjustment Mechanism to decouple sales from revenues.

·                                          Consolidation of GSWC’s existing offsetbalancing accounts, allowance for full cost recovery of supply offset costs,and elimination of a related earnings test.

·                                          Establishment of an increasing block ratestructure to promote water conservation and rates that more accurately reflectthe value of service.

·                                          Consolidation of GSWC’s existingratemaking districts into a state-wide, single tariff price rate structure toencourage and support long-term rate stability and affordability. 

·                                          Measures to provide appropriateincentives and procedures to carry out the Commission's objective ofconsolidation of non-viable water companies.

 

GSWC’s overallrevenues are not intended to increase or decrease as a result of thisApplication.

 

*MemorandumSupply Cost Accounts*

 

In a CPUC decision issued on June 19, 2003 related tomemorandum supply cost accounts, all water utilities regulated by the CPUC wererequired to seek review of under- and over- collections by filing an adviceletter annually. In addition, the utility’s recovery of such expenses wasreduced by the amount exceeding the authorized rate-of return (earnings test).On April 13, 2006, the CPUC issued a decision to remove these requirements.Pursuant to this order, GSWC recognized a cumulative under-collection ofapproximately $636,000 to the supply cost memorandum account provisions in thesecond quarter of 2006 for the under-collected balances not recognized at March31, 2006 and began recording under- and over- collections on a monthly basisthereafter.  

 

GSWC intends to file for recovery of the netunder-collected supply costs with the CPUC in 2006 or in subsequent generalrate case proceedings. GSWC filed advice letters in October 2006 for a $1.7million increase in supply cost and recovery of $2.0 million of previouslyunder-collected supply cost  for GSWC’s RegionI, for a total revenue increase of $3.7 million.  Management believes that it is probable thatthe CPUC will permit GSWC to recover in rates the net under-collections insupply costs.

 

*Santa Maria Groundwater Basin Adjudication*

 

In 1997, the Santa Maria Valley Water ConservationDistrict (“plaintiff”) filed a lawsuit against multiple defendants, includingGSWC, the City of Santa Maria, and several other public water purveyors. Theplaintiff’s lawsuit seeks an adjudication of the Santa Maria GroundwaterBasin. A settlement of the lawsuit has been reached, subject to CPUC approval.The settlement, among other things, if approved by the CPUC, would preserveGSWC’s historical pumping rights and secure supplemental water rights for usein case of drought or other reductions in the natural yield of the Santa MariaBasin. There are also a small number of nonsettling parties, and the case isgoing forward as to their claims. The stipulation, if approved, wouldpreserve GSWC’s position with the settling parties independent of the outcomeof the case as it moves forward with the nonsettling parties. GSWC can notpredict the outcome of the case as to the nonsettling parties.

 

As of September 30, 2006, GSWC has incurred costs ofapproximately $6.3 million in defending its rights in the Santa MariaBasin, including legal and expert witness fees, which have been recorded inUtility Plant for rate recovery. In February 2006, GSWC filed for recovery ofthese costs with the CPUC. Management believes that the recovery of these coststhrough rates is probable. 

 

*Refund of Water Rights Lease Revenues*

 

In 1994, GSWC enteredinto a contract to lease to the City of Folsom 5,000 acre-feet per year ofwater rights from the American River. GSWC included all associated revenues ina nonoperating income account. In a decision issued on March 16, 2004, the CPUCordered GSWC to refund 70 percent of the total amount of lease revenuesreceived since 1994, plus interest, to customers. On April 13, 2006, the CPUCauthorized GSWC to reinvest all lease revenues received from the City of Folsomsince January, 2004, inclusive of the balances in the regulatory liabilityaccounts, in water system infrastructure and to include such investments in therate base upon which GSWC earns a rate of return. As a result, GSWC transferredabout $2.3 million of water rights lease revenues received from the City ofFolsom in 2004 and 2005 from the regulatory liability account into income andrecorded an additional pretax income of $311,000 and $909,000 reflecting thethree and nine months ended September 30, 2006, respectively, water rightslease revenues.

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*Recovery of cost of tree removal and mitigation forBark Beetle Infestation*

 

In a Proclamation issued on March 7, 2003 former Governor Gray Davisdeclared a State of Emergency with respect to a severe fire risk caused by deadand dying trees plagued by drought and a major bark beetle infestation in thecounties of Riverside, San Bernardino, and San Diego. On April 3, 2003, theCPUC issued an order requiring Southern California Edison Company, San DiegoGas & Electric Company and Bear Valley Electric to take all reasonable and necessaryactions to mitigate the increased fire hazard by removing dead, dying ordiseased trees from falling or contacting distribution and transmission lineswithin their rights of way and to ensure compliance with existing vegetationclearance statutes and regulations. The utilities, including Bear ValleyElectric, are authorized to make annual advice letter filings requestingrecovery of the costs of complying with this order. On April 13, 2006, the CPUCapproved GSWC’s request for the amortization of about $351,000 for costsincurred through June 30, 2005 plus interest in the Bark Beetle CatastrophicEvent Memorandum Account. At September 30, 2006, approximately $596,000, whichincludes the $351,000, has been incurred and is recorded as a regulatory asseton the balance sheets.

 

*Outside Services MemorandumAccount*

 

In April 2006, the CPUCapproved GSWC’s Region II advice letter which requested recovery of theexpenses recorded in the Outside Services Memorandum Account (“OSMA”), as ofDecember 31, 2005. The decision authorized the recovery of this memorandumaccount to record costs incurred while working with the Water ReplenishmentDistrict (“WRD”), WRD Technical Advisory Committee, Central and West BasinMunicipal Water Districts, Metropolitan Water District, West Basin WaterAssociation and Central Basin Water Association on water supply reliability andrate-related issues in Region II. GSWC incurred approximately $374,000 and$345,000 in the OSMA in 2004 and 2005, respectively. GSWC sought and receivedauthorization to amortize the cumulative total of approximately $719,000 over a12-month period through customer rates. Accordingly, GSWC recorded a regulatoryasset for this amount in April of 2006 with an offset and reduction to outsidelegal services during the second quarter of 2006. A surcharge went into effectin April of 2006 and accordingly, GSWC began amortizing the OSMA account.Revenues of approximately $200,000 and $304,000 were received from customersduring the three and nine months ended September 30, 2006, respectively,relating to this surcharge. The surcharge will be in effect over a 12-monthperiod.

 

**Environmental Matters**

 

Registrant’s subsidiaries are subject to increasinglystringent environmental regulations including the 1996 amendments to theFederal Safe Drinking Water Act; enhanced surface water treatmentrules; regulation of disinfectant/disinfection by-products; the long-term enhanced surface watertreatment rules; ground water treatmentrule; contaminant regulation of radon and arsenic; and unregulatedcontaminants monitoring rule.

 

Additionalinformation on these requirements and other significant environmental mattersare described in *“Management’s Discussion and Analysis of**Financial Condition and Results of Operation”*included in our 2005 Annual Report on Form 10-K for the year endedDecember 31, 2005. 

 

In 1998, the South CoastAir Quality Management District (“AQMD”) issued a permit to GSWC for theinstallation and use of air stripping equipment at one of GSWC’s groundwater treatmentsystems in its Region II service area.  In 2005, the AQMD conducted an inspection of this facility and issued aNotice of Violation (“NOV”) for exceeding the amount of groundwater permittedto be treated by the treatment system during calendar year 2004.  Since receiving the NOV, changes in GSWCprocedures have prevented additional violations at the facility.  The AQMD could assess penalties associatedwith an NOV that can range from $10,000 up to $75,000 per day ofviolation.  GSWC estimates that it was inviolation approximately 180 days in 2004. GSWC has met with AQMD to ensure future compliance and resolve theNOV.  As part of this, GSWC also promptlysubmitted an application to amend the permit as an amendment may have beennecessary for continued operation of the subject air stripping equipment.

 

The AQMD has recentlyrecommended that GSWC be allowed to pursue a Supplemental Environmental Program(“SEP”) as part of the settlement of the NOV. A SEP typically involves capitalexpenditures resulting in a change of process, equipment, material, or indirectsource reduction for the purposes of eliminating or reducing air contaminantemissions.  As part of going forward withits permit amendment application, GSWS would amend its current application toalso include the addition of additional controls to the facility to reduceemissions.  The 

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penalties which GSWC hasbeen informed might be assessed, could likely be reduced or avoided through thesettlement of this matter based on the possible funding of a SEP.  In October 2006, GSWC submitted initialcapital cost estimates to the AQMD for the installation and operation ofgranular activated carbon filters at the facility as a proposed SEP which wouldeliminate the use of the air stripping equipment.  Initial discussions indicate that AQMD staffhas favorably received GSWC’s proposal and if approved, it could result in theimposition of only a nominal monetary penalty. However, until further notice from the AQMD on the proposed SEP, GSWCcannot reasonably estimate the amount of penalties which might beassessed.  

 

There have been noother material changes in any of the environmental matters discussed in theForm 10-K since December 31, 2005.

 

**Water Supply**

 

The adequacy of Registrant’s water supplies vary fromyear to year depending upon a variety of factors, including rainfall,availability of Colorado River water and imported water from northernCalifornia, the amount of water stored in reservoirs and groundwater basins,the amount of water used by Registrant’s customers and others, water qualityand legal limitations on use.

 

Population growthand increases in the amount of water used have increased limitations on use inorder to prevent over-drafting of groundwater basins. The importation of waterfrom the Colorado River, one of GSWC’s important sources of supply, is expectedto decrease in future years due to the requirements of the Central ArizonaProject (“CAP”) and other limitations on the amount of water that theMetropolitan Water District of Southern California (“MWD”) is entitled to takefrom the Colorado River. MWD is expected to increase its efforts to secureadditional supplies from conservation, desalination and water exchanges withthe agricultural water users.

 

CCWC obtains itswater supply from operating wells and from the Colorado River through the CAP.CCWC’s water supply may be subject to interruption or reduction if there is aninterruption or reduction in CAP water. In addition, CCWC’s ability to providewater service to new real estate developments is dependent upon its ability tomeet the requirements of the Arizona Department of Water Resources regardingits assured water supply account.

 

The U.S.Government is responsible for supplying water on military bases under the termsof contracts of the subsidiaries of ASUS with the U.S. Government.

 

**NewAccounting Pronouncements**

 

Registrantis subject to newly issued requirements as well as changes in existingrequirements issued by the Financial Accounting Standards Board. See Note 1included in the *Notes to Consolidated Financial Statements*for disclosure on new accounting pronouncements.

 

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

 

Registrantis exposed to certain market risks, including fluctuations in interest rates,and commodity price risk primarily relating to changes in the market price ofelectricity. Market risk is the potential loss arising from adverse changes inprevailing market rates and prices. Therehave been no material changes regarding Registrant’s market risk position fromthe information provided in its Annual Report on Form 10-K for the year endedDecember 31, 2005. The quantitative and qualitative disclosures about marketrisk are discussed in *Item 7A-Quantitative andQualitative Disclosures About Market Risk*, contained in Registrant’sAnnual Report on Form 10-K.

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**Item 4. Controls and Procedures**

 

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

 

As required byRule 13a-15(b) under the Securities and Exchange Act of 1934 (the“Exchange Act”), we have carried out an evaluation, under the supervision andwith the participation of our management, including our Chief Executive Officer(“CEO”) and our Chief Financial Officer (“CFO”), of the effectiveness, as ofthe end of the fiscal quarter covered by this report, of the design andoperation of our “disclosure controls and procedures” as defined inRule 13a-15(e) and 15d-15(e) promulgated by the Securities and ExchangeCommission (SEC) under the Exchange Act. Based upon that evaluation, the CEOand the CFO concluded that disclosure controls and procedures, as of the end ofsuch fiscal quarter, were adequate and effective to ensure that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms and that such information isaccumulated and communicated to our management, including our CEO and CFO, asappropriate to allow timely decisions regarding required disclosure.

 

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

 

Therehas been no change in our internal control over financial reporting during thequarter ended September 30, 2006, that has materially affected or is reasonablylikely to materially affect our internal control over financial reporting.

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**PART II**

 

**Item 1.Legal Proceedings**

 

Anofficer of the Company has asserted a potential claim against the Company forretaliation against the officer and others in connection with alleged discriminatoryconduct by the Company and its Board of Directors. Although management believesthat the allegations are without merit and intends to vigorously defend againstthem, the Company retained an independent investigator to review theallegations and investigate the facts. Based upon the results of suchinvestigation, the Company does not believe, but can give no assurance, thatthe ultimate resolution of this mater will have a material adverse effect onits financial position, results of operations, or cash flows.

 

There have been no materialdevelopments in any of the legal proceedings described in our 2005 AnnualReport on Form 10-K.

 

Registrantis subject to ordinary routine litigation incidental to its business. Otherthan those disclosed in this section and in the Notes to the ConsolidatedFinancial Statements in Registrant’s Form 10-K for the year ended December 31,2005, no other legal proceedings are pending, which are believed to bematerial. Management believes that rate recovery, proper insurance coverage andreserves are in place to insure against property, general liability andworkers’ compensation claims incurred in the ordinary course of business.

 

**Item 1A.Risk Factors**

 

Therehave been no significant changes in the risk factors disclosed in our 2005Annual Report on Form 10-K.

 

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

 

The shareholders of AWR haveapproved the material features of all equity compensation plans under which AWRdirectly issues equity securities. AWR did not directly issue any unregisteredequity securities during the third quarter of 2006.

 

The following table providesinformation about repurchases of Common Shares by AWR during the third quarterof 2006:

 
| **Period**             | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs**(1) | ** ** | **Maximum Number  of Shares That May  Yet Be Purchased  under the Plans or  Programs** | ** ** |
|------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1 – 31, 2006 |       | 891                                                  | (2)        | $                                                | 36.64      |                                                                                                                                | —     |                                                                                                                                | NA(3)      |   |
| August 1 - 31, 2006    |       | 80                                                   | (2)        | $                                                | 37.50      |                                                                                                                                | —     |                                                                                                                                | NA(3)      |   |
| September 1 - 30, 2006 |       | 57                                                   | (2)        | $                                                | 38.07      |                                                                                                                                | —     |                                                                                                                                | NA(3)      |   |
| Total                  |       | 1,028                                                |       | $                                                | 36.79      |                                                                                                                                | —     |                                                                                                                                | NA(3)      |   |

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(1)      None of the Common Shareswere purchased pursuant to any publicly announced stock repurchase program.

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

(3)      None of these plans containa maximum number of Common Shares that may be purchased in the open marketunder the plans.

 

**Item 3. Defaults UponSenior Securities**

 

None

 

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

 

No items were submitted during thethird quarter of the 2006 fiscal year covered by this report to a vote ofsecurity holders through the solicitation of proxies or otherwise.  

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**Item 5.Other Information**

 

(a) On October 27, 2006, the Boardof Directors of Registrant declared a regular quarterly dividend of $0.235 percommon share. The dividend will be paid December 1, 2006 to shareholders ofrecord as of the close of business on November 10, 2006.

 

Mr. Gary King was electedas a Class II director of the Company, effective November 7, 2006 with a termexpiring at the annual meeting of the Company in 2008 and as a director of two ofits subsidiaries, Golden State Water Company and Chaparral City Water Company,with a term expiring on the date of the annual meeting of each of thesesubsidiaries in 2007. There is no arrangement or understanding pursuant towhich Mr. King was elected a director. Mr. King was also named as a member ofthe Audit and Finance Committee of the Board of Directors of the Company. 

 

Under the terms ofthe  Company’s Amended 2003 Non-EmployeeDirectors Stock Plan, Mr. King was automatically granted an option to purchase3,000 of the Common Shares of the Company at an exercise price of $36.63 pershare, effective on the date of his appointment as a director. Each option isexercisable upon the date of grant and will expire ten years after the date ofgrant, unless Mr. King’s services as a director are terminated for cause. Mr.King will be entitled to receive director and committee fees on the same basisas other directors, except that Mr. King’s retainer for service as a director forthe remainder of 2006, will be reduced to $3,333.33. The Board also approvedthe execution of an Indemnification Agreement with Mr. King in the same formexecuted by the Company with its other directors.   

 

TheCompany amended its bylaws on November 7, 2006 to increase the size of its Boardof Directors from six to seven.

 

(b) There have been no materialchanges during the third quarter of 2006 to the procedures by whichshareholders may nominate persons to the Board of Directors of AWR.

 

## **Item 6. Exhibits**

 

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

 

| 3.1    |   | Bylaws of American States Water Company, as amended (1)                                                               |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                  |
| 3.2    |   | Bylaws of Golden State Water Company, as amended (1)                                                                  |
|   |   |                                                                                                                  |
| 10.1   |   | Form of Non-Employee Director Stock Option Agreement  (1)  (3)                                                        |
|   |   |                                                                                                                  |
| 10.2   |   | Form of Indemnification Agreement for Directors (1) (3)                                                               |
|   |   |                                                                                                                  |
| 31.1   |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 for AWR (1)  |
|   |   |                                                                                                                  |
| 31.1.1 |   | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 for GSWC (1)      |
|   |   |                                                                                                                  |
| 31.2   |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 for AWR (1)  |
|   |   |                                                                                                                  |
| 31.2.1 |   | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 for GSWC (1) |
|   |   |                                                                                                                  |
| 32.1   |   | Certification of Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (2)          |
|   |   |                                                                                                                  |
| 32.2   |   | Certification of Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (2)          |

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(1)    Filed concurrently herewith

(2)    Furnished concurrently herewith

(3)    Compensatory benefit agreement

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**SIGNATURE**

 

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

 
|            | ** ** | **AMERICAN STATES WATER COMPANY  and its subsidiary  GOLDEN STATE WATER COMPANY** |
|------------|------------|-----------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                        | ** ** | ** ** |
| ** ** | ** ** | ** **                                                                        | ** ** | ** ** |
| ** ** | ** ** | **By:**                                                                           | ** ** | /s/ Robert J. Sprowls |
| ** ** | ** ** | ** **                                                                        | ** ** | Robert J. Sprowls |
| ** ** | ** ** | ** **                                                                        | ** ** | Senior Vice President-Finance, Chief Financial  Officer, Treasurer and Corporate Secretary |

 

 

Dated:November 8, 2006

 

 

52

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