Table of Contents

 

 

 

**UNITED STATES**

**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, 2009 |
|           |   |
| Or             |
|           |   |
| **o**          | **Transition report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|           |   |
|           | For the transition period from                       to |

 

**Commission File Number 0-8176**

 

 

(Exact nameof registrant as specified in its charter)

 

| **Delaware**                     | ** ** | **95-1840947**          |
|----------------------------------|------------|-------------------------|
| (State or  other jurisdiction of |       | (I.R.S.  Employer       |
| incorporation  or organization)  |       | Identification  Number) |

 

**One Wilshire Building**

**624 South Grand Avenue, Suite 2900**

**Los Angeles, California 90017-3782**

(Address ofprincipal executive offices, including zip code)

 

**(213) 929-1800**

(Registrant’stelephone, including area code)

 

**None**

(Former name,former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes **x**   No  **o**

 

Indicate by check mark whether theregistrant has submitted electronically and posted on its corporate website, ifany, every Interactive Data File required to be submitted and posted pursuantto Rule 405 of Regulation S-T (**§**232.405of this chapter) during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post suchfiles).    Yes  **o**    No  **o**

 

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. (Check one):

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

 

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the Act).Yes **o**   No **x**

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latestpracticable date.

 

|   | Class                                   |   | Outstanding  as of October 31, 2009 |   |
|--------|-----------------------------------------|--------|------------------------------------------|--------|
|   |                                    |   |                                     |   |
|   | Common  Stock, $.01 par value per share |   | 24,875,369  shares                       |   |

 

 

 

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Table of Contents

 

**TABLE OFCONTENTS**

 
| ** **       | ** **                                                                                                                               | **Page** |
|------------------|------------------------------------------------------------------------------------------------------------------------------------------|----------|
|             |                                                                                                                                     |     |
| **Part I**  | **Financial Information**                                                                                                                | **2**    |
|             |                                                                                                                                     |     |
| Item 1.          | Financial Statements                                                                                                                     | 2        |
|             |                                                                                                                                     |     |
|             | Condensed  Consolidated Balance Sheets (Unaudited) as of September 30, 2009 and  December 31, 2008                             | 2        |
|             |                                                                                                                                     |     |
|             | Condensed  Consolidated Statements of Operations (Unaudited) for the three and nine  months ended September 30, 2009 and 2008       | 3        |
|             |                                                                                                                                     |     |
|             | Condensed  Consolidated Statement of Changes in Stockholders’ Equity for the nine  months ended September 30, 2009 (Unaudited) | 4        |
|             |                                                                                                                                     |     |
|             | Condensed  Consolidated Statements of Cash Flows (Unaudited) for the nine months  ended September 30, 2009 and 2008                 | 5        |
|             |                                                                                                                                     |     |
|             | Notes  to the Condensed Consolidated Financial Statements (Unaudited)                                                                    | 6        |
|             |                                                                                                                                     |     |
| Item 2.          | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                              | 17       |
|             |                                                                                                                                     |     |
| Item 3.          | Quantitative and Qualitative  Disclosures About Market Risk                                                                              | 35       |
|             |                                                                                                                                     |     |
| Item 4.          | Controls and Procedures                                                                                                                  | 35       |
|             |                                                                                                                                     |     |
| **Part II** | **Other Information**                                                                                                                    | **39**   |
|             |                                                                                                                                     |     |
| Item 1.          | Legal Proceedings                                                                                                                        | 39       |
|             |                                                                                                                                     |     |
| Item  1A.        | Risk  Factors                                                                                                                            | 39       |
|             |                                                                                                                                     |     |
| Item  6.         | Exhibits                                                                                                                                 | 39       |
|             |                                                                                                                                     |     |
| **Signatures**   |                                                                                                                                     | **40**   |

 

 

1

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Table of Contents

 

# **PART I – FINANCIAL INFORMATION**

 

## **ITEM 1. FINANCIAL STATEMENTS**

**SOUTHWEST WATER COMPANY**

 

### **CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

 
| *** *** | ***(In  thousands)***                            | ** ** | ** ** | **September 30,  2009** | ** ** | ** ** | ** ** | **December 31,  2008** | ** ** | ** ** |
|--------------|--------------------------------------------------|------------|------------|------------------------------|------------|------------|------------|-----------------------------|------------|------------|
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | **ASSETS**                                       |       |       |                         |       |       |       |                        |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Current  Assets:                                 |       |       |                         |       |       |       |                        |       |       |
|         | Cash  and cash equivalents                       |       |       | $                            | 1,593      |       |       |                        | $          | 1,112      |   |   |
|         | Accounts  receivable, net                        |       |       | 33,990                       |       |       |       | 29,697                      |       |       |
|         | Prepaid  expenses and other current assets       |       |       | 25,387                       |       |       |       | 26,902                      |       |       |
|         | Total  current assets                            |       |       | 60,970                       |       |       |       | 57,711                      |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Property,  Plant and Equipment, net              |       |       | 315,440                      |       |       |       | 429,251                     |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Other  Assets:                                   |       |       |                         |       |       |       |                        |       |       |
|         | Goodwill                                         |       |       | 16,475                       |       |       |       | 17,652                      |       |       |
|         | Intangible  assets                               |       |       | 1,260                        |       |       |       | 1,666                       |       |       |
|         | Other  assets                                    |       |       | 21,919                       |       |       |       | 20,927                      |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Total  assets                                    |       |       | $                            | 416,064    |       |       |                        | $          | 527,207    |   |   |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | **LIABILITIES AND STOCKHOLDERS’ EQUITY**    |       |       |                         |       |       |       |                        |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Current  Liabilities:                            |       |       |                         |       |       |       |                        |       |       |
|         | Accounts  payable                                |       |       | $                            | 15,025     |       |       |                        | $          | 16,139     |   |   |
|         | Current  portion of long-term debt               |       |       | 2,176                        |       |       |       | 2,213                       |       |       |
|         | Other  current liabilities                       |       |       | 18,547                       |       |       |       | 28,370                      |       |       |
|         | Total  current liabilities                       |       |       | 35,748                       |       |       |       | 46,722                      |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Other  Liabilities and Deferred Credits:         |       |       |                         |       |       |       |                        |       |       |
|         | Long-term  debt, less current portion            |       |       | 153,472                      |       |       |       | 190,578                     |       |       |
|         | Deferred  income taxes                           |       |       | 27,099                       |       |       |       | 23,750                      |       |       |
|         | Advances  for construction                       |       |       | 8,882                        |       |       |       | 8,910                       |       |       |
|         | Contributions  in aid of construction            |       |       | 44,741                       |       |       |       | 117,113                     |       |       |
|         | Other  liabilities and deferred credits          |       |       | 27,552                       |       |       |       | 26,334                      |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Commitments  and Contingencies                   |       |       |                         |       |       |       |                        |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Stockholders’  Equity:                      |       |       |                         |       |       |       |                        |       |       |
|         | Preferred  stock                                 |       |       | 458                          |       |       |       | 458                         |       |       |
|         | Common  stock                                    |       |       | 249                          |       |       |       | 249                         |       |       |
|         | Additional  paid-in capital                      |       |       | 148,053                      |       |       |       | 147,775                     |       |       |
|         | Accumulated  deficit                             |       |       | (30,285                      | )          |       |       | (34,794                     | )          |       |
|         | Accumulated  other comprehensive income          |       |       | 95                           |       |       |       | 112                         |       |       |
|         | Total  stockholders’ equity                 |       |       | 118,570                      |       |       |       | 113,800                     |       |       |
|         |                                             |       |       |                         |       |       |       |                        |       |       |
|         | Total  liabilities and stockholders’ equity |       |       | $                            | 416,064    |       |       |                        | $          | 527,207    |   |   |

 

*See accompanying notes tocondensed consolidated financial statements*

 

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**SOUTHWESTWATER COMPANY**

 

### **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

 
| ** **                                              | ** ** | ** ** | **Three Months Ended**   | ** ** | ** ** | ** ** | **Nine Months Ended**    | ** ** |
|---------------------------------------------------------|------------|------------|--------------------------|------------|------------|------------|--------------------------|------------|
| ** **                                              | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | ** ** | **September 30,**   | ** ** | ** ** | ** ** | **September 30,**   | ** ** |
| ***(In thousands, except per share  data)***            | ** ** | ** ** | **2009**                 | ** ** | ** ** | ** ** | **2008**                 | ** ** | ** ** | ** ** | **2009** | ** ** | ** ** | ** ** | **2008** | ** ** |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Operating  revenue                                      |       |       | $                        | 58,984     |       |       |                     | $          | 57,482 |   |   |   | $ | 161,492 |   |   |   | $ | 159,065 |   |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Expenses:                                               |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Operating  expenses                                     |       |       | 53,521                   |       |       |       | 52,637                   |       |   |   | 153,479 |   |   |   | 144,577 |   |
| Depreciation  and amortization                          |       |       | 3,842                    |       |       |       | 3,416                    |       |   |   | 11,532 |   |   |   | 10,426 |   |
| Impairment  of long-lived assets                        |       |       | —    |       |       |       | —    |       |   |   | 8,115 |   |   |   | 1,075 |   |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Total  operating expenses                               |       |       | 57,363                   |       |       |       | 56,053                   |       |   |   | 173,126 |   |   |   | 156,078 |   |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Operating  income (loss)                                |       |       | 1,621                    |       |       |       | 1,429                    |       |   |   | (11,634 | ) |   |   | 2,987 |   |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Other  income (expense):                                |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Interest  expense                                       |       |       | (2,402                   | )          |       |       | (2,151                   | )          |   |   | (7,265 | ) |   |   | (6,364 | ) |
| Interest  income                                        |       |       | 45                       |       |       |       | 349                      |       |   |   | 129 |   |   |   | 459 |   |
| Loss  from continuing operations before income taxes    |       |       | (736                     | )          |       |       | (373                     | )          |   |   | (18,770 | ) |   |   | (2,918 | ) |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Benefit  from income taxes                              |       |       | (237                     | )          |       |       | (130                     | )          |   |   | (6,803 | ) |   |   | (1,038 | ) |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Loss  from continuing operations                        |       |       | (499                     | )          |       |       | (243                     | )          |   |   | (11,967 | ) |   |   | (1,880 | ) |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Income  (loss) from discontinued operations, net of tax |       |       | —    |       |       |       | (733                     | )          |   |   | 17,731 |   |   |   | (89 | ) |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Net  income (loss)                                      |       |       | (499                     | )          |       |       | (976                     | )          |   |   | 5,764 |   |   |   | (1,969 | ) |
| Preferred  stock dividends                              |       |       | (6                       | )          |       |       | (6                       | )          |   |   | (12 | ) |   |   | (18 | ) |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Net  income (loss) applicable to common stockholders    |       |       | $                        | (505       | )          |       |                     | $          | (982 | ) |   |   | $ | 5,752 |   |   |   | $ | (1,987 | ) |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Income  (loss) per common share:                        |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Basic  and diluted:                                     |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Loss  from continuing operations                        |       |       | $                        | (0.02      | )          |       |                     | $          | (0.01 | ) |   |   | $ | (0.49 | ) |   |   | $ | (0.08 | ) |
| Income  (loss) from discontinued operations             |       |       | —    |       |       |       | (0.03                    | )          |   |   | 0.72 |   |   |   | (0.00 | ) |
| Net  income (loss) applicable to common stockholders    |       |       | $                        | (0.02      | )          |       |                     | $          | (0.04 | ) |   |   | $ | 0.23 |   |   |   | $ | (0.08 | ) |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
|                                                    |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Weighted  average common shares outstanding:            |       |       |                     |       |       |       |                     |       |   |   |   |   |   |   |   |   |
| Basic                                                   |       |       | 24,608                   |       |       |       | 24,607                   |       |   |   | 24,605 |   |   |   | 24,498 |   |
| Diluted                                                 |       |       | 24,608                   |       |       |       | 24,607                   |       |   |   | 24,605 |   |   |   | 24,498 |   |

 

*See accompanying notes tocondensed consolidated financial statements.*

 

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**SOUTHWESTWATER COMPANY**

 

### **CONDENSEDCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)**

 
| ** **                                              | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** **  | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **  | ** ** |
|---------------------------------------------------------|------------|------------|------------|--------------------------|------------|------------|------------|--------------------------|------------|------------|------------|--------------------------|------------|------------|------------|--------------------------|------------|------------|------------|--------------------------|------------|------------|-------------|--------------------------|------------|------------|------------|--------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-------------|------------|
| ** **                                              | ** ** | ** ** | ** ** | **Preferred Stock**      | ** ** | ** ** | ** ** | **Common Stock**         | ** ** | ** ** | ** ** | **Additional**           | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | **Accumulated  Other**   | ** ** | ** ** | ** **  | ** **               | ** ** |
| ** **                                              | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** **  | ** **               | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | ** ** | ** ** | **Number of**            | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | **Number of**            | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** | **Paid-in**              | ** ** | ** ** | ** **  | **Accumulated**          | ** ** | ** ** | ** ** | **Comprehensive**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | ** ** | ** ** | **Shares**               | ** ** | ** ** | ** ** | **Amount**               | ** ** | ** ** | ** ** | **Shares**               | ** ** | ** ** | ** ** | **Amount**               | ** ** | ** ** | ** ** | **Capital**              | ** ** | ** ** | ** **  | **Deficit**              | ** ** | ** ** | ** ** | **Income**               | ** ** | ** ** | ** ** | **Total**  | ** ** |
| ***(In thousands)***                                    |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
|                                                    |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| **Balance - December 31, 2008**                    | ** ** | ** ** | ** ** | **9**                    | ** ** | ** ** | ** ** | **$**                    | **458**    | ** ** | ** ** | ** **               | **24,897** | ** ** | ** ** | ** **               | **$**      | **249**    | ** ** | ** **               | ** ** | **$**      | **147,775** | ** **               | ** ** | ** ** | **$**      | **(34,794**              | **)**      | ** ** | ** ** | **$**      | **112**    | ** ** | ** ** | ** ** | **$**      | **113,800** | ** ** |
|                                                    |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| Comprehensive  income:                                  |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| Net  income                                             |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |        | 5,764                    |       |       |       | —    |       |       |       | 5,764      |       |
| Other  comprehensive loss:                              |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| Amortization  of actuarial gains                        |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |        | —    |       |       |       | (17                      | )          |       |       | (17        | )          |
|                                                    |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| Comprehensive  income                                   |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       | 5,747      |       |
|                                                    |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| Restricted  stock repurchases and retirement            |       |       |       | —    |       |       |       | —    |       |       |       | (21                      | )          |       |       | —    |       |       |       | (18                      | )          |       |        | —    |       |       |       | —    |       |       |       | (18        | )          |
|                                                    |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| Post-vest cancellations of  non-qualified stock options |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | (271                     | )          |       |        | —    |       |       |       | —    |       |       |       | (271       | )          |
| Share-based  compensation                               |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | 567                      |       |       |        | —    |       |       |       | —    |       |       |       | 567        |       |
| Cash  dividends declared:                               |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| Preferred  stock—$1.3125 per share                 |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |        | (12                      | )          |       |       | —    |       |       |       | (12        | )          |
| Common  stock—$0.05 per share                      |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |       | —    |       |       |        | (1,243                   | )          |       |       | —    |       |       |       | (1,243     | )          |
|                                                    |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |       |                     |       |       |        |                     |       |       |       |                     |       |       |       |       |       |
| **Balance - September 30, 2009**                   | ** ** | ** ** | ** ** | **9**                    | ** ** | ** ** | ** ** | **$**                    | **458**    | ** ** | ** ** | ** **               | **24,876** | ** ** | ** ** | ** **               | **$**      | **249**    | ** ** | ** **               | ** ** | **$**      | **148,053** | ** **               | ** ** | ** ** | **$**      | **(30,285**              | **)**      | ** ** | ** ** | **$**      | **95**     | ** ** | ** ** | ** ** | **$**      | **118,570** | ** ** |

 

*See accompanying notes tocondensed consolidated financial statements.*

 

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**SOUTHWESTWATER COMPANY**

 

### **CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

 
| ** **   | ** **                                                          | ** **   | ** **   | ** **   | **Nine Months Ended**    | ** ** |
|--------------|---------------------------------------------------------------------|--------------|--------------|--------------|--------------------------|------------|
| ** **   | ** **                                                          | ** **   | ** **   | ** **   | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **   | ** **                                                          | ** **   | ** **   | ** **   | **September 30,**   | ** ** |
| *** *** | ***(In thousands)***                                                | *** *** | *** *** | *** *** | **2009**                 | ** ** | ** ** | ** ** | **2008** | ** ** |
|         |                                                                |         |         |         |                     |       |   |   |   |   |
|         | Cash  flows from operating activities of continuing operations:     |         |         |         |                     |       |   |   |   |   |
|         | Net  income (loss)                                                  |         |         |         | $                        | 5,764      |   |   |   | $ | (1,969 | ) |
|         | Adjustments  to reconcile net income (loss) to net cash             |         |         |         |                     |       |   |   |   |   |
|         | provided  by operating activities:                                  |         |         |         |                     |       |   |   |   |   |
|         | Loss  (income) from discontinued operations, net of tax             |         |         |         | (17,731                  | )          |   |   | 89 |   |
|         | Depreciation  and amortization                                      |         |         |         | 11,532                   |       |   |   | 10,426 |   |
|         | Deferred  income taxes                                              |         |         |         | 2,592                    |       |   |   | 719 |   |
|         | Provision  for doubtful accounts                                    |         |         |         | 1,518                    |       |   |   | 1,529 |   |
|         | Share-based  compensation expense                                   |         |         |         | 567                      |       |   |   | 762 |   |
|         | Post-vest  cancellations of non-qualified stock options             |         |         |         | (271                     | )          |   |   | —    |   |
|         | Impairment  of long-lived assets                                    |         |         |         | 8,115                    |       |   |   | 1,075 |   |
|         | Gain  on sale of businesses and assets                              |         |         |         | 39                       |       |   |   | —    |   |
|         | Amortization  of deferred financing costs                           |         |         |         | 654                      |       |   |   | —    |   |
|         | Other,  net                                                         |         |         |         | (28                      | )          |   |   | 459 |   |
|         | Changes  in assets and liabilities, net of effects of acquisitions: |         |         |         |                     |       |   |   |   |   |
|         | Accounts  receivable                                                |         |         |         | (6,943                   | )          |   |   | (5,867 | ) |
|         | Other  current assets                                               |         |         |         | 2,090                    |       |   |   | 877 |   |
|         | Other  assets                                                       |         |         |         | (278                     | )          |   |   | (2,540 | ) |
|         | Accounts  payable                                                   |         |         |         | (231                     | )          |   |   | (4,687 | ) |
|         | Other  current liabilities                                          |         |         |         | (491                     | )          |   |   | (361 | ) |
|         | Other  liabilities                                                  |         |         |         | 454                      |       |   |   | (202 | ) |
|         | Other,  net                                                         |         |         |         | —    |       |   |   | (33 | ) |
|         |                                                                |         |         |         |                     |       |   |   |   |   |
|         | Net  cash provided by operating activities                          |         |         |         | 7,352                    |       |   |   | 277 |   |
|         |                                                                |         |         |         |                     |       |   |   |   |   |
|         | Cash  flows from investing activities of continuing operations:     |         |         |         |                     |       |   |   |   |   |
|         | Additions  to property, plant and equipment                         |         |         |         | (12,343                  | )          |   |   | (25,140 | ) |
|         | Acquisition  of businesses, net of cash acquired                    |         |         |         | —    |       |   |   | (23,330 | ) |
|         | Proceeds  from sale of minority interest                            |         |         |         | —    |       |   |   | 170 |   |
|         | Proceeds  from sale of businesses                                   |         |         |         | 54,436                   |       |   |   | —    |   |
|         | Proceeds  from sale of equipment                                    |         |         |         | 125                      |       |   |   | 9 |   |
|         |                                                                |         |         |         |                     |       |   |   |   |   |
|         | Net  cash provided by (used in) investing activities                |         |         |         | 42,218                   |       |   |   | (48,291 | ) |
|         |                                                                |         |         |         |                     |       |   |   |   |   |
|         | Cash  flows from financing activities of continuing operations:     |         |         |         |                     |       |   |   |   |   |
|         | Borrowings  under lines of credit                                   |         |         |         | 33,000                   |       |   |   | 147,000 |   |
|         | Repayments  under lines of credit                                   |         |         |         | (56,500                  | )          |   |   | (98,000 | ) |
|         | Capital  improvement reimbursements                                 |         |         |         | 3,233                    |       |   |   | 2,158 |   |
|         | Proceeds  from share-based equity incentive plans and stock         |         |         |         |                     |       |   |   |   |   |
|         | purchase  plans                                                     |         |         |         | —    |       |   |   | 2,788 |   |
|         | Restricted  stock repurchases                                       |         |         |         | (18                      | )          |   |   | —    |   |
|         | Dividends  paid                                                     |         |         |         | (1,884                   | )          |   |   | (4,438 | ) |
|         | Payments  on long-term debt                                         |         |         |         | (13,699                  | )          |   |   | (1,574 | ) |
|         | Repayment  of advances for construction                             |         |         |         | (499                     | )          |   |   | (599 | ) |
|         | Deferred  financing costs                                           |         |         |         | (2,745                   | )          |   |   | (537 | ) |
|         |                                                                |         |         |         |                     |       |   |   |   |   |
|         | Net  cash provided by (used in) financing activities                |         |         |         | (39,112                  | )          |   |   | 46,798 |   |
|         | Cash  flows from discontinued operations:                           |         |         |         |                     |       |   |   |   |   |
|         | Operating  activities                                               |         |         |         | (8,710                   | )          |   |   | 2,239 |   |
|         | Investing  activities                                               |         |         |         | (291                     | )          |   |   | (746 | ) |
|         | Financing  activities                                               |         |         |         | (976                     | )          |   |   | 26 |   |
|         | Net  cash provided by (used in) discontinued operations             |         |         |         | (9,977                   | )          |   |   | 1,519 |   |
|         |                                                                |         |         |         |                     |       |   |   |   |   |
|         | Net  increase in cash and cash equivalents                          |         |         |         | 481                      |       |   |   | 303 |   |
|         | Cash  and cash equivalents at beginning of period                   |         |         |         | 1,112                    |       |   |   | 2,950 |   |
|         |                                                                |         |         |         |                     |       |   |   |   |   |
|         | Cash  and cash equivalents at end of period                         |         |         |         | $                        | 1,593      |   |   |   | $ | 3,253 |   |

 

*See accompanying notes to condensed consolidated financial statements.*

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ( UNAUDITED )**

 

**Note 1.   Summaryof Significant Accounting Policies**

 

**Basis of Presentation**

 

These condensed consolidated interimfinancial statements of SouthWest Water Company are unaudited. We believe theinterim financial statements are presented on a basis consistent with theaudited consolidated financial statements for the year ended December 31,2008 and include all adjustments necessary for a fair presentation of thefinancial condition, results of operations and cash flows for such interimperiods.

 

The December 31, 2008 condensedconsolidated balance sheet data were derived from the audited financialstatements, but do not include all disclosures required by accountingprinciples generally accepted in the United States of America (“GAAP”), and, asa result, are labeled unaudited.

 

Certain information and disclosuresnormally included in financial statements prepared in accordance with GAAP havebeen omitted in accordance with Securities and Exchange Commission’s rules andregulations for interim financial reporting. These condensed consolidatedinterim financial statements should be read in conjunction with the auditedfinancial statements and related notes included in our 2008 Annual Report on Form 10-K.Our businesses are seasonal because they are affected by weather. As a result,operating results for interim periods are not necessarily predictive of theoperating results for any other interim period or for the full year.

 

**AccountingAdjustments Impacting Other Periods**

 

We recorded a net after tax benefit of $0.3 million in thethree-month period ended September 30, 2009 related to prior periods. Theseadjustments relate primarily to a water revenue adjustment mechanism (“WRAM”)implemented in October 2008 at our California utility. The WRAM adjusts revenuegenerated by conservation oriented rates to equivalent revenue that would havebeen generated by non-conservation oriented rates, or uniform rates. Managementhas determined that the effect of recording these adjustments are not materialto either the results of operations of the current period or the previouslyreported periods. 

 

We recorded a net after tax charge of $0.4million in the nine-month period ended September 30, 2009 related to priorperiods. Management has determined that the effect of recognizing theseadjustments during 2009 is not material to our results of operations for thenine-month period ended September 30, 2009 or for any prior period.

 

**RecentAccounting Pronouncements**

 

We only discuss recent accountingpronouncements that will or are expected to have a significant effect on ourfinancial statements or disclosures currently or in the near term.

 

*Subsequent Events*

 

InMay 2009, new authoritative guidance was issued on subsequent events thatestablishes general accounting and disclosure standards for events that occurafter the balance sheet date, but before financial statements are issued. Thisguidance sets forth the period after the balance sheet date during whichmanagement should evaluate events or transactions that may occur for potentialrecognition in the financial statements, identifies the circumstances underwhich an entity should recognize these events or transactions in its financialstatements, and the disclosures that should be made about these events ortransactions. We adopted this guidance for the quarter ended June 30,2009, as required. For this reporting period, we evaluated the existence of subsequent events through November 9,2009. Significant subsequent events or transactions requiring disclosure onlyin the financial statements are disclosed in Note 10.

 

***FairValue Measurements***

 

We apply the current authoritativeguidance for fair value measurement which defines fair value and providesguidance for measuring fair value and expands disclosures about thesemeasurements. It does not require any new fair value measurements, but ratherapplies to all other accounting pronouncements that require or permit fairvalue measurements.

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ( UNAUDITED )**

 

In accordance with authoritativeguidance issued in February 2008, we apply the fair value provisions tononfinancial assets and nonfinancial liabilities that are recognized at fairvalue in the financial statement disclosures on a nonrecurring basis in thecurrent fiscal year beginning January 1, 2009. We had no nonrecurringmeasurements recognized at fair value during the quarter ended September 30,2009. We generally apply fair value techniques on a nonrecurring basisassociated with (1) valuing potential impairment loss related to goodwilland indefinite-lived intangible assets, and (2) valuing potentialimpairment losses related to long-lived assets.

 

The guidance enables the reader ofthe financial statements to assess the inputs used to develop thosemeasurements by establishing a hierarchy for ranking the quality andreliability of the information used and requires that assets and liabilitiescarried at fair value be classified and disclosed in one of the following threecategories:

 

·                   Level 1: Quotedmarket prices in active markets for identical assets or liabilities.

 

·                   Level 2: Observablemarket based inputs or unobservable inputs that are corroborated by marketdata.

 

·                   Level 3:Unobservable inputs that are not corroborated by market data.

 

The fair values of our cashequivalents are based on quoted prices in active markets for identical assets(Level 1).

 

Recent guidance adopted beginning inthe quarter ended June 30, 2009, requires additional disclosure of certainfair value information as follows:

 

As of September 30, 2009 and December 31,2008, our revolving credit facility and long-term debt with aggregate bookvalues of $155.6 million and $192.8 million had fair values of approximately$145.0 million and $196.4 million, respectively. We believe that these changesin fair value from their carrying amounts are primarily due to current unstableeconomic conditions and the current state of the credit markets for similardebt instruments. We determined the estimated fair value amounts by usingrecent trade activity, available market information and commonly acceptedvaluation methodologies (Level 2). However, considerable judgment is requiredin interpreting market data to develop estimates of fair value. Accordingly,the fair value estimates presented herein are not necessarily indicative of theamount that we could realize in a current market exchange. The use of differentassumptions and/or estimation methodologies may have a material effect on theestimated fair values.

 

**Note 2.   Acquisition**

 

OnJanuary 31, 2008, we acquired substantially all of the assets of awastewater collection system and related treatment plant in Birmingham,Alabama. The purchase price was $23.3 million in cash which we borrowed underour revolving credit facility. The acquisition was accounted for as an assetpurchase and the assets acquired have been recorded at their estimated fairvalues, consisting of $20.8 million of utility plant and $2.5 million of land.

 

Theaccompanying condensed consolidated financial statements reflect the financialposition and results of operations of the acquired utility subsequent to itsacquisition date. Unaudited pro forma consolidated results of operations arenot presented for the nine-month period ended September 30, 2008 as if theacquisition had occurred as of the beginning of the period presented, as theresults are not significantly different than those presented.

 

**Note 3.   AssetsHeld for Sale, Dispositions and Impairments**

 

*Texas Wholesale Water andWastewater*

 

During2007, we committed to a plan to sell our wholesale water and wastewateroperations in Texas.   In December 2008,we completed the sale of our wholesale wastewater business for net cashproceeds of $2.2 million and established a receivable of $0.6 million. Thewastewater treatment plant sold represented a portion of the asset group heldfor sale. The Company is uncertain whether it can consummate the sale of theremaining water business during 2009. Accordingly, the business activity of the wholesale water component isreflected in consolidated continuing operations in all periods presented.  The results of operations and cash flows forthe wastewater operations are reflected as discontinued operations for thethree- and nine-month periods ended September 30, 2008.  Net assets held for sale at December 31,2008 consisted of property, plant and equipment aggregating $6.3 million anddeferred revenue liabilities of $3.5 million.

 

*New Mexico Utilities, Inc.*

 

Asmore fully described in Note 5, “Legal Proceedings”, as part of a settlement ofeminent domain proceedings against our New Mexico utility, New Mexico UtilitiesInc. (“NMUI”), we completed the sale of NMUI on May 8, 2009.  We 

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ( UNAUDITED )**

 

received$53.9 million in cash at closing ($60.0 million settlement and $0.9 million netcash settlement primarily related to accounts receivable, less $7.0 millionretained by the condemning entity in settlement of previously disputed sewertreatment fees).  The sale reflects a$107.2 million reduction in assets, offset by a reduction in liabilities of$79.5 million which include $69.0 million of contributions in aid ofconstruction. The results of operations and cash flows for NMUI are reflectedas discontinued operations for all periods presented.

 

*Discontinued Operations*

 

Thefollowing table summarizes the results of operations of the Texas wastewaterand NMUI operations included in the condensed consolidated statement ofoperations as discontinued operations:

 
| ** **                                                    | ** ** | ** ** | **Three Months Ended**   | ** **                      | ** ** | **Nine Months Ended**    | ** ** | ** **  |
|---------------------------------------------------------------|------------|------------|--------------------------|---------------------------------|------------|--------------------------|------------|-------------|
| ** **                                                    | ** ** | ** ** | ** **               | ** **                      | ** ** | ** **               | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                    | ** ** | ** ** | **September 30,**   | ** **                      | ** ** | **September 30,**   | ** ** | ** **  |
| ***(In thousands)***                                          | ** ** | ** ** | **2009**                 | ** **                      | **2008**   | ** **               | **2009**   | ** **  | **2008** | ** ** |
|                                                          |       |       |                     |                            |       |                     |       |        |   |   |   |   |   |   |
| Revenue                                                       |       |       | $                        |  —     |       |                     | $          |  3,094 |   |   | $ |  4,729 |   |   | $ |  8,334 |   |   |
| Expenses                                                      |       |       | —    |                            |       | (4,057                   | )          |        | (2,895 | ) |   | (7,835 | ) |   |
| Impairment  of long-lived assets                              |       |       | —    |                            |       | —    |       |        | —    |   |   | (95 | ) |   |
| Interest  expense                                             |       |       | —    |                            |       | (189                     | )          |        | (270 | ) |   | (569 | ) |   |
| Income  (loss) before taxes                                   |       |       | —    |                            |       | (1,152                   | )          |        | 1,564 |   |   | (165 | ) |   |
| Income  tax provision (benefit)                               |       |       | —    |                            |       | (419                     | )          |        | 561 |   |   | (76 | ) |   |
| Income  (loss) before gain on sale of discontinued operations |       |       | —    |                            |       | (733                     | )          |        | 1,003 |   |   | (89 | ) |   |
| Gain  on sale of discontinued operations,                     |       |       |                     |                            |       |                     |       |        |   |   |   |   |   |   |
| net  of $9,361 of tax                                         |       |       | —    |                            |       | —    |       |        | 16,728 |   |   | —    |   |   |
| Income  (loss) from discontinued operations, net of tax       |       |       | $                        |  —     |       |                     | $          |  (733  | ) |   | $ |  17,731 |   |   | $ |  (89 | ) |   |

 

Interestexpense reflects interest on debt relating to these operations, and costs andexpenses exclude the allocation of general corporate overhead.

 

*Southwest EnvironmentalLaboratories, Inc.*

 

In April 2009, we agreed tosell certain assets of our Southwest Environmental Laboratories, Inc., apart of the Texas MUD Services segment, for $0.5 million cash and up to anadditional $0.75 million, consisting of 25% of the buyer’s quarterly salessubsequent to the closing. Subsequent to the sale, $0.4 million has been paid,leaving a remaining balance of $0.35 million. We also sold the remaining realproperty for $0.7 million. The sold operations were not considered adiscontinued operation in the accompanying consolidated financial statementsdue to the on-going business relationship.

 

*Cornerstone Internal-use SoftwareDevelopment Project*

 

In May 2009, we terminated ourpreviously suspended software development project; as a result, an impairmentcharge of $8.0 million was recorded, net of recoveries from vendors.

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS ( UNAUDITED )**

 

**Note 4.   Long-Term Debt**

 

Long-term debt consists of thefollowing as of September 30, 2009 and December 31, 2008:

 
| *** ***                                          | *** *** | ***September 30,*** | *** *** | ***December 31,*** | *** *** |
|-------------------------------------------------------|--------------|--------------------------|--------------|-------------------------|--------------|
| ***(In thousands)***                                  | ** **   | **2009**                 | ** **   | **2008**                | ** **   |
|                                                  |         |                     |         |                    |         |
| Revolving credit facility                             |         | $                        | 74,500       |                    | $            | 98,000 |   |
|                                                  |         |                     |         |                    |         |
| 6.85% convertible subordinated debentures due 2021    |         | 11,859                   |         | 11,962                  |         |
|                                                  |         |                     |         |                    |         |
| Capital leases                                        |         | 3,423                    |         | 4,332                   |         |
|                                                  |         |                     |         |                    |         |
| Term Loans:                                           |         |                     |         |                    |         |
| Monarch Utilities, Inc.:                         |         |                     |         |                    |         |
| 7.37% fixed rate term loan due 2022                   |         | 9,689                    |         | 10,267                  |         |
| 5.77% fixed rate term loan due 2021                   |         | 667                      |         | 706                     |         |
| 6.10% fixed rate term loan due 2031                   |         | 20,000                   |         | 20,000                  |         |
|                                                  |         |                     |         |                    |         |
| First Mortgage Bonds:                                 |         |                     |         |                    |         |
| Suburban Water Systems:                               |         |                     |         |                    |         |
| 9.09% series B first mortgage bond due 2022           |         | 8,000                    |         | 8,000                   |         |
| 5.64%  series D first mortgage bond due 2024          |         | 15,000                   |         | 15,000                  |         |
| 6.30%  series E first mortgage bond due 2026          |         | 10,000                   |         | 10,000                  |         |
| New  Mexico Utilities, Inc.:                     |         |                     |         |                    |         |
| 6.10%  series C first mortgage bond due 2024          |         | —                   |         | 12,000                  |         |
|                                                  |         |                     |         |                    |         |
| Economic  Development Revenue Bonds:                  |         |                     |         |                    |         |
| 6.0%  series 1998A due 2018                           |         | 1,810                    |         | 1,810                   |         |
|                                                  |         |                     |         |                    |         |
| Acquisition-related  indebtedness and other           |         | 78                       |         | 78                      |         |
| Total  long-term debt payment obligations             |         | 155,026                  |         | 192,155                 |         |
| Unamortized  Monarch term loan fair value adjustments |         | 622                      |         | 636                     |         |
| Total  long-term debt                                 |         | 155,648                  |         | 192,791                 |         |
| Less  current portion of long-term debt               |         | (2,176                   | )            | (2,213                  | )            |
| Long-term debt, less current portion                  |         | $                        | 153,472      |                    | $            | 190,578 |   |

 

Monarchutilities and Suburban Water Systems utility plants secure the above Term Loansand First Mortgage Bonds, respectively. Our remaining assets have been pledgedas collateral under our revolving credit facility agreement, as amended.

 

InFebruary 2008, we replaced our previous revolving line of credit byentering into a credit agreement with several lenders including Bank ofAmerica, as lender and Administrative Agent, KeyBank, CoBank, U.S. Bank,JPMorgan Chase Bank, Comerica Bank, Bank of the West, Citibank and Union Bankof California (the “Bank Group”). The credit agreement initially provided for a$150.0 million revolving credit facility. Proceeds from the initial borrowingunder the credit agreement were used to repay borrowings under the Company’sprior $100.0 million revolving line of credit.

 

Wepay commitment fees under the facility and must maintain customary financialratios, prescribed cash flow results and meet other restrictive covenants. Wewere not in compliance with certain covenants due to our failure to timely fileour September 30, 2008, March 31, 2009 and June 30, 2009Quarterly Reports on Form 10-Q and 2008 Annual Report on Form 10-K.  In addition, we were in violation of ourdebt-to-capitalization ratio at December 31, 2008 and at March 31,2009.   However, we received amendmentsfrom the Bank Group which waived existing and anticipated defaults, primarilygranting additional time to complete our financial filings and waiving thedebt-to-capitalization ratio for the periods of non-compliance. The May 28,2009 amendment also reduced the credit amount available under the line to$110.0 million, secured the facility with certain assets of the Company, andsignificantly increased our borrowing margins. Fees and expenses charged by theBank Group for all the amendments were $3.0 million, of which $2.7 million werecharged during the nine months ended September 30, 2009. These fees werecapitalized and are being amortized over the remaining life of the facilitywhich extends through February 2013.

 

Borrowingsunder the credit facility bear interest, at our option, based on either amargin over the designated LIBOR rate or the prime rate. If ourdebt-to-capitalization ratio is 60% or lower, the applicable margins are 4.00%over the LIBOR 

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS ( UNAUDITED )**

 

rateand 3.00% over the prime rate. As of September 30, 2009 ourdebt-to-capitalization ratio is 57%, the applicable margins are 4.00% over theLIBOR rate and 3.00% over the prime rate. The margins decline on a slidingscale as our debt-to-capitalization ratio improves. The nominal averageinterest rates, excluding bank amendment and waiver fees, on all creditfacility borrowings outstanding were 4.37% at September 30, 2009, and1.58% at December 31, 2008.

 

Asof September 30, 2009, we had irrevocable standby letters of credit in theamount of $3.3 million issued and outstanding under our revolving creditfacility and our available borrowing capacity was $32.2 million.

 

**Note 5.   Commitmentsand Contingencies**

 

**LegalProceedings**

 

*New Mexico Utilities, Inc.*

 

NewMexico Utilities, Inc. (“NMUI”), one of our wholly-owned regulatedutilities, had an agreement with the Albuquerque Bernalillo County WaterUtility Authority, a political subdivision of the State of New Mexico (the “ABCWUA”),whereby the ABCWUA treated the effluent from NMUI’s wastewater collectionsystem for a fee. The treated effluent is returned to the Rio GrandeUnderground Basin, creating return flow credits. Return flow creditssupplemented NMUI’s existing water rights, enabling it to pump additional waterfrom the basin.

 

InAugust 2004, the ABCWUA increased the fee charged to NMUI, using adifferent formula than had been used to calculate fee increases since 1973. Webelieved the increase violated the terms of a 1973 written agreement betweenthe parties. Subsequently, the ABCWUA also claimed ownership of the return flowcredits. On September 13, 2004, we filed a Complaint for DeclaratoryJudgment in the Second Judicial District Court, County of Bernalillo, State ofNew Mexico (the “Court”), requesting that the Court settle these disputes. In aletter ruling dated May 2, 2007, the Court ruled that the ABCWUA could usea new formula to set fees for NMUI. We filed a motion for reconsideration andthat motion was denied on October 2, 2007. The Court did not rule onwhether the new rate was appropriate, made no determination as to any amountNMUI may owe to the ABCWUA, and did not rule on the ownership of thereturn flow credits.

 

Additionally,the ABCWUA had asserted that NMUI owed to the ABCWUA an amount of approximately$0.8 million related to back payments, penalties and interest arising from analleged underpayment by NMUI for three years for its discharge of effluentthrough an unmetered second connection between NMUI and the ABCWUA. The claimwas contested by NMUI. On October 29, 2008, the matter was settled by aone-time payment by NMUI to the ABCWUA of $0.5 million.

 

TheNew Mexico Public Regulation Commission (the “NMPRC”) ruled that NMUI maycommence billing its customers for a portion of the sewer fee increase and holdthe collected amounts in escrow (“Rate Rider Escrow”), pending a final courtdecision.

 

Inaddition, on January 19, 2007, the ABCWUA and the City of Rio Rancho, ahome-rule municipal corporation, as Petitioners, filed a Petition forCondemnation against NMUI and others, as defendants, in the Court (the “Petition”).The Petition sought to acquire, by condemnation, all of the assets of NMUI,including all real property, through the stated power of eminent domain. ThePetition also alleged that the Petitioners need to acquire the NMUI assets forthe public purposes of providing water and wastewater services to NMUIcustomers and that the acquisition of NMUI is necessary, appropriate and in thepublic interest. The Company contested the Petition.  In the fourth quarter of 2008, the Companyattempted to globally settle the condemnation and the sewer rate and returnflow credit issues, including an $8.0 million cash offer. The settlement offerwas not accepted by ABCWUA.

 

OnJanuary 29, 2009, NMUI and the ABCWUA entered into a Settlement,Arbitration Award, and Acquisition Agreement (the “Agreement”) to resolve alloutstanding claims, demands and existing lawsuits between them. The Agreementclosed on May 8, 2009 (the “Closing”) after the financing wascompleted.  Under the Agreement, theABCWUA acquired certain of the assets of NMUI necessary for the ABCWUA to own,operate and maintain the water and wastewater system of NMUI in settlement ofcondemnation. In consideration of the assets acquired, the ABCWUA agreed to payto NMUI at the Closing as full, final and complete consideration the sum of$60.0 million plus a net cash settlement of an amount equal to the NMUIaccounts receivable at the date of Closing and an amount equal to theunbilled services at the date of Closing.

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS ( UNAUDITED )**

 

NMUIalso received the right to receive Rate Rider Escrow Funds deposited from theperiod from November 27, 2007 through January 12, 2009.  The total amount received by the Company on May 12,2009 from the Rate Rider Escrow Funds was $1.4 million.

 

Inaddition, the settlement resolves all other legal issues between NMUI andABCWUA including the dispute over the sewer fee the ABCWUA charged NMUI for thetreatment of effluent from NMUI’s wastewater collection system and the ownershipof the return flow credits from that treated wastewater, as well as all otherdisputed amounts of the ABCWUA. As part of the settlement, NMUI agreed to pay$7.0 million to the ABCWUA at the time of closing to resolve the sewer feeissue.  This amount was accrued at December 31,2008, and paid in full at closing of settlement.

 

Netcash proceeds from settlement were $53.9 million and the resulting gain, net ofdirect transactional costs of $0.1 million, was $26.1 million.  Substantially all of the utility plant assetsof NMUI were pledged as collateral for $12.3 million in first mortgage bondswith an original maturity of 2024 and related accrued interest.  We repaid these bonds in full, includingaccrued interest of $0.3 million. The remaining cash proceeds of $41.6 millionwere used to pay the balance of liabilities of NMUI, and to pay down ourrevolving credit facility. The sale reflects a $107.2 million reduction inassets, offset by reduction in liabilities of $79.5 million, which includes a $69.0million reduction in contributions in aid of construction.

 

*Investigations*

 

OnMay 18, 2005, the Environmental Protection Agency (“EPA”) executed asearch warrant at our Texas-based testing laboratory and on July 20, 2006the laboratory received a subpoena to provide additional records andinformation to a grand jury. We have cooperated fully with the EPA’sinvestigation and have provided the records requested. We remain in closecooperation and coordination with both Department of Justice and EPA’s counselin an attempt to resolve the matter favorably. In April 2009, we submittedour formal request that the EPA not pursue criminal sanctions.  Given the nature and preliminary status ofthis matter, we cannot yet determine the amount or even a reasonable range ofpotential loss in these matters, if any.

 

Wereceived a letter dated January 28, 2008 from the California State WaterResources Control Board Office of Enforcement (the “Board”). The letterindicates that the Board has conducted an investigation of the operations ofone of our subsidiaries with respect to various California wastewater treatmentfacilities which are operated, but not owned, by the subsidiary. The Boardalleges that the subsidiary has violated certain provisions of the CaliforniaWater Code and may be subject to civil administrative liability in excess of$15.0 million, and possible administrative action against the subsidiary’sstatus as a contract operator in California. Since receipt of the letter, we have conducted an internal investigationand worked in cooperation with the Board to resolve the matter favorably. TheBoard has made an offer of settlement, requiring that we implement anacceptable compliance program and pay fines and penalties of $1.5 million,which we believe we have appropriately accrued. We continue to negotiate withthe Board with respect to this matter.

 

*Class Action Litigation*

 

*Perrin v. SouthWest Water Company, et al.*, Case No. CV08-07844 (Central District of California) and related, consolidatedcases:  On November 26, 2008, an alleged purchaser of our publiclytraded common stock filed a securities class action lawsuit in the UnitedStates District Court for the Central District of California.  Thecomplaint generally alleges that from May 10, 2005 through November 9,2008, we made false statements or omitted to state facts necessary to make ourdisclosures not misleading.  Five additional and substantially similarcases were filed in the same court.  On January 26, 2009, motions forconsolidation and for the appointment of lead plaintiff and lead counsel werefiled by the plaintiffs.  On February 12, 2009, the court granted themotion for consolidation and for the appointment of lead plaintiff and leadcounsel.  Pursuant to stipulation of the parties, the lead plaintiff on October 15,2009, filed a consolidated complaint.  We have 60 days to answer or moveto dismiss the consolidated complaint. Given the nature and preliminary statusof these cases, we cannot yet determine the amount or even a reasonable rangeof potential loss in these matters, if any.

 

*Derivative Litigation*

 

*Sherman v. Christie, et al.*, Case No. BC404946 (Los AngelesCounty Superior Court) and related cases:  On January 2, 2009, analleged shareholder of our publicly traded common stock filed a shareholderderivative case, alleging breach of fiduciary duty arising from theannouncement of our intent to restate financial statements against certainpresent and former members of our Board of Directors.  Two additional,substantially similar cases were filed.  Stipulations were enteredextending the time to respond to the complaints.  On April 23, 2009,the court found that the three derivative suits were “complex” and related andtransferred the cases to a single judge for all purposes and 

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS ( UNAUDITED )**

 

orderedan initial status conference for December 3, 2009.  The cases wereconsolidated on May 19, 2009.  The lead plaintiff by stipulation ofthe parties, filed a consolidated complaint on October 8, 2009. Wehave 60 days to answer or move to dismiss the consolidated complaint. Given thenature and preliminary status of these cases, we cannot yet determine theamount or even a reasonable range of potential loss in these matters, if any.

 

*Other Matters*

 

Weare also involved in other routine legal and administrative proceedings arisingduring the ordinary course of business. We believe that the ultimatedisposition of such matters will not have a material adverse effect on ourconsolidated financial position, results of operations or cash flows.  Any related legal costs are expensed whenincurred.

 

**Note6.   Earnings Per Share**

 

The following table is a reconciliation of the numerators(income or loss) and denominators (shares) used in both the basic and dilutedearnings per share calculations.

 
| ** **                                                                     | ** ** | ** ** | **Three Months Ended** | ** **    |
|--------------------------------------------------------------------------------|------------|------------|------------------------|---------------|
| ** **                                                                     | ** ** | ** ** | **September 30,** | ** **    |
| ***(In thousands)***                                                           | ** ** | ** ** | **2009**               | ** **    | ** ** | **2008** |
|                                                                           |       |       |                   |          |   |   |   |   |
| Numerators—Net  loss applicable to common stockholders:                   |       |       |                   |          |   |   |   |   |
| Loss  from continuing operations                                               |       |       | $                      |  (499    | ) |   |   | $ |  (243 | ) |
| Less  preferred stock dividends                                                |       |       | (6                     | )             |   |   | (6 | ) |
| Loss  from continuing operations applicable to common stockholders, net of tax |       |       | (505                   | )             |   |   | (249 | ) |
| Loss  from discontinued operations, net of tax                                 |       |       | -                      |          |   |   | (733 | ) |
| Loss  applicable to common stockholders                                        |       |       | $                      |  (505    | ) |   |   | $ |  (982 | ) |
|                                                                           |       |       |                   |          |   |   |   |   |
| Denominators—                                                             |       |       |                   |          |   |   |   |   |
| Basic  weighted average common shares outstanding                              |       |       | 24,608                 |          |   |   | 24,607 |   |
| Diluted  weighted average common shares outstanding                            |       |       | 24,608                 |          |   |   | 24,607 |   |
|                                                                           |       |       |                   |          |   |   |   |   |
|                                                                           |       |       |                   |          |   |   |   |   |
| ** **                                                                     | ** ** | ** ** | **Nine Months Ended**  | ** **    |
| ** **                                                                     | ** ** | ** ** | **September 30,** | ** **    |
| ***(In thousands)***                                                           | ** ** | ** ** | **2009**               | ** **    | ** ** | **2008** |
| Numerators—Net  loss applicable to common stockholders:                   |       |       |                   |          |   |   |   |   |
| Loss  from continuing operations                                               |       |       | $                      |  (11,967 | ) |   |   | $ |  (1,880 | ) |
| Less  preferred stock dividends                                                |       |       | (12                    | )             |   |   | (18 | ) |
| Loss  from continuing operations applicable to common stockholders, net of tax |       |       | (11,979                | )             |   |   | (1,898 | ) |
| Income  (loss) from discontinued operations, net of tax                        |       |       | 17,731                 |          |   |   | (89 | ) |
| Net  income (loss) applicable to common stockholders                           |       |       | $                      |  5,752   |   |   |   | $ |  (1,987 | ) |
|                                                                           |       |       |                   |          |   |   |   |   |
| Denominators—                                                             |       |       |                   |          |   |   |   |   |
| Basic  weighted average common shares outstanding                              |       |       | 24,605                 |          |   |   | 24,498 |   |
| Diluted  weighted average common shares outstanding                            |       |       | 24,605                 |          |   |   | 24,498 |   |

 

Wehave $11.9 million of 6.85% fixed-rate convertible subordinate debenturesoutstanding at September 30, 2009. The debentures, due in 2021, are convertible into common stock at anytime prior to maturity at a conversion price of $11.018 per share (1.1 millionshares).  The debentures are currentlyanti-dilutive; however, they will be included in the calculation of dilutedearnings per share if their conversion would be dilutive.

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ( UNAUDITED )**

 

**Note7.    Consolidated Statements of Cash Flows**

** **

The following information supplements our consolidatedstatements of cash flows.

 
| ** **                                                                                                      | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                      | ** ** | **September 30,** | ** ** |
| ***(In thousands)***                                                                                            | ** ** | **2009**               | ** ** | **2008** | ** ** |
| *** ***                                                                                                    | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** |
| Cash  paid during the period for:                                                                               |       |                   |       |   |   |   |
| Interest                                                                                                        |       | $                      | 6,707      |   |   | $ | 6,261 |   |
| Income  taxes paid, net                                                                                         |       | 448                    |       |   | 1,764 |   |
|                                                                                                            |       |                   |       |   |   |   |
| Non-cash  investing and financing activities:                                                                   |       |                   |       |   |   |   |
| Non-cash  contributions in aid of construction and advances for construction conveyed  to Company by developers |       | $                      | 258        |   |   | $ | 5,953 |   |

 

 

**Note 8. Dividend Reinvestment and Direct Stock Purchase Plan (“DRIP / DSPP”)**

 

Wehave a dividend reinvestment and stock purchase plan that gives our commonstockholders the option of receiving their dividends in cash or in common stockat a discount from prevailing market prices (“DRIP”). The plan also permitsexisting stockholders to purchase additional common stock, up to a maximum of$10,000 per month, at a discount (“DSPP”); new investors may participate in theplan, subject to a $250 minimum initial investment. We may, at our solediscretion, permit purchases above the $10,000 stated maximum. The discountsmay range from 0% to 5%, as determined from time to time by us. As of September 30,2009, there are 0.7 million shares that remain available for issuance.  However, in November 2008, we determinedthat participation in these plans would be suspended due to the RegistrationStatement on Form S-3, under which the plans are filed, no longer beingeffective as a result of our SEC filings not being filed timely.

 

**Note9.    Segment Information**

** **

Our principal business activity is to operate and maintainwater and wastewater infrastructure. Through our operating subsidiaries, we own 131 systems and operatehundreds more under contract to cities, utility districts and privatecompanies. We have four reporting segments, and separate our segments first bywhether we own the utility or provide contract services to others. Our ownedwater and wastewater utilities are referred to as our Utilities operations. Inour financial statements we report our Texas utilities operations (“TexasUtilities”) as a separate segment because of different economiccharacteristics. This is primarily because our Texas Utilities areunder-recovering their current cost of service, including a reasonable rate ofreturn, as we have made large investments in these operations that are not yetbeing recovered through the rates we are allowed to charge. Our contractoperations are segmented by contract type into those that are generally larger,stand-alone operations (“O&M Services”), and those that are small, fullservice contracts operated by a common team of personnel whose cost isallocated to a number of clients (“Texas MUD Services”).

 

Thefollowing tables present information about the operations of each segment forthe three- and nine-month periods ended September 30, 2009 and 2008.

 

 

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**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ( UNAUDITED )**

 

 
| ***(In thousands)***                                            | ** ** | ** **    | ** ** | **Texas**     | ** ** | **O&M**  | ** ** | **Texas MUD** | ** ** | ** **    | ** ** | **Consol-** | ** ** |
|-----------------------------------------------------------------|------------|---------------|------------|---------------|------------|--------------|------------|---------------|------------|---------------|------------|-------------|------------|
| *** ***                                                    | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** |
| *** ***                                                    | ** ** | **Utilities** | ** ** | **Utilities** | ** ** | **Services** | ** ** | **Services**  | ** ** | **Corporate** | ** ** | **idated**  | ** ** |
| **Three Months Ended September 30, 2009**                  | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating  revenue                                              |       | $             | 19,332     |          |       | $            | 10,231     |          |       | $             | 9,471      |        |       | $ | 19,950 |   |   | $ | —     |   |   | $ | 58,984 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Expenses:                                                       |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  expenses                                             |       | 11,207        |       |          | 7,674      |         |       | 9,401         |       |          | 19,801     |        |       | 5,438 |   |   | 53,521 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Depreciation  and Amortization                                  |       | 2,007         |       |          | 1,187      |         |       | 140           |       |          | 187        |        |       | 321 |   |   | 3,842 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Total  expenses                                                 |       | 13,214        |       |          | 8,861      |         |       | 9,541         |       |          | 19,988     |        |       | 5,759 |   |   | 57,363 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  income (loss)                                        |       | 6,118         |       |          | 1,370      |         |       | (70           | )          |          | (38        | )           |       | (5,759 | ) |   | 1,621 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Interest  expense                                               |       | (564          | )          |          | (390       | )            |       | (28           | )          |          | (24        | )           |       | (1,396 | ) |   | (2,402 | ) |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Interest  income                                                |       | 25            |       |          | 17         |         |       | —        |       |          | 3          |        |       | — |   |   | 45 |   |   |
| Other  income (expense)                                         |       | 160           |       |          | (276       | )            |       | (69           | )          |          | (77        | )           |       | 262 |   |   | — |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Income  (loss) from continuing

operations  before income taxes |       | $             | 5,739      |          |       | $            | 721        |          |       | $             | (167       | )           |       | $ | (136 | ) |   | $ | (6,893 | ) |   | $ | (736 | ) |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| ***(In thousands)***                                            | ** ** | ** **    | ** ** | **Texas**     | ** ** | **O&M**  | ** ** | **Texas MUD** | ** ** | ** **    | ** ** | **Consol-** | ** ** |
| *** ***                                                    | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** |
| *** ***                                                    | ** ** | **Utilities** | ** ** | **Utilities** | ** ** | **Services** | ** ** | **Services**  | ** ** | **Corporate** | ** ** | **idated**  | ** ** |
| **Three Months Ended September 30, 2008**                  | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating  revenue                                              |       | $             | 18,045     |          |       | $            | 10,020     |          |       | $             | 10,472     |        |       | $ | 18,945 |   |   | $ | —     |   |   | $ | 57,482 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Expenses:                                                       |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  expenses                                             |       | 10,474        |       |          | 6,174      |         |       | 11,249        |       |          | 20,697     |        |       | 4,043 |   |   | 52,637 |   |   |
| Depreciation  and Amortization                                  |       | 1,818         |       |          | 1,071      |         |       | (131          | )          |          | 268        |        |       | 390 |   |   | 3,416 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Total  expenses                                                 |       | 12,292        |       |          | 7,245      |         |       | 11,118        |       |          | 20,965     |        |       | 4,433 |   |   | 56,053 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  income (loss)                                        |       | 5,753         |       |          | 2,775      |         |       | (646          | )          |          | (2,020     | )           |       | (4,433 | ) |   | 1,429 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Interest  expense                                               |       | (542          | )          |          | (398       | )            |       | (1            | )          |          | (33        | )           |       | (1,177 | ) |   | (2,151 | ) |   |
| Interest  income                                                |       | 4             |       |          | 6          |         |       | 3             |       |          | 326        |        |       | 10 |   |   | 349 |   |   |
| Other  income (expense)                                         |       | 115           |       |          | (1,253     | )            |       | (177          | )          |          | 280        |        |       | 1,035 |   |   | — |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Income  (loss) from continuing

operations  before income taxes |       | $             | 5,330      |          |       | $            | 1,130      |          |       | $             | (821       | )           |       | $ | (1,447 | ) |   | $ | (4,565 | ) |   | $ | (373 | ) |   |
|                                                                 |            |               |            |               |            |              |            |               |            |               |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS ( UNAUDITED )**

 

 
| ***(In thousands)***                                            | ** ** | ** **    | ** ** | **Texas**     | ** ** | **O&M**  | ** ** | **Texas MUD** | ** ** | ** **    | ** ** | **Consol-** | ** ** |
|-----------------------------------------------------------------|------------|---------------|------------|---------------|------------|--------------|------------|---------------|------------|---------------|------------|-------------|------------|
| *** ***                                                    | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** |
| *** ***                                                    | ** ** | **Utilities** | ** ** | **Utilities** | ** ** | **Services** | ** ** | **Services**  | ** ** | **Corporate** | ** ** | **idated**  | ** ** |
| **Nine Months Ended September 30, 2009**                   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating  revenue                                              |       | $             | 49,144     |          |       | $            | 27,827     |          |       | $             | 27,599     |        |       | $ | 56,922 |   |   | $ | —    |   |   | $ | 161,492 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Expenses:                                                       |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  expenses                                             |       | 27,928        |       |          | 18,511     |         |       | 27,285        |       |          | 55,745     |        |       | 24,010 |   |   | 153,479 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Depreciation  and Amortization                                  |       | 5,958         |       |          | 3,527      |         |       | 414           |       |          | 600        |        |       | 1,033 |   |   | 11,532 |   |   |
| Impairment  of long-lived assets                                |       | —        |       |          | —     |         |       | —        |       |          | 122        |        |       | 7,993 |   |   | 8,115 |   |   |
| Total  expenses                                                 |       | 33,886        |       |          | 22,038     |         |       | 27,699        |       |          | 56,467     |        |       | 33,036 |   |   | 173,126 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  income (loss)                                        |       | 15,258        |       |          | 5,789      |         |       | (100          | )          |          | 455        |        |       | (33,036 | ) |   | (11,634 | ) |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Interest  expense                                               |       | (1,754        | )          |          | (1,217     | )            |       | (84           | )          |          | (28        | )           |       | (4,182 | ) |   | (7,265 | ) |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Interest  income                                                |       | 78            |       |          | 37         |         |       | 2             |       |          | 8          |        |       | 4 |   |   | 129 |   |   |
| Other  income (expense)                                         |       | 424           |       |          | (704       | )            |       | (216          | )          |          | (248       | )           |       | 744 |   |   | — |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Income  (loss) from continuing

operations  before income taxes |       | $             | 14,006     |          |       | $            | 3,905      |          |       | $             | (398       | )           |       | $ | 187 |   |   | $ | (36,470 | ) |   | $ | (18,770 | ) |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| ***(In thousands)***                                            | ** ** | ** **    | ** ** | **Texas**     | ** ** | **O&M**  | ** ** | **Texas MUD** | ** ** | ** **    | ** ** | **Consol-** | ** ** |
| *** ***                                                    | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **    | ** ** | ** **    | ** ** | ** **  | ** ** |
| *** ***                                                    | ** ** | **Utilities** | ** ** | **Utilities** | ** ** | **Services** | ** ** | **Services**  | ** ** | **Corporate** | ** ** | **idated**  | ** ** |
| **Nine Months Ended September 30, 2008**                   |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  revenue                                              |       | $             | 46,553     |          |       | $            | 26,751     |          |       | $             | 30,559     |        |       | $ | 55,202 |   |   | $ | —    |   |   | $ | 159,065 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Expenses:                                                       |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  expenses                                             |       | 25,920        |       |          | 17,061     |         |       | 31,708        |       |          | 56,613     |        |       | 13,275 |   |   | 144,577 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Depreciation  and Amortization                                  |       | 5,239         |       |          | 3,038      |         |       | (9            | )          |          | 885        |        |       | 1,273 |   |   | 10,426 |   |   |
| Impairment  of long-lived assets                                |       | —        |       |          | 865        |         |       | —        |       |          | 210        |        |       | — |   |   | 1,075 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Total  expenses                                                 |       | 31,159        |       |          | 20,964     |         |       | 31,699        |       |          | 57,708     |        |       | 14,548 |   |   | 156,078 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Operating  income (loss)                                        |       | 15,394        |       |          | 5,787      |         |       | (1,140        | )          |          | (2,506     | )           |       | (14,548 | ) |   | 2,987 |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Interest  expense                                               |       | (1,649        | )          |          | (1,060     | )            |       | (2            | )          |          | (103       | )           |       | (3,550 | ) |   | (6,364 | ) |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Interest  income                                                |       | 28            |       |          | 19         |         |       | 16            |       |          | 375        |        |       | 21 |   |   | 459 |   |   |
| Other  income (expense)                                         |       | 379           |       |          | (3,006     | )            |       | (336          | )          |          | 435        |        |       | 2,528 |   |   | — |   |   |
|                                                            |       |          |       |          |       |         |       |          |       |          |       |        |       |   |   |   |   |   |   |
| Income  (loss) from continuing

operations  before income taxes |       | $             | 14,152     |          |       | $            | 1,740      |          |       | $             | (1,462     | )           |       | $ | (1,799 | ) |   | $ | (15,549 | ) |   | $ | (2,918 | ) |   |

 

 

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**SOUTHWEST WATER COMPANY**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS ( UNAUDITED )**

 

 

**Note 10.     Subsequent Events**

** **

*Dividend Declared*

 

On October 23, 2009 we declaredquarterly cash dividends of $0.05 per share of common stock, an increase fromthe prior quarterly dividend of $0.025 per share, and $0.65625 per share of Series Apreferred stock.  The dividends will bepaid on November 20, 2009 to stockholders of record on November 4,2009.

* *

*Dispute Notificationon E*nvironmental Matters

* *

Somegroundwater sources for our California water utility have been affected bygroundwater contaminants consisting mainly of chemicals disposed of by certaincompanies in the 1940s and 1950s. In 2001 and 2002, this contamination requiredus to shutdown a number of our wells and purchase replacement water at a costsubstantially higher than the cost of water pumped from our own wells.

 

In2002, a Settlement Agreement was reached between some of the parties allegedlyresponsible for the contamination (“Cooperating Respondents”) and certain waterentities, including our California water utility. Under this agreement, we havereceived payments since 2002, and we expect to continue to receive paymentsuntil completion of remediation. These payments are intended to represent theadditional incremental cost of our purchasing water over the cost that wouldhave been incurred by us to pump water from our wells had they not beencontaminated. These reimbursements reduce our operating expenses. Totalreimbursements were $23.9 million from 2002 through September 30, 2009.

 

Thesettlement agreement also provides for contributions by the CooperatingRespondents for construction of new wells and interconnections with nearbywater sources. These contributions totaled $9.9 million through September 30,2009, and were recorded as contributions in aid of construction.

 

InOctober 2009, we received notice from the Cooperating Respondents that asubmission of a major dispute had been filed under the Settlement Agreementquestioning the scope and method of calculating the Cooperating Respondentsobligation to reimburse us. It is not possible at this time to determine withany certainty the likely outcome of this matter nor the cost impact that may beinvolved.

 

 

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**ITEM 2.**** ****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

**SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS**

### ** **

Management’sDiscussion and Analysis of Financial Condition and Results of Operations (“MD&A”)is intended to help the reader understand the results of operations andfinancial condition of SouthWest Water Company. This MD&A also contains “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. All statements containedherein that are not clearly historical in nature are forward-looking, and thewords “anticipate,” “believe,” “belief,” “expect,” “estimate,” “project,” “plan,”“intend,” “continue,” “predict,” “may,” “will,” “should,” “strategy,” “willlikely result,” “will likely continue,” and similar expressions are generallyintended to identify forward-looking statements. Forward-looking statements aresubject to risks and uncertainties that could cause actual results to differmaterially from our historical experience and our present expectations orprojections. A detailed discussion of these and other risks and uncertaintiesthat could cause actual results and events to differ materially from suchforward-looking statements is included in the section entitled “Item 1A. RiskFactors” in our 2008 Annual Report on Form 10-K. Caution should be takennot to place undue reliance on any such forward-looking statements since suchstatements speak only as of the date when made. Other than as required byapplicable law, we undertake no obligation to publicly update or reviseforward-looking statements whether as a result of new information, futureevents, or otherwise.

 

TheMD&A is intended to help the reader understand the results of operations,financial condition and cash flows of SouthWest Water Company and is providedas a supplement to, and should be read in conjunction with, our condensedconsolidated financial statements and the accompanying notes to the financialstatements included in this report.

 

### **OVERVIEW**

### ** **

SouthWest Water’s principal business activity is to own,operate and maintain water and wastewater infrastructure.  Through our operating subsidiaries, we own131 systems and operate hundreds more under contract to cities, utilitydistricts and private companies. SouthWest Water was incorporated in Californiain 1954 and reincorporated in Delaware in 1988. Our corporate offices arelocated in Los Angeles, California.

 

In the past ten years, we have completed 19 acquisitions ofboth utility and contract service businesses. These acquisitions previouslyoperated largely independent of each other, resulting in a complex businessstructure with varying business practices. In 2006, our Board of Directorsappointed a new Chief Executive Officer to, among other things, review ouroperations and plan for future growth. Beginning in 2007, we implementedchanges to better integrate the various segments of the business.  In 2007 and 2008, we made a major change tohow we operate; we consolidated many of the departments that provide commonsupport functions such as environmental health and safety, our financial andaccounting services, information technology and our customer call center. Theseconsolidated departments allocate their costs to each operating segment whereappropriate. In 2008, our operations were divided into four operating segmentsto better focus the distinct strategies of each of our operating businesses.Each segment has imbedded in it the direct operating cost and infrastructure todeliver on its business plan, relying upon the allocated common supportfunctions discussed above. Each operating segment is led by a Managing Directorand a Financial Director.  We believethis management structure brings both direct operational and financialaccountability to each of the operations.

 

As a result of this reorganization, we now have fourreporting segments.  We separate oursegments first by whether we own the utility or we provide contract services toothers. Our owned water and wastewater utilities are referred to as ourUtilities operations. In our financial statements we report our Texas utilityoperations (“Texas Utilities”) as a separate segment because of differenteconomic characteristics. This is principally because the Texas Utilitiespredominantly under-recovering their current cost of service, which includes areasonable return on equity, as we have made large investments in theseoperations since acquisition that are not yet being recovered through the rateswe charge. Our contract operations are segmented by contract type into thosethat are generally larger, stand-alone operations (“O&M Services”) andthose that are small, full service contracts operated by a common team ofpersonnel resulting in a model that proportions a fractional cost to eachclient (“Texas MUD Services”).

 

**Utilities** consist of ourowned water and wastewater utilities located in California, Alabama andMississippi. The New Mexico utility was part of this segment prior to its salein May 2009 (see Note 5 to our Condensed Consolidated FinancialStatements, “Legal Proceedings,” for detailed information on the New Mexicoutility sale). Residential 

 

 

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customers make up the largest component of our Utilitiescustomer base, with these customers representing approximately 91% of our waterand wastewater connections. Substantially all of our Utilities customers aremetered which allows us to measure and bill for each customer’s waterconsumption. Each of the operations in this segment has a unique serviceterritory that is subject to state and federal regulations regarding standardsof water quality, safety, environmental and other matters. The rates that wecan charge for water and wastewater service include the opportunity to earn areasonable rate of return on investments in these utilities as approved bystate regulatory agencies; except for some of our Alabama wastewater rateswhich are governed by our service agreements. Some of these governmentalagencies approve a forward looking recovery of costs and some approve recoveryof costs based on a historical test year (backward looking). Our Utilitiesoperations are characterized by ongoing capital investments to maintain andenhance the reliability and quality of the service we provide, as well asroutine growth from rate increases and new connections.

 

**Texas Utilities** consists of 120small, mostly rural systems that are grouped into nine jurisdictional utilitiesacross Texas. Residential customers make up the largest component of our TexasUtilities customer base, with these customers representing approximately 98% ofour water and wastewater connections. Substantially all of our Texas Utilitiescustomers are metered which allows us to measure and bill for our customers’water consumption. These systems are broadly dispersed geographically. Themajority of the systems are organized as one utility with a single tariff,known as Monarch utilities.  The Monarchutilities, as well as two smaller systems acquired in 2007, were in variousstages of disrepair at the time of acquisition and we continue to spendsignificant amounts of capital to maintain regulatory compliance and to improvethe quality of service. We are not yet recovering all of these costs in ourrates and as a result, we have a lower rate of return than typically expectedfrom a utility. We intend to actively pursue recovery of these costs in therate setting process. All other aspects of operations for these utilities arethe same as our Utilities operations; therefore, as soon as we are recoveringour costs, including a reasonable return on equity, we expect to aggregate thissegment within our Utilities segment.

 

**O&M Services** generally consistsof operations that are project-specific contracts with cities, public agenciesand private owners. Most contracts are stand-alone operations staffed withproject-specific personnel, with an average contract life of two to threeyears. Under a typical O&M contract, we charge a fee that covers aspecified level of service that includes facility operations and maintenanceand may include other water or wastewater related services. Services aretypically provided evenly throughout the contract period and are billed on amonthly basis. If we provide services beyond the scope of a contract, we billfor the additional services on a time-and-materials basis or negotiate a uniqueprice. These contracts are largely located in California, Colorado, Alabama,Mississippi, and Georgia.

 

**Texas MUD Services** is a full serviceprovider of utility services to a large number of small utilities in Texas thatare mostly owned by municipal utility districts (“MUD”). A MUD is created toprovide water supply, wastewater treatment and drainage service to areas wheremunicipal services are not available. We service over 270 MUD clients with acommon team of client managers, operators, customer service and billingpersonnel. Therefore, these contracts are allocated a proportional amount ofeach cost center creating a business model that is significantly different fromthat of O&M Services. Under a typical MUD contract, we bill a monthly basefee to provide a specified level of service; usually water and/or wastewaterfacility inspections, routine operations, equipment maintenance, and utilitycustomer service including meter reading, call center, dispatch, and billingand collection services. We bill for any additional services provided beyondthe basic contract on a time-and-materials basis as such services are rendered.Most contracts provide for an increase in the monthly base fee as the number ofcustomer connections increases and generally include inflation adjustments. Themajority of our MUD contracts are cancelable with 30 to 60 days prior notice byeither party, but tend to last for long periods due to the close workingrelationships between the operators and the clients. No one district representsmore than 5% of the overall revenue of this segment.

 

**Impacts to Results of Operations2009 and 2008**

 

**Utilities & Texas Utilities:**Our utilitiessegments’ results of operations are generally influenced by a variety offactors that are similar between the two segments and the industry in general.A more complete understanding of these factors can be gained by reviewing thissection along with the Risk Factors section in our Form 10-K. As we reviewand discuss performance, the general areas of impact we evaluate are asfollows:

 

§**      Growth Related**: Growth inour utilities segments is generally characterized by the following drivers; 1)growth in the number of connections served within existing utility serviceareas, or 2) acquisition of new service areas. In our Utilities segment, ourlargest utility is our California utility which is a substantially built outsystem that does not generally have much change in connection count. Themajority of our other utilities are in markets that experienced significant newhome construction in the past, however, with the recent decline in the housingmarket, this rate of growth significantly declined throughout 2008 and thefirst three quarters of 2009. Growth through acquisitions occurred in 2008 withthe acquisition of a 4,000 connection wastewater utility system in Alabama inlate January 2008.

 

 

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§**      Rate Related**: Each of ourutilities will increase rates from time to time as allowed by the regulator orgoverning contract, to recover expenses and realize a return on investedcapital. Rate cases can take months or years to impact results due to the timeneeded to prepare, present and ultimately receive approval from the regulator.In each of our utilities, we have a long-term rate strategy that matches ourexpectation for growth, regulatory change and demand. In 2008, we were activelypursuing rate increases in our California, Texas and Alabama utilities. OurTexas Utilities benefited in 2008 from a full year impact of a proposed rateincrease from our 2007 Monarch rate filing, which was resolved through anall-party settlement in December 2008. The settlement resulted in an 8%reduction from proposed rates collected in 2008 and required us to refund anestimated $0.5 million which was recorded in the fourth quarter of 2008.  We will implement a step-rate increase of 8%in March 2010 per the settlement. We also initiated rate increases inthree smaller Texas utilities and reached all-party settlements with two inlate 2008 and the third in the second quarter of 2009. In Alabama we haveagreement with the local government over our Shelby County wastewater utilitythat provides us with the ability to request rate increases annually, andaccordingly, we requested and received an 8% increase in January 2008.

 

Additionally, we were actively working with our regulatorsin 2009 on additional rate cases that will impact 2009 and future periods.Increases that impacted the first three quarters include rate increases inCalifornia and Alabama.  In California weworked with the California Public Utilities Commission (“CPUC”) on our 2009general rate case which was settled in the first quarter of 2009 for an 11%increase over our rates at the beginning of 2008.  In Alabama, we applied for a rate increaseunder our Shelby County and Riverview wastewater utility contracts and receivedpermission to raise rates approximately 14% and 4.5% respectively, in January 2009.

 

§     **Demand Related**: Our utilityresults are largely dependent upon the sale and distribution of water, theamount of which is dependent on seasonal weather fluctuations, particularlyduring the summer months when water demand will vary greatly with rainfall andtemperature levels.  Not only does rainfall vary from season toseason, but from year to year. The uniform rate design that regulators requirefor our utilities can result in unrecovered fixed costs and lower earningsduring periods of lower than expected water use. This can occur during abnormalweather conditions, such as when summer temperatures are cooler than normal orduring mandatory restrictions on water use because of drought. Also, demandrelated changes can occur as a result of conservation and socio-economicimpacts.  In 2008 and the first ninemonths of 2009, we saw increased demand in Texas due to drought conditions andlower demand at our California utility largely due to conservation andgenerally slow economic conditions.

 

§     **Supply Related**: The cost ofwater and related commodities is a major driver of our results. Utilities thatpurchase water are subject to changes in operating results due to the amountand cost of that water. Purchased water supply changes are typically driven bylonger-term climate issues such as extended drought but can also be driven byshort-term maintenance needs. In the first nine months of 2009, we sawincreased cost of purchased water in Texas due to drought conditions and wellrepairs. In California, our unit cost of purchased water has increased;however, our total purchased costs have decreased due to reduced demand as aresult of customer conservation efforts.

 

§     **Operation & MaintenanceRelated**: Our operation and maintenance costs include fuel, power,labor and  benefits, facility costs, andother ordinary costs of producing, treating and delivering water.  These costs are impacted by compliance withenvironmental and health safety standards. They are also typically subject toinflation effects and while we can file for recovery after inflation effectsare incurred in backward looking rate making jurisdictions, we often experiencea lag between the time we incur these costs and when we receive the rateincrease to cover these costs. In California, which is a forward looking ratemaking environment, we estimate the impact of inflation in our rate filings andmust absorb any costs that are higher than our estimates.

 

§     **General & AdministrativeRelated**: Our general and administrative costs include expensesdirectly incurred by the segment such as management expense as well as costsfor services performed by consolidated support functions that are thenallocated to each segment. These support costs include information technology (“IT”),shared financial services, the customer service center, environmental healthand safety and insurance. In 2008, we made large investments in ourconsolidated support functions that drove costs higher in the short term, butwe now have a foundation upon which to drive sustainable continuous improvementinto the organization. As the efficiencies of these investments take hold, wehave targeted objectives to reduce the costs of supporting our operations.

 

§     **Other**: Other isreserved for unusual items that may impact results from time to time. Mostsignificantly in 

 

 

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the first nine months of 2009, we sawan increase in revenue in our California utility as a result of a conservationrate adjustment, an increase in costs in our Mississippi utility due to arefund of sales tax in the comparable prior period, and a reduction in costs inTexas due to a write-off of assets in the comparable prior period.

 

**O&M Services Segment**: Our O&MServices segment results of operations are generally influenced by a variety ofevents. As we review and discuss performance, the general areas of impact weevaluate are as follows:

 

§     **Contract Growth: **Growth is generally due to newcontracts, additional project work under existing contracts and contract priceincreases. Our primary driver of contract growth in the first three quarters of2009 was from expanding the scope of work provided to existing customers.

 

§     **Lost Work: **Lost work is generally driven by lostcontracts or a reduction in project work for existing contracts. The primarydriver in the first three quarters of 2009 was reduced project work as well asour cancellation of two contracts in California in 2008 due in part to the financialunder performance of the contracts.

 

§     **General & AdministrativeRelated: **Our general andadministrative costs include expenses directly incurred by the segment such asmanagement expense as well as costs for services performed by consolidatedsupport functions that are then allocated to each segment. These support costsinclude IT, shared financial services, customer service center, environmentalhealth and safety and insurance.  In2008, we made large investments in our consolidated support functions that havedriven costs higher but we now have a foundation upon which to drivesustainable continuous improvement into the organization. As the efficienciesof these investments take hold, we have targeted objectives to reduce the fixedcosts of supporting our operations.

 

§     **Other: **Other is reserved for unusual itemsthat may impact results from time to time, such as legal fees, fines or theelimination of certain non-core service offerings. Most significantly in thefirst nine months of 2009, we eliminated certain non-core service offerings inColorado and reduced legal costs versus the comparable prior period.

 

**Texas MUD Services Segment**: Our TexasMUD Services segment results of operations are generally influenced by avariety of events. As we review and discuss performance, the general areas ofimpact we evaluate are as follows:

 

§     **Contract Growth: **Growth is generally due to newcontracts, additional project work and contract price increases.  In the first three quarters of 2009, ourgrowth was primarily driven by increases in service order work.

 

§     **Lost Work:**Lost work isgenerally driven by lost contracts, reduction in project work or a reduction inancillary services, such as new taps and inspection services for new homeconstruction.  In the first threequarters of 2009, lost work was primarily driven by lost contracts and the saleof our environmental testing laboratory.

 

§     **General & AdministrativeRelated: **Our general andadministrative costs include expenses directly incurred by the segment such asmanagement expense as well as costs for services performed by consolidatedsupport functions that are then allocated to each segment. These support costsinclude IT, shared financial services, customer service center, environmentalhealth and safety and insurance. In 2008, we made large investments in ourconsolidated support functions that have driven costs higher, but we now have afoundation upon which to drive sustainable continuous improvement into theorganization. As the efficiencies of these investments take hold, we havetargeted objectives to reduce the fixed costs of supporting our operations.

 

§     **Other: **Other is reserved for unusual itemsthat may impact results from time to time.

 

**Corporate Segment**: Our Corporatesegment represents costs related to executive management, investor relations,human resources, general legal and insurance, certain IT functions that supportall operations and public company needs, audit costs, and other expensesgenerally related to the parent organization. Most of the costs are general andadministrative in nature and not subject to much variation.  A portion of these costs are allocated toutilities in rate filings as allowed costs in rates.  In the first nine months of 2009, costs wereprimarily impacted by $12.6 million of expenses associated with our restatementof historical financial results and a charge of $8.0 million related to thewrite-off of Cornerstone assets, net of recoveries from vendors.

 

Onoccasion, we do have other costs that flow through the segment. In 2008, theexpenses associated with the Cornerstone internal-use software developmentproject were largely absorbed by the corporate segment. This project upgradedour core IT infrastructure such as telecommunication, servers and data links.In addition, as of January 1,

 

 

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2008we are operating on a single company-wide financial ledger system. In thefourth quarter of 2008, the remaining portions of the project were put on holdand certain portions of the project were eliminated and in May 2009, basedon additional information, we determined that it was not probable that theimplementation of the remaining uncompleted software modules would be completedwhich generated the write-off discussed above.

 

#### **Acquisitions**

#### ** **

Ourfinancial position, results of operations and cash flows have been affected byour history of acquisitions. Our most recent significant acquisition was madein late January 2008 (“Riverview”), which affects the comparability of thehistorical financial condition and results of operations described in theMD&A, is the acquisition of a Birmingham, Alabama-based wastewatercollection and treatment system. It serves approximately 4,000 residential andcommercial connections in a service area directly adjacent to our existingShelby County collection and treatment system.

 

**Assets Held for Sale and Dispositions**

** **

During2007, we committed to a plan to sell our wholesale water and wastewateroperations in Texas.  In December 2008,we completed the sale of our wholesale wastewater business for net cashproceeds of $2.2 million and a receivable of $0.6 million.  The wastewater treatment plant soldrepresents a portion of the combined water and wastewater operations’ assetsand liabilities. We are uncertain whether we can consummate the sale of theremaining business during 2009; accordingly, the business activity of thewholesale water component is reflected in consolidated continuing operations inall periods presented.

 

Weentered into an agreement to sell the assets of our Southwest EnvironmentalLaboratories, Inc. subsidiary in 2009 for $0.5 million in cash paid atclosing, and up to an additional $0.75 million consisting of 25% of the buyer’squarterly aggregate invoice amounts subsequent to the sale.  The sale closed on April 1, 2009 and theremaining amount due is $0.35 million in cash.

 

InJanuary 2009 we reached a settlement in eminent domain proceedings againstour New Mexico utility, New Mexico Utilities Inc. (“NMUI”). On May 8,2009, net cash proceeds from settlement were $53.9 million and the resultinggain, net of direct transactional costs of $0.1 million, but before taxes was$26.1 million.   Substantially all of theutility plant assets of NMUI were pledged as collateral for $12.3 million infirst mortgage bonds.  We repaid thesebonds in full, including accrued interest of $0.3 million. The remaining cashproceeds of $41.6 million were used to pay the balance of NMUI liabilities, andto pay down our revolving credit facility. The sale reflects a $107.2 millionreduction in assets, offset by reduction in liabilities of $79.5 million, whichincludes a $69.0 million reduction in contributions in aid of construction.

 

### **RESULTS OFOPERATIONS**

### ** **

#### **Three-monthperiod ended September 30, 2009 Compared to 2008**

#### ** **

Consolidatedoperating revenue increased $1.5 million, or 2.6%, to $59.0 million for thethree-month period ended September 30, 2009 from $57.5 million for thesame period in the prior year. Consolidated operating expenses increased $1.3 million, or 2.3%, to$57.4 million for the three-month period ended September 30, 2009 from$56.1 million for the 2008 period. Resulting operating income for the three-monthperiod ended September 30, 2009 was $1.6 million compared to $1.4 millionfor the same period in the prior year. The operating income for the quarter ended September 30, 2009includes the impact of $2.3 million of costs associated with the restatement ofhistorical financial results.

 

 

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| *** ***           | ** ** | ** ** | **Three Months Ended September 30,** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **             |
|------------------------|------------|------------|-------------------------------------------|------------|------------|------------|----------------|------------|------------------------|
| *** ***           | ** ** | ** ** | ** **                                | ** ** | ** ** | ** ** | **Increase**   | ** ** | **Percent of Revenue** | ** ** | ** ** |
| ***(In thousands)***   | ** ** | ** ** | **2009**                                  | ** ** | **2008**   | ** ** | **(decrease)** | ** ** | **2009**               | ** ** | **2008** | ** ** | ** ** |
| **Utilities**          |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| Operating  Revenue     |       |       | $                                         | 19,332     |       | $          | 18,045         |       | $                      | 1,287 |   |   |   |   |   |   |
| Operating  Expenses    |       |       | 13,214                                    |       | 12,292     |       | 922            |       | 68.4                   | % | 68.1 | % |   |
| Operating  Income      |       |       | $                                         | 6,118      |       | $          | 5,753          |       | $                      | 365 |   | 31.6 | % | 31.9 | % |   |
|                   |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| **Texas Utilities**    |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| Operating  Revenue     |       |       | $                                         | 10,231     |       | $          | 10,020         |       | $                      | 211 |   |   |   |   |   |   |
| Operating  Expenses    |       |       | 8,861                                     |       | 7,245      |       | 1,616          |       | 86.6                   | % | 72.3 | % |   |
| Operating  Income      |       |       | $                                         | 1,370      |       | $          | 2,775          |       | $                      | (1,405 | ) | 13.4 | % | 27.7 | % |   |
|                   |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| **O&M Services**   |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| Operating  Revenue     |       |       | $                                         | 9,471      |       | $          | 10,472         |       | $                      | (1,001 | ) |   |   |   |   |   |
| Operating  Expenses    |       |       | 9,541                                     |       | 11,118     |       | (1,577         | )          | 100.7                  | % | 106.2 | % |   |
| Operating  Loss        |       |       | $                                         | (70        | )          | $          | (646           | )          | $                      | 576 |   | (0.7 | %) | (6.2 | %) |   |
|                   |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| **Texas MUD Services** |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| Operating  Revenue     |       |       | $                                         | 19,950     |       | $          | 18,945         |       | $                      | 1,005 |   |   |   |   |   |   |
| Operating  Expenses    |       |       | 19,988                                    |       | 20,965     |       | (977           | )          | 100.2                  | % | 110.7 | % |   |
| Operating  Loss        |       |       | $                                         | (38        | )          | $          | (2,020         | )          | $                      | 1,982 |   | (0.2 | %) | (10.7 | %) |   |
|                   |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| **Corporate**          |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| Operating  Revenue     |       |       | $                                         | —     |       | $          | —         |       | $                      | — |   |   |   |   |   |   |
| Operating  Expenses    |       |       | 5,759                                     |       | 4,433      |       | 1,326          |       |                   |   |   |   |   |
| Operating  Loss        |       |       | $                                         | (5,759     | )          | $          | (4,433         | )          | $                      | (1,326 | ) |   |   |   |   |   |
|                   |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| **Total**              |       |       |                                      |       |       |       |           |       |                   |   |   |   |   |
| Operating  Revenue     |       |       | $                                         | 58,984     |       | $          | 57,482         |       | $                      | 1,502 |   |   |   |   |   |   |
| Operating  Expenses    |       |       | 57,363                                    |       | 56,053     |       | 1,310          |       | 97.3                   | % | 97.5 | % |   |
| Operating  Income      |       |       | $                                         | 1,621      |       | $          | 1,429          |       | $                      | 192 |   | 2.7 | % | 2.5 | % |   |

 

***Utilities***

*** ***
| ***(In thousands)***                              | ** ** | **Operating  Revenue** | ** ** | ** ** | **Operating  Expense** | ** ** | ** ** | **Operating  Income** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|------------|------------------------|------------|------------|-----------------------|------------|
| ** **                                        | ** ** | ** **             | ** ** | ** ** | ** **             | ** ** | ** ** | ** **            | ** ** |
| Three-month  period ended September 30, 2008 |       | $                      | 18,045     |       |                   | $          | 12,292     |                  |       |   $ | 5,753 |   |
| Rate  Related                                     |       | 1,428                  |       |       | -                      |       |       |                  |       |
| Demand  Related                                   |       | (680                   | )          |       | -                      |       |       |                  |       |
| Supply  Related                                   |       | -                      |       |       | 232                    |       |       |                  |       |
| G&A  Related                                  |       | -                      |       |       | 479                    |       |       |                  |       |
| Other                                             |       | 539                    |       |       | 211                    |       |       |                  |       |
| Three-month  period ended September 30, 2009 |       | $                      | 19,332     |       |                   | $          | 13,214     |                  |       |   $ | 6,118 |   |

 

Operatingrevenue increased $1.3 million, or 7.1%, to $19.3 million for three-monthperiod ended September 30, 2009 from $18.0 million for the same period inprior year.  The net increase wasprimarily due to the following events:

 

·                   Rate Related:A $1.4 million increase due to rate increases in California and Alabama, ofwhich $1.2 million is due to our California utility implementing a general rateincrease in January 2009 and $0.2 million is due to rate increases at twoof our Alabama utilities.

 

·                   DemandRelated: A $0.7 million decrease primarily due to reduced consumption at ourCalifornia utility related to customers’ conservation efforts.

 

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·                   Other: A $0.5million increase related to a conservation rate adjustment on revenue.

 

Operatingexpenses increased $0.9 million, or 7.5%, to $13.2 million for the three-monthperiod ended September 30, 2009, from $12.3 million for the same period inthe prior year. The increase was primarily due to the following events:

 

·                   SupplyRelated: A $0.2 million increase primarily due to increased unit cost of waterin California offset by reduced costs due to lower demand.

 

·                   G&ARelated: A $0.5 million increase primarily due to increased costs associatedwith the upgrade of IT and financial systems and insurance related expenses.

 

·                   Other: A $0.2million increase primarily related to legal costs and other settlements.

 

Asa result of the above events, operating income increased $0.4 million to $6.1million for the three-month period ended September 30, 2009 from $5.8million for the same period in the prior year. Operating income includes $0.5 million of Other revenue and $0.2 millionof Other expense for the three-month period ended September 30, 2009.

 

***Texas Utilities***

*** ***
| ***(In thousands)***                              | ** ** | **Operating  Revenue** | ** ** | ** ** | **Operating  Expense** | ** ** | ** ** | **Operating  Income** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|------------|------------------------|------------|------------|-----------------------|------------|
| ** **                                        | ** ** | ** **             | ** ** | ** ** | ** **             | ** ** | ** ** | ** **            | ** ** |
| Three-month  period ended September 30, 2008 |       | $                      | 10,020     |       |                   | $          | 7,245      |                  |       |   $ | 2,775 |   |
| Rate  Related                                     |       | 89                     |       |       | -                      |       |       |                  |       |
| Demand  Related                                   |       | 122                    |       |       | -                      |       |       |                  |       |
| Supply  Related                                   |       | -                      |       |       | 239                    |       |       |                  |       |
| O&M  Related                                  |       | -                      |       |       | 969                    |       |       |                  |       |
| G&A  Related                                  |       | -                      |       |       | 258                    |       |       |                  |       |
| Other                                             |       | -                      |       |       | 150                    |       |       |                  |       |
| Three-month  period ended September 30, 2009 |       | $                      | 10,231     |       |                   | $          | 8,861      |                  |       |   $ | 1,370 |   |

 

Operatingrevenue increased $0.2 million, or 2.1%, to $10.2 million for three-monthperiod ended September 30, 2009 from $10.0 million for the same period inprior year. The increase was primarily due to the following events:

 

·                   Rate Related:A $0.1 million increase due to rate increases at one utility implemented duringthe fourth quarter of 2008 and a step-increase in rates at another utilityduring the first quarter of 2009. These increases were partially offset by adecrease due to settlement of rates at our Monarch utility which were belowproposed rates charged in the third quarter of 2008.

 

·                   DemandRelated: A $0.1 million increase due to increased consumption associated withhot and dry weather patterns.

 

Operatingexpenses increased $1.6 million, or 22.3%, to $8.9 million for the three-monthperiod ended September 30, 2009, from $7.2 million for the same period inthe prior year.  The increase wasprimarily due to the following events:

 

·                   SupplyRelated: A $0.2 million increase due to higher cost of purchased water as aresult of well repairs requiring a temporary alternate source of supply.

 

·                   O&MRelated: A $1.0 million increase, driven by asset retirements, increaseddepreciation expenses and repair and maintenance costs.

 

·                   G&ARelated: A $0.3 million increase primarily due to increased IT, supportfunctions, and insurance expenses.

 

·                   Other: A $0.2million increase related to severance expense.

 

Asa result of the above events, operating income decreased $1.4 million, to $1.4million for the three-month period ended September 30, 2009, from incomeof $2.8 million for the same period in the prior year.

 

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***O&M Services***

*** ***
| ***(In thousands)***                              | ** ** | **Operating  Revenue** | ** ** | ** ** | **Operating  Expense** | ** ** | ** ** | **Operating  loss** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|------------|------------------------|------------|------------|---------------------|------------|
| ** **                                        | ** ** | ** **             | ** ** | ** ** | ** **             | ** ** | ** ** | ** **          | ** ** |
| Three-month  period ended September 30, 2008 |       | $                      | 10,472     |       |                   | $          | 11,118     |                |       | $ | (646) |   |
| Contract  Growth                                  |       | 729                    |       |       | 120                    |       |       |                |       |
| Lost  Work                                        |       | (1,568                 | )          |       | (1,857                 | )          |       |                |       |
| Other                                             |       | (162                   | )          |       | 160                    |       |       |                |       |
| Three-month  period ended September 30, 2009 |       | $                      | 9,471      |       |                   | $          | 9,541      |                |       | $ | (70) |   |

 

Operatingrevenue decreased $1.0 million, or 9.6%, to $9.5 million for the three-monthperiod ended September 30, 2009 from $10.5 million for the same period inthe prior year. The net decrease in revenue was primarily due to the followingevents:

 

·                   ContractGrowth: A $0.7 million increase, primarily due to price and scope increases.

 

·                   Lost Work: A$1.6 million decrease due to $1.2 million from lost contracts, which includes$0.9 million related to two underperforming contracts that were terminated bymanagement in late 2008, and $0.4 million from reduced project work.

 

·                   Other: A $0.2million decrease as we stopped certain non-core service offerings in Colorado.

 

Operatingexpenses decreased $1.6 million, or 14.2%, to $9.5 million for the three-monthperiod ended September 30, 2009, from $11.1 million for the same period inthe prior year.  The net decrease wasprimarily due to the following events:

 

·                   ContractGrowth: A $0.1 million increase due to expanded scope on contracts identifiedabove.

 

·                   Lost Work: A$1.9 million decrease due to lost contracts and reduced project work.

 

·                   Other: A $0.2million increase primarily due to a favorable settlement of outstandinglitigation in the third quarter of 2008, offset by a decrease in expense as westopped pursuing certain service offerings in Colorado.

 

Asa result of the above events, operating loss narrowed to a loss of $0.1 millionfor the three-month period ended September 30, 2009, from a loss of $0.6million for the same period in the prior year.

 

***Texas MUD Services***

*** ***
| ***(In thousands)***                              | ** ** | **Operating  Revenue** | ** **   | ** ** | **Operating  Expense** | ** ** | ** **   | **Operating  loss** | ** ** |
|---------------------------------------------------|------------|------------------------|--------------|------------|------------------------|------------|--------------|---------------------|------------|
| ** **                                        | ** ** | ** **             | ** **   | ** ** | ** **             | ** ** | ** **   | ** **          | ** ** |
| Three-month  period ended September 30, 2008 |       | $                      | 18,945  |       |                   | $          | 20,965  |                |       |   $ | (2,020 | ) |
| Contract  Growth                                  |       | 3,065             |         |       | 2,296             |       |         |                |       |
| Lost  Work                                        |       | (2,060)                |         |       | (1,718)                |       |         |                |       |
| G&A  Related                                  |       | -                 |         |       | (1,876)                |       |         |                |       |
| Other                                             |       | -                 |         |       | 321               |       |         |                |       |
| Three-month  period ended September 30, 2009 |       | $                      | 19,950  |       |                   | $          | 19,988  |                |       |   $ | (38 | ) |

 

Operatingrevenue increased $1.0 million, or 5.3%, to $20.0 million for three-monthperiod ended September 30, 2009 from $18.9 million for the same period inthe prior year. The net increase was primarily due to the following events:

 

·                   ContractGrowth: A $3.1 million increase due to increased service order work, generallyrelated to repairs and maintenance work associated with hot and dry weatherpatterns.

 

·                   Lost Work: A$2.1 million decrease primarily due to a $0.6 million decrease in new housingrelated services, a $0.7 million decrease related to the sale of ourenvironmental testing laboratory on April 1, 2009, and $0.7 million due tolost contracts.

 

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Operatingexpenses decreased $1.0 million, or 4.7%, to $20.0 million for the three-monthperiod ended September 30, 2009, from $21.0 million for the same period inthe prior year.  The net decrease wasprimarily due to the following events:

 

·                   ContractGrowth: A $2.3 million increase related to increases in service and maintenancework orders.

 

·                   Lost Work: A$1.7 million decrease due to $1.5 million related to lost contracts and $0.2 millionfrom the sale of our environmental testing laboratory on April 1, 2009.

 

·                   G&ARelated: A $1.9 million decrease, primarily due to cost savings across multiplegeneral and administrative costs.

 

·                   Other:  A $0.3 million increase primarily related tothe settlement of a historical legal issue.

 

Asa result of the above events, operating income improved $2.0 million tobreak-even for the three-month period ended September 30, 2009, comparedto a loss of $2.0 million for the same period in the prior year.  Operating income for the three-month periodended September 30, 2009 includes Other expense of $0.3 million.

 

***Corporate***

 

Operatingexpenses increased $1.4 million to $5.8 million for the three-month periodended September 30, 2009, from $4.4 million for the same period in theprior year. The net increase was primarily due to the following events:

 

·                   ProjectCosts: A $0.6 million decrease as a result of costs incurred in the thirdquarter of 2008 related to our Cornerstone internal-use software developmentproject. In May 2009 the project was terminated.

 

·                   G&ARelated: A $0.3 million decrease primarily due to reductions in generalexpenses and a previously accrued performance bonus.

 

·                   Other: A $2.2million increase, primarily driven by $2.3 million of financial restatementrelated costs, including audit fees and accounting resource expenses to supportthe restatement of historical financial results and prior period SEC filingscompleted in the quarter, offset by a $0.2 million decrease associated with consultingexpenses in the comparable prior period.

 

**Other Income (Expense)**

 

Aggregateother expenses increased $0.6 million, or 30.8%, to $2.4 million for thethree-month period ended September 30, 2009, compared to $1.8 million forthe same period in the prior year as follows:

 
| ** **           | ** ** | **Three-month period ended** | ** ** | ** ** | ** ** |
|----------------------|------------|------------------------------|------------|------------|------------|
| ** **           | ** ** | **September 30,**       | ** ** | ** ** | ** ** |
| ***(In thousands)*** | ** ** | **2009**                     | ** ** | **2008**   | ** ** | **Change** | ** ** |
| Interest  expense    |       | $                            | (2,402)    |       | $          | (2,151) |   | $ | (251) |   |
| Interest  income     |       | 45                      |       | 349   |       | (304) |   |
| Total                |       | $                            | (2,357)    |       | $          | (1,802) |   | $ | (555) |   |

 

***Interest Expense.***Interestexpense increased by $0.3 million, or 11.7%, to $2.4 million for thethree-month period ended September 30, 2009 from $2.1 million for the sameperiod during the prior year primarily as a result of an increase inamortization of debt issuance cost due to recent amendments to our line ofcredit arrangements that resulted in an additional deferred debt issuance costin 2009.

 

Thebalance of the change in interest expense is due to increased interest ratesand lower average outstanding debt balances. The weighted average annual interest rate on total borrowings wasapproximately 6.3% at September 30, 2009 and 4.4% for the same period inthe prior year.  The average balance ofinterest-bearing debt outstanding decreased to $153.2 million during the three-monthperiod ended September 30, 2009 compared to $194.0 million for the sameperiod in the prior year.

 

**Provision for Income Taxes**

 

Oureffective consolidated income tax rate on continuing operations was a benefitof 32.2% for the three-month period ended September 30, 2009 compared to abenefit of 34.9% for the same period in 2008. The effective rate in 

 

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2009and 2008 was lower than the expected statutory rate due to the effect of theTexas Franchise Tax which reduced our overall income tax benefit.

 

#### **Nine-monthperiod ended September 30, 2009 Compared to 2008**

#### ** **

Consolidatedoperating revenue increased $2.4 million, or 1.5%, to $161.5 million for thenine-month period ended September 30, 2009 from $159.1 million for thesame period in the prior year. Consolidated operating expenses increased $17.0 million, or 10.9%, to $173.1million for the nine-month period ended September 30, 2009 from $156.1million for the comparable 2008 period. Resulting operating income decreased $14.6 million to a loss of $11.6million for the nine-month period ended September 30, 2009, from operatingincome of $3.0 million for the same period in the prior year.  The operating loss for the nine-month periodended September 30, 2009 includes the impact to operating income of $12.6million of costs associated with the restatement of historical financialresults, and $8.0 million of impairment of assets related to the Cornerstoneproject, as well as other items as described below.  The operations of our New Mexico utility arenot reflected in the results below, as it was sold in May 2009 and is,therefore, part of discontinued operations for the periods prior to the sale.

 
| ** **               | ** ** | ** ** | **Nine Months Ended September 30,** | ** ** | ** **      | ** ** | ** **     | ** ** | ** **             |
|--------------------------|------------|------------|------------------------------------------|------------|-----------------|------------|----------------|------------|------------------------|
| ** **               | ** ** | ** ** | ** **                               | ** ** | **2008**        | ** ** | **Increase**   | ** ** | **Percent of Revenue** | ** ** | ** ** |
| ***(In thousands)***     | ** ** | ** ** | **2009**                                 | ** ** | **As Restated** | ** ** | **(decrease)** | ** ** | **2009**               | ** ** | **2008** | ** ** | ** ** |
| **Utilities**            |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| Operating  Revenue       |       |       | $                                        | 49,144     |            | $          | 46,553         |       | $                      | 2,591 |   |   |   |   |   |   |
| Operating  Expenses      |       |       | 33,886                                   |       | 31,159          |       | 2,727          |       | 69.0                   | % | 66.9 | % |   |
| Operating  Income        |       |       | $                                        | 15,258     |            | $          | 15,394         |       | $                      | (136 | ) | 31.0 | % | 33.1 | % |   |
|                     |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| **Texas Utilities**      |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| Operating  Revenue       |       |       | $                                        | 27,827     |            | $          | 26,751         |       | $                      | 1,076 |   |   |   |   |   |   |
| Operating  Expenses      |       |       | 22,038                                   |       | 20,964          |       | 1,074          |       | 79.2                   | % | 78.4 | % |   |
| Operating  Income        |       |       | $                                        | 5,789      |            | $          | 5,787          |       | $                      | 2 |   | 20.8 | % | 21.6 | % |   |
|                     |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| **O&M Services**     |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| Operating  Revenue       |       |       | $                                        | 27,599     |            | $          | 30,559         |       | $                      | (2,960 | ) |   |   |   |   |   |
| Operating  Expenses      |       |       | 27,699                                   |       | 31,699          |       | (4,000         | )          | 100.4                  | % | 103.7 | % |   |
| Operating  Loss          |       |       | $                                        | (100       | )               | $          | (1,140         | )          | $                      | 1,040 |   | (0.4 | %) | (3.7 | %) |   |
|                     |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| **Texas MUD Services**   |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| Operating  Revenue       |       |       | $                                        | 56,922     |            | $          | 55,202         |       | $                      | 1,720 |   |   |   |   |   |   |
| Operating  Expenses      |       |       | 56,467                                   |       | 57,708          |       | (1,241         | )          | 99.2                   | % | 104.5 | % |   |
| Operating  Income (Loss) |       |       | $                                        | 455        |            | $          | (2,506         | )          | $                      | 2,961 |   | 0.8 | % | (4.5 | %) |   |
|                     |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| **Corporate**            |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| Operating  Revenue       |       |       | $                                        | —     |            | $          | —         |       | $                      | — |   |   |   |   |   |   |
| Operating  Expenses      |       |       | 33,036                                   |       | 14,548          |       | 18,488         |       |                   |   |   |   |   |
| Operating  Loss          |       |       | $                                        | (33,036    | )               | $          | (14,548        | )          | $                      | (18,488 | ) |   |   |   |   |   |
|                     |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| **Total**                |       |       |                                     |       |            |       |           |       |                   |   |   |   |   |
| Operating  Revenue       |       |       | $                                        | 161,492    |            | $          | 159,065        |       | $                      | 2,427 |   |   |   |   |   |   |
| Operating  Expenses      |       |       | 173,126                                  |       | 156,078         |       | 17,048         |       | 107.2                  | % | 98.1 | % |   |
| Operating  Income (Loss) |       |       | $                                        | (11,634    | )               | $          | 2,987          |       | $                      | (14,621 | ) | (7.2 | %) | 1.9 | % |   |

 

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***Utilities***

 
| ***(In thousands)***                             | ** ** | **Operating  Revenue** | ** ** | ** ** | **Operating  Expense** | ** ** | ** ** | **Operating  Income** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|------------|------------------------|------------|------------|-----------------------|------------|
| ** **                                       | ** ** | ** **             | ** ** | ** ** | ** **             | ** ** | ** ** | ** **            | ** ** |
| Nine-month  period ended September 30, 2008 |       | $                      | 46,553     |       |                   | $          | 31,159     |                  |       | $ | 15,394 |   |
| Growth  Related                                  |       | 490                    |       |       | 278                    |       |       |                  |       |
| Rate  Related                                    |       | 3,988                  |       |       | -                      |       |       |                  |       |
| Demand  Related                                  |       | (2,094                 | )          |       | -                      |       |       |                  |       |
| Supply  Related                                  |       | -                      |       |       | (373                   | )          |       |                  |       |
| O&M  Related                                 |       | -                      |       |       | 185                    |       |       |                  |       |
| G&A  Related                                 |       | -                      |       |       | 2,017                  |       |       |                  |       |
| Other                                            |       | 207                    |       |       | 620                    |       |       |                  |       |
| Nine-month  period ended September 30, 2009 |       | $                      | 49,144     |       |                   | $          | 33,886     |                  |       | $ | 15,258 |   |

 

Operatingrevenue increased $2.6 million, or 5.6%, to $49.1 million for nine-month periodended September 30, 2009 from $46.6 million for the same period in theprior year.  The net increase wasprimarily due to the following events:

 

·                   GrowthRelated: A $0.5 million increase primarily due to the acquisition of theRiverview wastewater treatment plant in Alabama at the end ofJanuary 2008.

 

·                   Rate Related:A $4.0 million increase due to rate increases in California and Alabama, ofwhich $3.4 million is due to our California utility implementing a step-rateincrease in July 2008 and general rate increase in January 2009, and$0.5 million is due to rate increases at two of our Alabama utilities.

 

·                   DemandRelated: A $2.1 million decrease primarily due to reduced consumption at ourCalifornia utility related to customers’ conservation efforts.

 

·                   Other: A $0.2million increase related to a conservation rate adjustment on revenue.

 

Operatingexpenses increased $2.7 million, or 8.8%, to $33.9 million for the nine-monthperiod ended September 30, 2009, from $31.2 million for same period in theprior year.  The net increase wasprimarily due to the following events:

 

·                   GrowthRelated: A $0.3 million increase due to the acquisition of the Riverviewwastewater treatment plant in Alabama at the end of January 2008.

 

·                   SupplyRelated: A $0.4 million decrease primarily due to lower purchased water inCalifornia driven by lower demand.

 

·                   O&MRelated: A $0.2 million increase primarily due to increased depreciationexpense.

 

·                   G&ARelated: A $2.0 million increase primarily due to increased costs associatedwith the upgrade of IT and financial systems, lower overhead recovery due tofewer capital projects than in the comparable prior period, and insurancerelated expenses.

 

·                   Other: A $0.6million increase, primarily due to a refund of sales tax at our Mississippiutility that was received in the second quarter of 2008 and an increase inlegal expenses.

 

Asa result of the above events, operating income decreased $0.1 million, to $15.3million for the nine-month period ended September 30, 2009, from $15.4million for the same period in the prior year.

 

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***Texas Utilities***

 
| ***(In thousands)***                             | ** ** | **Operating  Revenue**                                                    | ** ** | ** ** | **Operating  Expense**                                                    | ** ** | ** ** | **Operating  Income**                                                    | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------------------------|------------|------------|---------------------------------------------------------------------------|------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | ** **                                                                | ** ** | ** ** | ** **                                                                | ** ** | ** ** | ** **                                                               | ** ** |
| Nine-month  period ended September 30, 2008 |       | $           26,751 |       |       | $           20,964 |       |       | $           5,787 |       |
| Growth  Related                                  |       | (58                                                                       | )          |       | -                                                                         |       |       |                                                                     |       |
| Rate  Related                                    |       | 543                                                                       |       |       | -                                                                         |       |       |                                                                     |       |
| Demand  Related                                  |       | 591                                                                       |       |       | -                                                                         |       |       |                                                                     |       |
| Supply  Related                                  |       | -                                                                         |       |       | 381                                                                       |       |       |                                                                     |       |
| O&M  Related                                 |       | -                                                                         |       |       | 1,063                                                                     |       |       |                                                                     |       |
| G&A  Related                                 |       | -                                                                         |       |       | 345                                                                       |       |       |                                                                     |       |
| Other                                            |       | -                                                                         |       |       | (715                                                                      | )          |       |                                                                     |       |
| Nine-month  period ended September 30, 2009 |       | $           27,827 |       |       | $           22,038 |       |       | $           5,789 |       |

 

Operatingrevenue increased $1.1 million, or 4.0%, to $27.8 million for nine-month periodended September 30, 2009 from $26.8 million for the same period in prioryear. The net increase was primarily due to the following events:

 

·      Growth Related: A $0.1 million decrease due to theslowdown in housing growth reducing taps and inspection revenue.

 

·      Rate Related: A $0.5 million increase comprised ofincreases at two small utilities implemented in the latter half of 2008 and astep-increase in rates at one utility during the first quarter of 2009, offsetby a decrease due to settlement of rates at our Monarch utility which werebelow proposed rates charged in the second and third quarter of 2008.

 

·      Demand Related: A $0.6 million increase due toincreased consumption associated with hot and dry weather patterns.

 

Operatingexpenses increased $1.1 million, or 5.1%, to $22.0 million for the nine-monthperiod ended September 30, 2009, from $21.0 million for the same period inthe prior year.  The net increase wasprimarily due to the following events:

 

·      Supply Related: A $0.4 million increase due toincreased purchased water as a result of the inability of our owned sources ofground water to produce enough water due to ongoing drought conditions and wellrepairs requiring a temporary alternate source of supply.

 

·      O&M Related: A $1.1 million increase, primarilydriven by an increase in asset retirements, depreciation costs, and repairs andmaintenance costs.

 

·      G&A Related: A $0.3 million increase primarily dueto increased costs associated with the implementation of our strategy toconsolidate support functions and insurance related expenses.

 

·      Other: A $0.7 million decrease due to the write-off ofassets in the second quarter of 2008 related to a wholesale water operation,offset by severance expenses.

 

Asa result of the above events, operating income was $5.8 million for thenine-month period ended September 30, 2009 compared to $5.8 million forthe same period in 2008.

 

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***O&M Services***

 
| ***(In  thousands)***                            | ** ** | **Operating  Revenue**                                                    | ** ** | ** ** | **Operating  Expense**                                                    | ** ** | ** ** | **Operating  loss**                                                            | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------------------------|------------|------------|---------------------------------------------------------------------------|------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | ** **                                                                | ** ** | ** ** | ** **                                                                | ** ** | ** ** | ** **                                                                     | ** ** |
| Nine-month period ended  September 30, 2008 |       | $           30,559 |       |       | $           31,699 |       |       | $         (1,140)                 |       |
| Contract  Growth                                 |       | 2,251                                                                     |       |       | 897                                                                       |       |       |                                                                           |       |
| Lost  Work                                       |       | (4,622                                                                    | )          |       | (4,919                                                                    | )          |       |                                                                           |       |
| G&A  Related                                 |       | -                                                                         |       |       | 60                                                                        |       |       |                                                                           |       |
| Other                                            |       | (589                                                                      | )          |       | (38                                                                       | )          |       |                                                                           |       |
| Nine-month period ended  September 30, 2009 |       | $           27,599 |       |       | $           27,699 |       |       | $            (100) |       |

 

Operatingrevenue decreased $3.0 million, or 9.7%, to $27.6 million for the nine-monthperiod ended September 30, 2009 from $30.6 million for the same period inthe prior year. The net decrease in revenue was primarily due to the followingevents:

 

·      Contract Growth: A $2.3 million increase, primarilydue to increased project work and price and scope increases.

 

·      Lost Work: A $4.6 million decrease due to $3.2 millionfrom lost contracts, including $1.8 million related to two underperformingcontracts that were terminated by management in late 2008 as well as $1.4million from reduced project work.

 

·      Other: A $0.6 million decrease as we stopped certainnon-core service offerings in Colorado.

 

Operatingexpenses decreased $4.0 million, or 12.6%, to $27.7 million for the nine-monthperiod ended September 30, 2009, from $31.7 million for the same period inthe prior year.  The net decrease was primarilydue to the following events:

 

·      Contract Growth: A $0.9 million increase due to newand expanded scope on contracts identified above.

 

·      Lost Work: A $4.9 million decrease due to lostcontracts and reduced project work.

 

·      G&A related: A $0.1 million increase due to costsrelated to implementation of our strategy to consolidate support functions.

 

Asa result of the above events, operating loss narrowed to $0.1 million for thenine-month period ended September 30, 2009, from a loss of $1.1 million forthe same period in the prior year.

 

***Texas MUD Services***

*** ***
| ***(In thousands)***                             | ** ** | **Operating  Revenue**                                                    | ** ** | ** ** | **Operating  Expense**                                                    | ** ** | ** ** | **Operating  Income (loss)**                                                             | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------------------------|------------|------------|---------------------------------------------------------------------------|------------|------------|------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | ** **                                                                | ** ** | ** ** | ** **                                                                | ** ** | ** ** | ** **                                                                               | ** ** |
| Nine-month  period ended September 30, 2008 |       | $           55,202 |       |       | $           57,708 |       |       | $          (2,506)                     |       |
| Contract  Growth                                 |       | 7,384                                                                     |       |       | 5,311                                                                     |       |       |                                                                                     |       |
| Lost  Work                                       |       | (5,664                                                                    | )          |       | (4,182                                                                    | )          |       |                                                                                     |       |
| G&A  Related                                 |       | -                                                                         |       |       | (2,476                                                                    | )          |       |                                                                                     |       |
| Other                                            |       | -                                                                         |       |       | 106                                                                       |       |       |                                                                                     |       |
| Nine-month  period ended September 30, 2009 |       | $           56,922 |       |       | $           56,467 |       |       | $              455 |       |

 

Operatingrevenue increased $1.7 million, or 3.1%, to $56.9 million for nine-month periodended September 30, 2009 from $55.2 million for the same period in theprior year. The net increase was primarily due to the following events:

 

·      Contract Growth: A $7.4 million increase due toincreases in service order work.

 

·      Lost Work: A $5.7 million decrease due to a $1.8million decrease in new housing related services, a $2.5 million decrease dueto lost contracts, and a $1.4 million decrease related to the sale of ourenvironmental testing laboratory on April 1, 2009.

 

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Operatingexpenses decreased $1.2 million, or 2.2%, to $56.5 million for the nine-monthperiod ended September 30, 2009, from $57.7 million for the same period inthe prior year.  The net decrease wasprimarily due to the following events:

 

·      Contract Growth: A $5.3 million increase primarilyrelated to increases in service and maintenance work orders.

 

·      Lost Work: A $4.2 million decrease related to lostwork, including $1.6 million due to the sale of our environmental testinglaboratory.

 

·      G&A Related: A $2.5 million decrease, primarilydue to various savings and efficiency gains in multiple general andadministrative costs.

 

·      Other:  A $0.1million increase related to the settlement of a legal issue, offset byimpairment of long-lived assets in the comparable period of 2008.

 

Asa result of the above events, operating income increased $3.0 million to $0.5million for the nine-month period ended September 30, 2009, compared to anoperating loss of $2.5 million for the same period in the prior year.

 

***Corporate***

 

Operatingexpenses increased $18.5 million, to $33.0 million for the nine-month periodended September 30, 2009, from $14.5 million for the same period in theprior year.

 

Thenet increase was primarily due to the following events:

 

·      Project Costs: A $2.2 million decrease as a result ofcosts incurred in the first nine months of 2008 related to our Cornerstoneinternal-use software development project. In October 2008, we announcedthe suspension of the project due to the uncertain financial markets that ledto the decision to minimize all cash expenditures.

 

·      G&A Related: A $0.3 million increase primarily dueto increases in multiple general and administrative costs.

 

·      Other: A $20.3 million increase, primarily driven by$12.6 million of financial restatement related costs, including audit fees andaccounting resource expenses to support the restatement of historical financialresults, and $8.0 million related to a write-off of Cornerstone assets net ofrecoveries from vendors, offset by reduced costs associated with consultingexpenses in the comparable prior period.

 

**Other Income (Expense)**

 

Aggregateother expenses increased $1.2 million, or 20.8%, to $7.1 million for thenine-month period ended September 30, 2009, compared to $5.9 million forthe same period in the prior year as follows:

 
| ** **           | ** ** | **Nine-month period ended** | ** ** | ** ** | ** ** |
|----------------------|------------|-----------------------------|------------|------------|------------|
| ** **           | ** ** | **September 30,**      | ** ** | ** ** | ** ** |
| ***(In thousands)*** | ** ** | **2009**                    | ** ** | **2008**   | ** ** | **Change** | ** ** |
| Interest  expense    |       | $                           | (7,265     | )          | $          | (6,364 | ) | $ | (901 | ) |
| Interest  income     |       | 129                         |       | 459        |       | (330 | ) |
| Total                |       | $                           | (7,136     | )          | $          | (5,905 | ) | $ | (1,231 | ) |

 

***Interest Expense.***Interestexpense increased by $0.9 million, or 14.2%, to $7.3 million for the nine-monthperiod ended September 30, 2009 from $6.4 million for the same periodduring the prior year.

 

Thechange in total interest incurred is partially the result of a $0.4 millionacceleration of deferred financing costs due to an amendment to the creditfacility in May 2009.  The balanceof the change is due to increased interest rates.  The weighted average annual interest rate ontotal borrowings was approximately 5.6% for the nine-month period ended September 30,2009 and 4.7% for the same period in the prior year. The increased rates ofinterest were caused in part by the increases of 3% and 2.75% in our marginsover the LIBOR and prime rate indexes under our amended credit facilityagreement. These increases were offset by a decrease in borrowing levels. Theaverage balance of interest-bearing debt outstanding decreased to $173.9million during the nine-month period ended September 30, 2009 compared to$179.7 million for the same period in the prior year.

 

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**Provision for Income Taxes**

 

Oureffective consolidated income tax rate on continuing operations was a benefitof 36.2% for the nine-month period ended September 30, 2009 compared to abenefit of 35.6% for the same period in 2008. The effective rate in 2009 and 2008 was lower than the expectedstatutory rate due to the effect of the Texas Franchise Tax which reduced ouroverall income tax benefit.

 

**Income (loss) from Discontinued Operations**

 

Income from discontinued operations of $17.7 million duringthe nine-month period ended September 30, 2009 reflects primarily the$16.7 million gain on sale of our New Mexico utility, net of tax. The salereflects a $107.2 million reduction in assets, offset by a reduction inliabilities of $79.5 million which include a $69.0 million of contributions inaid of construction.  Prior year lossfrom discontinued operations includes results of our New Mexico utility, offsetby losses associated with a wholesale wastewater business sold late in 2008.

 

**RECENT ACCOUNTINGPRONOUNCEMENTS**

 

Seethe discussion under the caption “Recent Accounting Pronouncements” containedin Note 1 to the Condensed Consolidated Financial Statements included in Part I,Item 1 of this report.

 

### **LIQUIDITY ANDCAPITAL RESOURCES**

### ** **

Ouroverall objectives with respect to liquidity and capital resources are to:

 

·      Generate sufficient operating cash flows to serviceour debt and tax obligations, fund capital improvements and organic growth, andpay dividends to our stockholders;

 

·      Utilize our credit facility for minor capitalimprovements and to manage seasonal cash needs;

 

·      Obtain external financing for significantacquisitions; and

 

·      Achieve approximately equal levels of debt and equityconsistent with the investor-owned water utility industry.

 

Our statements of cash flows are summarized as follows:

 
| ** **                             | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------------------|------------|------------|------------|
| ** **                             | ** ** | **September 30,** | ** ** | ** ** | ** ** |
| ***(In thousands)***                   | ** ** | **2009**               | ** ** | **2008**   | ** ** | **Change** | ** ** |
| Net  Cash provided by (used in):       | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Continuing  operations:                |       |                   |       |       |       |   |   |
| Operating  activities                  |       | $                      | 7,352      |       | $          | 277 |   | $ | 7,075 |   |
| Investing  activities                  |       | 42,218                 |       | (48,291    | )          | 90,509 |   |
| Financing  activities                  |       | (39,112                | )          | 46,798     |       | (85,910 | ) |
| Total  continuing operations           |       | 10,458                 |       | (1,216     | )          | 11,674 |   |
| Discontinued  operations:              |       |                   |       |       |       |   |   |
| Total  discontinued operations         |       | (9,977                 | )          | 1,519      |       | (11,496 | ) |
|                                   |       |                   |       |       |       |   |   |
| Increase  in cash and cash equivalents |       | $                      | 481        |       | $          | 303 |   | $ | 178 |   |

 

**Cash Flows from Operating Activities of Continuing Operations.**Net cashprovided by operating activities was $7.4 million for the nine-months ended September 30,2009 versus $0.3 million for the same period last year.  Operational aspects of our businesses thataffected working capital in the nine months ended September 2009 versusthe comparable period in 2008, are highlighted below:

 

·      Net income of $5.8 million, as compared to a net lossof $2.0 million in 2008;

 

·      Non-cash operating expense items of $24.7 million, ascompared to $15.0 million in 2008;

 

·      Income from discontinued operations of $17.7 million,as compared to a loss of $0.1 million in 2008; and,

 

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·      Changes in operating assets and liabilities decreasingcash by $5.4 million, as compared to $12.8 million in 2008.

 

**Cash Flows from Investing Activities of Continuing Operations.**Cash providedby investing activities totaled $42.2 million, representing proceeds from thesale of businesses and related property, plant and equipment of $54.4 million(primarily New Mexico Utility Inc. “NMUI”). This was offset by capital investments in property, plant and equipmentof $12.3 million.

 

**Cash Flows from Financing Activities of Continuing Operations.**Cash used infinancing activities totaled $39.1 million, primarily related to net repaymentsof our long-term debt of $13.7 million, our credit facility of $23.5 millionand the payment of $2.7 million of deferred financing costs related to amendingour credit facility, offset by capital improvement reimbursements of $3.2million.

 

Ourcredit facility was primarily used to fund our investing activities and, to alesser extent, to manage seasonal cash needs. Additional borrowing availability under our revolving credit facilitywas $32.2 million as of September 30, 2009.

 

Duringthe nine-month period ended September 30, 2009, we declared two quarterlycash dividends of $0.025 per share on common stock and $0.65625 per share of Series Apreferred stock on both April 9, 2009 and July 12, 2009. Thedividends were paid on May 5, 2009 and July 27, 2009,respectively.  Quarterly cash dividendsin the same amounts were paid on January 22, 2009 for dividends declaredin December 2008.

 

### **FINANCIALCONDITION**

### ** **

Webelieve our existing sources of liquidity are adequate to meet our anticipatedneeds in the coming year. Our business is capital intensive, requiringsignificant resources to fund operating expenses, construction expenditures,and interest and dividend payments. During 2009 and in subsequent years, we mayfrom time to time satisfy these requirements with a combination of cashgenerated by operations, borrowings under our revolving credit facility orfunds from the capital markets as conditions allow. We expect that borrowingcapacity under our revolving credit facility will continue to be available tomanage working capital during those periods.

 

Asof September 30, 2009, we had working capital of $25.2 million compared toworking capital of $11.0 million at December 31, 2008. The increase wasprimarily due to increases in accounts receivable related to seasonably higherrevenue, along with reduced other liabilities in connection with the NMUIdisposition.

 

Wehave access to $110 million in financing under our credit facility that expiresFebruary 15, 2013. A total of nine banks participate in the facility. Asof September 30, 2009, we had $32.2 million of borrowing capacityavailable under our credit facility. The impact of the prior period restatementon our retained earnings, combined with the additional borrowings on thefacility during 2008, and the lack of timeliness of Securities and ExchangeCommission (“SEC”) financial filings created a number of defaults under ourcredit facility agreement at the quarter ended March 31, 2009 and December 31,2008. The defaults were cured with several amendments to the credit facilityagreement dated from November 28, 2008 through July 31, 2009. Underthe amendments, our credit facility was reduced from $150 million to its currentavailability of $110 million. The facility was also secured with certain assetsof the Company and our borrowing margins were significantly increased. If ourdebt-to-capitalization ratio is 60% or lower, the applicable margins are 4.00%over the LIBOR rate and 3.00% over the prime rate. As of September 30,2009 our debt-to-capitalization ratio is 57%, the applicable margins are 4.00%over the LIBOR rate and 3.00% over the prime rate. Fees charged in connectionwith securing these amendments were $2.7 million in the nine months ended September 30,2009. These fees were capitalized and are being amortized over the remainingterm of the agreement as interest expense. Our ability to comply with financialcovenants, pay principal or interest and refinance our debt obligations willdepend on our future operating performance as well as other factors that may bebeyond our control.  The continuedopportunity for operating improvements, enhanced cash management and suspensionof elective capital expenditures should improve our ability to comply with therevised covenants in the revolving credit facility.

 

Aspart of the amended credit agreement for our credit facility, we have agreed toutilize only $12.5 million under our capital lease facility.  Our California mortgage bond indenturespermit the issuance of an additional $91.2 million of first mortgage bonds asof September 30, 2009. However, the terms of our revolving credit facilitydo not permit additional first mortgage bond indebtedness without prior consentfrom the credit facility lenders. The mortgage bond indentures also limit theamount of cash and property dividends our California utility company pays tothe parent Company. Dividends have averaged $5.0 million to $5.6 million peryear and are less than the aggregate cumulative dividend restriction thresholdby $23.1 million as of September 30, 2009. We were in compliance with orhad obtained waivers for all loan agreement covenants during the three-monthand nine-month period, ended September 30, 2009.

 

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Wehave previously filed a shelf registration statement with the SEC, for theissuance of up to $50.0 million aggregate principal amount of common stock,debt securities and warrants. We issued approximately $43.6 million of commonstock under the shelf registration. As we were unable to timely file ourrequired SEC filings for the September 30, 2008, March 31, 2009 and June 30,2009 Quarterly Reports on Form 10-Q and our 2008 Annual Report on Form 10-K,we cannot use Form S-3 Registration Statements for our securities with theSEC at this time. Use of Form S-3 requires, among other things, that theissuer be current and timely in its reports under the Exchange Act for at leasttwelve months. Accordingly, we will have to meet more demanding requirements toregister additional securities, which may make it more difficult for us toeffect public offering transactions, and our range of available financingalternatives could be limited and more costly.

 

### **CONTRACTUALOBLIGATIONS**

### ** **

Thefollowing table summarizes our known contractual obligations to make futurecash payments as of September 30, 2009, as well as an estimate of theperiods during which these payments are expected to be made.

 
| ** **                                           | ** ** | **Years Ended December 31,**                 | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                        | ** ** | **Remainder** | ** ** | **2010** | ** ** | **2012** | ** ** | **2014** | ** ** |
| ** **                                           | ** ** | ** **                                        | ** ** | **of** | ** ** | **and** | ** ** | **and** | ** ** | **and** | ** ** |
| ***(In thousands)***                                 | ** ** | **Total**                                         | ** ** | **2009** | ** ** | **2011** | ** ** | **2013** | ** ** | **Beyond** | ** ** |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |
| Long-term debt (1):                                  |       |                                              |       |   |   |   |   |   |   |   |   |
| Bank line of credit (2)                              |       | $       74,500 |       | $          — |   | $          — |   | $       74,500 |   | $          — |   |
| Mortgage bonds                                       |       | 33,000                                            |       | — |   | — |   | — |   | 33,000 |   |
| Bank term loans (3)                                  |       | 30,356                                            |       | 206 |   | 1,646 |   | 1,646 |   | 26,858 |   |
| Convertible subordinated debentures (4)              |       | 11,859                                            |       | — |   | — |   | — |   | 11,859 |   |
| Capital lease obligations (5)                        |       | 3,423                                             |       | 293 |   | 2,195 |   | 935 |   | — |   |
| Economic development revenue bonds (6)               |       | 1,810                                             |       | 120 |   | 260 |   | 295 |   | 1,135 |   |
| Note Payable                                         |       | 78                                                |       | 78 |   | — |   | — |   | — |   |
| Total  long-term debt                                |       | 155,026                                           |       | 697 |   | 4,101 |   | 77,376 |   | 72,852 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |   |   |
| Repayment  of advances for construction (7)          |       | 9,250                                             |       | 223 |   | 711 |   | 697 |   | 7,619 |   |
| Water  purchase commitment (8)                       |       | 6,837                                             |       | 115 |   | 920 |   | 920 |   | 4,882 |   |
| Operating  lease obligations                         |       | 19,948                                            |       | 1,284 |   | 6,985 |   | 3,703 |   | 7,976 |   |
| Total  obligations as of September 30, 2009 (9) |       | $     191,061            |       | $         2,319 |   | $       12,717 |   | $       82,696 |   | $       93,329 |   |

 

----

(1)    Excludes interest payments, which are described inthe following notes. The terms of the long-term debt are also more fullydescribed in the notes to the condensed consolidated financial statementsincluded in this report, and in our 2008 Annual Report on Form 10-K.

 

(2)    The bank lines of credit bear interest at variablerates and therefore the amount of future interest payments are uncertain.Borrowings bear interest, at our option, based on a margin over either: a) theLIBOR rate; or b) the prime rate. The margins vary on a sliding scale based onour consolidated debt-to-capitalization ratio. The weighted-average annualinterest rate on our bank line of credit borrowings was 4.37% as of September 30,2009, excluding amendment and waiver fees.

 

(3)    Interest on the bank term loans is fixed at aweighted-average annual interest rate of 6.50% and is payable monthly.

 

(4)    Interest on the convertible debentures is fixed at a6.85% annual rate and is payable quarterly. The debentures are convertible, atthe option of the holder, into shares of our common stock at any time prior totheir maturity in 2021.

 

(5)    Interest on the capital lease obligations is imputedat a weighted-average annual interest rate of 5.29% and is payable monthly.

 

(6)    Interest on the economic development bonds is fixedat a weighted-average annual interest rate of 6.00% and is payablesemiannually.

 

(7)    Advances for construction are non-interestbearing.  Our repayment assumptions oncertain obligations are based upon forecasted connection growth.  If forecasted connections do not materialize,the related payments are not due as shown and corresponding amounts may becomecontributed capital.

 

(8)    Reflects the minimum annual contractual commitment topurchase water through 2024. The price per unit is subject to increases infuture periods for production cost increases and may also increase, but notdecrease, if our average actual purchase volumes exceed specified amounts.

 

(9)    The totals exclude preferred stock dividendobligations. Preferred stockholders are entitled to receive annual dividends of$2.625 per share and there are 9,156 shares of preferred stock currentlyoutstanding. The preferred stock is redeemable by the Company at any time for$52.00 per share and, from time to time, we have elected to repurchase sharesoffered to us by preferred stockholders at prices less than $52.00 per share.

 

### **CERTAINCONTRACTUAL COMMITMENTS AND INDEMNITIES**

### ** **

Asof September 30, 2009, we had irrevocable standby letters of credit in theamount of $3.3 million issued and outstanding under our credit facility.

 

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Duringour normal course of business, we have entered into agreements containingindemnities which may require us to make payments in the future. Theseindemnities are in connection with facility leases and liabilities andoperations and maintenance contracts entered into by our contract servicesbusinesses. The duration of these indemnities, commitments and guaranteesvaries, and in certain cases may be indefinite. Substantially all of theseindemnities provide no limitation on the maximum potential future payments wecould be obligated to make and are not quantifiable. We have not recorded anyliability for these indemnities.

 

### **OFF-BALANCESHEET ARRANGEMENTS**

### ** **

Throughthe date of this report, we did not have any relationships with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes. In addition, we do not engagein trading activities involving non-exchange traded contracts. We are notmaterially exposed to any financing, liquidity, market or credit risk thatcould arise if we had engaged in these relationships. We do not have relationshipsor transactions with persons or entities that derive benefits from theirnon-independent relationship with our subsidiaries or us.

 

Welease some of our equipment and office facilities under operating leases whichare deemed to be off-balance sheet arrangements. Our future operating leasepayment obligations are more fully described under the caption “ContractualObligations” above.

 

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**ITEM 3.    QUANTITATIVEAND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

Asof September 30, 2009, we had $155.0 million of long-term variable andfixed-rate debt.  We are exposed tomarket risk based on changes in prevailing interest rates.

 

Marketrisk related to our variable-rate debt is estimated as the potential decreasein pre-tax earnings resulting from an increase in interest rates. We have $74.5million of long-term debt that bears interest at variable rates based on eitherthe prime rate or LIBOR rate. Our variable-rate debt had a weighted averageannual interest rate of 4.37% as of September 30, 2009. A hypothetical onepercent (100 basis points) increase in the average annual interest ratescharged on our variable-rate debt would reduce our pre-tax earnings byapproximately $0.7 million per year.

 

Ourfixed-rate debt, which has a carrying value of $80.5 million, has a fair valueof $71.2 million as of September 30, 2009. Market risk related to ourfixed-rate debt is deemed to be the potential increase in fair value resultingfrom a decrease in prevailing interest rates. Our fixed-rate debt had aweighted average annual interest rate of 6.6% as of September 30, 2009. Ahypothetical ten percent decrease in annual interest rates, from 6.6% to 5.9%,would increase the fair value of our fixed-rate debt by approximately $4.9million.

 

Wedo not use derivative financial instruments to manage or reduce these risksalthough we may do so in the future. We do not enter into derivatives or otherfinancial instruments for trading or speculative purposes.

 

## **ITEM 4.**                 CONTROLSAND PROCEDURES

## ** **

ThisReport includes the certifications attached as Exhibits 31.1 and 31.2 ofour Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”)required by Rule 13a-14 of the Exchange Act. This Item 4 includesinformation concerning the controls and control evaluations referred to inthose certifications.

 

### **DISCLOSURECONTROLS AND PROCEDURES**

### ** **

Disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act) are designed to provide reasonable assurance that informationrequired to be disclosed in reports we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the SEC and that such information is accumulatedand communicated to our management, including the CEO and CFO, as appropriateto allow timely decisions regarding required disclosures.

 

Ourmanagement, under the supervision and with the participation of our CEO andCFO, evaluated the effectiveness of the design and operation of our disclosurecontrols and procedures as of December 31, 2008. Based on our evaluationand the identification of the material weaknesses in internal control overfinancial reporting described below, our CEO and CFO concluded that, ourdisclosure controls and procedures were not effective. Plans for remediation ofthe disclosed weaknesses are in process as described in this section. As of September 30,2009, sufficient progress has not been made to change our previously disclosedconclusions. No new material weaknesses were identified in this period.

 

Inconnection with our assessment of our disclosure controls and procedures as of December 31,2008, we have identified the following deficiencies that constitutedindividually, or in the aggregate, material weaknesses in our internal controlover financial reporting.  As of September 30,2009, although remediation is in progress, until remediation testing to verifyeffectiveness is complete for each point, we must assume these weaknessesremain material, and will continue to be disclosed:

 

1.              We did notmaintain an effective control environment because of the following materialweaknesses:

 

·      We did notmaintain an environment that consistently emphasized strict adherence togenerally accepted accounting principles. This control deficiency, in certaininstances, led to inappropriate accounting decisions and entries. This controldeficiency was magnified by the decentralized nature of the accounting functionthat existed at our various operating locations.

 

·      We did notmaintain in certain areas of our internal audit, finance and accounting departments,a sufficient complement of resources with an appropriate level of accountingknowledge, experience and training commensurate with our financial reportingrequirements.  These areas includeperiod-end financial reporting process, acquisition accounting, goodwill,regulatory accounting, stock-based compensation, property, plant and equipment,estimates and accruals.

 

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·      We did notmaintain complete and accurate business documentation to support certaintransactions and accounting records. The controls in these areas with respectto the creation, maintenance and retention of complete and accurate business recordswere not effective.  This controldeficiency was magnified by the number of legacy financial systems and thedecentralized nature of the accounting function that existed at our variousoperating locations.

 

2.     We did not maintaineffective monitoring of controls over areas including period end financialreporting process, acquisition accounting, goodwill, regulatory accounting,stock-based compensation, property, plant and equipment, estimates andaccruals.  This deficiency resulted ineither not having adequate controls designed and in place or not achieving theintended operating effectiveness of controls.

 

3.     We did not maintaineffective controls over risk assessments. Specifically, we did not maintain processes to perform and evaluate theannual business and fraud risks affecting financial reporting processes.  This deficiency resulted in either not havingadequate controls designed and in place or not achieving the intended operatingeffectiveness of controls.

 

Thematerial weaknesses in control environment, monitoring of controls and riskassessment described above contributed to the material weaknesses set forthbelow.

 

4.     We did not maintainand communicate sufficient and consistent accounting policies with respect togenerally accepted accounting principles. This control deficiency, among otherthings, limited our ability to detect and correct accounting errors inpreviously issued financial statements.

 

5.     We did not maintaineffective controls over the recording of journal entries, both recurring andnon-recurring.  Specifically, effectivecontrols were not designed and in place to ensure that journal entries wereproperly prepared with sufficient supporting documentation or were reviewed andapproved to ensure the accuracy and completeness of the journal entries.

 

6.     We did not maintaineffective controls over the completeness and accuracy of key spreadsheets andsystem-generated reports.  Specifically,effective controls were not designed and in place to ensure that key spreadsheetsand system-generated reports were properly reviewed for accuracy andcompleteness.

 

7.     We did not maintaineffective controls over the application of generally accepted accountingprinciples commensurate with financial reporting requirements.  This deficiency led to, in certain instances,inappropriate accounting decisions and entries related to the income taxprovision, termination benefits, recognition of revenue, bonus accrual, assetretirement obligations, and various cost and expense accounts.

 

8.     We did not maintain effectivecontrols over the completeness and accuracy of our accounting foracquisitions.  Specifically, we did notdesign and maintain effective controls with respect to the application ofrelevant GAAP and the deficiency resulted in errors in the allocation of thepurchase price to the underlying assets acquired, including goodwill and theliabilities assumed.  This deficiencyaffected property, plant and equipment, deferred income tax and liabilities,goodwill and long-term liability accounts.

 

9.     We did not maintain effectivecontrols over the completeness, accuracy and valuation of our accountingestimates related to our claims process associated with medical, automobile andworkers’ compensation self-insurance. Specifically, we did not design and maintain effective controls withrespect to the maintenance and reconciliation of claims and the review ofactuarial valuations.  This deficiencyaffected accrued liabilities and expense accounts.

 

10.  We did not maintaineffective controls over the completeness and accuracy of our accounting for theimpairment of goodwill.   Specifically,we did not design and maintain effective controls to ensure properidentification of reporting units, triggering events and proper cash flowprojections to determine fair value. This deficiency affected goodwill related accounts.

 

11.  We did not maintaineffective controls over the completeness and accuracy of our accounting forregulated entities.  Specifically, we didnot design and maintain effective controls with respect to the application ofrelevant GAAP and the deficiency resulted in errors in the accounting forintercompany profit, regulatory assets and liabilities.  This deficiency affected revenue, property,plant and equipment, and regulatory asset and regulatory liability accounts.

 

12.  We did not maintaineffective controls over the accuracy and valuation of stock-basedcompensation.  Specifically, we did notmaintain effective controls over the assumptions used in the calculation ofstock-based compensation.  Thisdeficiency affected stock-based compensation related accounts.

 

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13.  We did not maintaineffective controls over the completeness and accuracy of property, plant andequipment and related depreciation expense. Specifically, we did not design and maintain effective controls toensure that there was timely transfer of property, plant and equipmentadditions from construction work in progress; that retirements were properlyrecorded; that depreciation expense was accurately recorded based onappropriate useful lives assigned to the related property, plant and equipment;that assets are capitalized properly; and that impairment losses were timelyidentified and determined.  Thisdeficiency affected property, plant and equipment, depreciation expense andoperating expense accounts.

 

14.  We did not maintain effectivecontrols over the completeness and accuracy of unbilled utilities revenue.  Specifically, we did not maintain effectivecontrols to standardize a process and methodology of calculating and recordingunbilled revenue in the proper period. This deficiency affected utility revenue and unbilled receivableaccounts.

 

15.  We did not maintain effectivecontrols to ensure the completeness of the recording of accounts payable andaccrued liabilities, operating expenses and property, plant and equipmentadditions on a timely basis.  Specifically,we did not review and approve invoices and their supporting documentation on atimely basis.  Material outstandingliabilities were not recorded for which goods were received or services wererendered by vendors prior to the balance sheet date.  Consequently, our accounts payable andaccrued liability balances were understated at the period end by the aggregatevalue of these unpaid invoices which relate to construction work in progressand other selling and administrative expenses.

 

Webelieve that because of the substantial work performed restating our historicalaccounting records, the performance of additional procedures by managementdesigned to ensure the reliability of our financial reporting and the ongoingefforts to remediate the material weaknesses in internal control over financialreporting described below, the condensed consolidated financial statements forthe periods covered by and included in this report are fairly stated in allmaterial respects.

 

### **CHANGES ININTERNAL CONTROL OVER FINANCIAL REPORTING**

### ** **

Therewas no change in our controls during the three-month period ended September 30,2009 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

### **PLANS FORREMEDIATION OF MATERIAL WEAKNESSES**

### ** **

Wehave engaged in and are continuing to engage in substantial efforts to improveour internal control over financial reporting and disclosure controls andprocedures related to the preparation of our financial statements anddisclosures. We have begun the implementation of some of the measures describedbelow and concentrated our efforts on (i) communicating, both internallyand externally, our commitment to a strong effective control environment, highethical standards and financial reporting integrity, (ii) certainpersonnel actions, (iii) comprehensive training for Finance and AccountingDepartment personnel, (iv) the implementation of policies and proceduresto ensure that we retain important business and accounting records and (v) morerigorous period end reporting policies and processes involving journal entryapproval, account reconciliations and supporting documentation includingmanually prepared spreadsheets.

 

Wehave implemented a remediation plan (“the Plan”) to address the materialweaknesses for each of the affected areas presented above. The Plan builds uponmany of the initiatives we started over the past two years, such as developmentof a centralized financial services platform and consolidation of financialaccounts onto a common system.  The Planensures that each area affected by a material control weakness is put through acomprehensive remediation process.  Theremediation process entails a thorough analysis which includes the followingphases:

 

a)    Define andassess the deficiency: ensure a thorough understanding of the “as is” state,process owners, and gaps in the deficiency. This work is underway for allidentified areas.

 

b)    Design and evaluatea remediation plan of action for each weakness for each affected area: validateor improve the related policy and procedures, evaluate skills of the processowners with regards to the policy and adjust as required. The Plan requires anassessment of all failures; many of these improvements are well underway.

 

c)     Implement specificremediation actions: train process owners, allow time for process adoption andadequate transaction volume for next steps.

 

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d)    Test and measure thedesign and effectiveness of the remediation plan, and test and provide feedbackon the design and operating effectiveness of the updated controls.

 

e)    Management reviewand acceptance of completion of the remediation effort.

 

ThePlan is administered by a Controls Committee comprised of key leaders fromcross functional portions of the organization, including the CFO. The Committeereports quarterly and as needed to the Audit Committee of our Board ofDirectors on progress.

 

Webelieve the steps taken to date have substantially improved the effectivenessof our internal control over financial reporting, however we have not completedthe corrective processes and procedures identified herein, that we believenecessary. Accordingly, as we continue to monitor the effectiveness of ourinternal control over financial reporting in the areas affected by the materialweaknesses described above, we will perform additional procedures prescribed bymanagement including the use of manual mitigating control procedures to ensurethat our financial statements continue to be fairly stated in all materialrespects.

 

### **INHERENTLIMITATIONS OF DISCLOSURE CONTROLS AND PROCEDURES**

### ** **

Wedo not expect that our disclosure controls and procedures will prevent or detectall errors. A control system, no matter how well designed and operated, canprovide only reasonable, not absolute, assurance that the control system’sobjectives will be met. Further, the design of a control system mustacknowledge the fact that there are resource constraints and the benefits ofcontrols must be considered relative to their costs. These inherent limitationsinclude the realities that judgments in decision making can be faulty and thatbreakdowns can occur because of a simple error or mistake. Controls can also becircumvented by the deliberate acts of one or more persons. The design of anysystem of controls is based, in part, upon certain assumptions about thelikelihood of future events and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions.Over time, controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with associated policies orprocedures. Because of the inherent limitations in a cost-effective controlsystem, misstatements due to error may occur and not be detected.

 

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# **PART II – OTHER INFORMATION**

# ** **

## **ITEM 1.**              LEGAL PROCEEDINGS

## ** **

Therehave been no new, material developments to or terminations of legalproceedings, other than ordinary routine litigation incidental to the business,to which the Company or any of its subsidiaries is a party or of which any oftheir property is the subject during the period covered by this QuarterlyReport, except for the settlement of eminent domain proceedings against our NewMexico utility, more fully described in Note 5 to our Condensed ConsolidatedFinancial Statements, “Legal Proceedings.”

 

## **ITEM 1A.**          RISK FACTORS

## ** **

Therehave been no material changes in our risk factors since we last reported under Part I,Item 1A, in our Annual Report on Form 10-K for the year ended December 31,2008.

 

## **ITEMS 2, 3, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEENOMITTED.**

## ** **

## **ITEM 6.**              EXHIBITS

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                              |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Exhibit Description**                                                                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                    |
| 3.1         |       | Restated Certificate of  Incorporation of SouthWest Water Company dated May 24, 2005  (incorporated by reference to Exhibit 3.1 included in the Company’s  Form 10-Q for the quarterly period ended June 30, 2005)             |
|        |       |                                                                                                                                                                                                                                                    |
| 3.1.1       |       | Certificate of Amendment to  Restated Certificate of Incorporation of SouthWest Water Company  (incorporated by reference to Exhibit 3.1 included in the Company’s  Form 8 K filed with the Commission on May 22, 2008)             |
|        |       |                                                                                                                                                                                                                                                    |
| 3.2         |       | Amended and Restated Bylaws of  SouthWest Water Company (incorporated by reference to Exhibit 3.2  included in the Company’s Form 10-Q filed with the Commission on  September 18, 2009)                                            |
|        |       |                                                                                                                                                                                                                                                    |
| 10.17.2     |       | Amendment No. 2 to Amended and  Restated Credit Agreement dated as of May 28, 2009 (incorporated by  reference to Exhibit 10.17.2 included in the Company’s Form 10-K  filed with the Commission on July 9, 2009)    |
|        |       |                                                                                                                                                                                                                                                    |
| 10.17.3     |       | Amendment No. 3 to Amended and  Restated Credit Agreement dated as of June 17, 2009 (incorporated by  reference to Exhibit 10.17.3 included in the Company’s Form 10-K  filed with the Commission on July 9, 2009)   |
|        |       |                                                                                                                                                                                                                                                    |
| 10.17.4     |       | Amendment No. 4 to Amended and  Restated Credit Agreement dated as of July 9, 2009 (incorporated by  reference to Exhibit 10.17.4 included in the Company’s Form 10-K  filed with the Commission on July 9, 2009)    |
|        |       |                                                                                                                                                                                                                                                    |
| 10.17.5     |       | Amendment No. 5 to Amended and  Restated Credit Agreement dated as of July 31, 2009 (incorporated by  reference to Exhibit 10.17.5 included in the Company’s Form 10-Q  filed with the Commission on August 3, 2009) |
|        |       |                                                                                                                                                                                                                                                    |
| 31.1        | *          | Certification of Principal  Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act of  2002                                                                                                                                           |
|        |       |                                                                                                                                                                                                                                                    |
| 31.2        | *          | Certification of Principal Financial  Officer Pursuant to Section 302 of the Sarbanes Oxley Act of 2002                                                                                                                                            |
|        |       |                                                                                                                                                                                                                                                    |
| 32.1        | *          | Certification of Chief Executive  Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                                    |
| 32.2        | *          | Certification of Chief Financial  Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002                                                                                                                                                |

 

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*              Filedherewith

 

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# **SIGNATURES**

# ** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned, theretoduly authorized.

 

 
|                         | SOUTHWEST WATER COMPANY (REGISTRANT**)** |
|------------------------------|------------------------------------------|
|                         |                                     |
|                         |                                     |
| Dated: November 9, 2009 | /s/ DAVID STANTON                        |
|                         | David Stanton                            |
|                         | Chief Financial Officer                  |

 

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