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**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 June  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 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past 90 days.  Yes **o**  No **x**

 

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 such files).    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 August 31, 2009 |   |
|--------|-----------------------------------------|--------|------------------------------------|--------|
|   |                                    |   |                               |   |
|   | Common  Stock, $.01 par value per share |   | 24,888,745  shares                 |   |

 

 

 

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**TABLE OFCONTENTS**

 
| ** **     | ** ** | ** **                                                                                                                            | ** ** | **Page**   |
|----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|           |       |                                                                                                                                  |       |       |
| **Part I**     | ** ** | **Financial Information**                                                                                                             | ** ** | **2**      |
|           |       |                                                                                                                                  |       |       |
| Item 1.        |       | Financial Statements                                                                                                                  |       | 2          |
|           |       |                                                                                                                                  |       |       |
|           |       | Condensed  Consolidated Balance Sheets (Unaudited) as of June 30, 2009 and December 31,  2008                                         |       | 2          |
|           |       |                                                                                                                                  |       |       |
|           |       | Condensed  Consolidated Statements of Operations (Unaudited) for the three and six  months ended June 30, 2009 and 2008 (As Restated) |       | 3          |
|           |       |                                                                                                                                  |       |       |
|           |       | Condensed Consolidated Statement of  Changes in Stockholders’ Equity for the six months ended June 30, 2009  (Unaudited)         |       | 4          |
|           |       |                                                                                                                                  |       |       |
|           |       | Condensed Consolidated Statements of Cash Flows  (Unaudited) for the six months ended June 30, 2009 and 2008 (As Restated)            |       | 5          |
|           |       |                                                                                                                                  |       |       |
|           |       | Notes to the  Condensed Consolidated Financial Statements (Unaudited)                                                                 |       | 6          |
|           |       |                                                                                                                                  |       |       |
| Item 2.        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                           |       | 23         |
|           |       |                                                                                                                                  |       |       |
| Item 3.        |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                           |       | 41         |
|           |       |                                                                                                                                  |       |       |
| Item 4.        |       | Controls and  Procedures                                                                                                              |       | 41         |
|           |       |                                                                                                                                  |       | ** ** |
| **Part II**    | ** ** | **Other Information**                                                                                                                 |       | **46**     |
|           |       |                                                                                                                                  |       | ** ** |
| Item 1.        |       | Legal Proceedings                                                                                                                     |       | 46         |
|           |       |                                                                                                                                  |       |       |
| Item 1A.       |       | Risk Factors                                                                                                                          |       | 46         |
|           |       |                                                                                                                                  |       |       |
| Item 6.        |       | Exhibits                                                                                                                              |       | 46         |
|           |       |                                                                                                                                  |       | ** ** |
| **Signatures** | ** ** |                                                                                                                                  |       | **47**     |

 

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**EXPLANATORY NOTE REGARDING RESTATEMENTS**

 

SouthWestWater Company and its subsidiaries’ (“SouthWest Water” or the “Company”)condensed consolidated financial statements as of and for the three- andsix-month periods ended June 30, 2008 and related financial information havebeen restated to correct certain accounting errors. For further details on thenature of the corrections and the related effects on the Company’s previouslyissued consolidated financial statements, see Note 2, “Restatement of CondensedConsolidated Financial Statements.” Restated balances have been identified withthe notation “As Restated” where appropriate. Throughout the financialstatements, the term “as previously reported” will be used to refer to balancesfrom the 2008 condensed consolidated financial statements as reported prior torestatement for the correction of errors.

 

Wehave not filed amendments to any previously filed Quarterly Reports on Form 10-Qfor the periods affected by the restatement. The financial information that hasbeen previously filed or otherwise reported for these periods is superseded bythe information in this Quarterly Report on Form 10-Q, and the financialstatements and related financial information contained in previously filedreports should no longer be relied upon.

 

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# **PART I — FINANCIALINFORMATION**

# ** **

## **ITEM 1.**                 FINANCIALSTATEMENTS

**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

 

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

 
| ***(In thousands)***                             | ** ** | ** ** | **June 30,   2009** | ** ** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------------------|------------|------------|---------------------|------------|------------|------------------------|------------|
|                                             |       |       |                |       |       |                   |       |
| **ASSETS**                                       |       |       |                |       |       |                   |       |
|                                             |       |       |                |       |       |                   |       |
| Current  Assets:                                 |       |       |                |       |       |                   |       |
| Cash  and cash equivalents                       |       |       | $                   | 1,580      |       |                   | $          | 1,112 |   |
| Accounts  receivable, net                        |       |       | 31,688              |       |       | 29,697                 |       |
| Prepaid  expenses and other current assets       |       |       | 24,541              |       |       | 26,902                 |       |
|                                             |       |       |                |       |       |                   |       |
| Total  current assets                            |       |       | 57,809              |       |       | 57,711                 |       |
|                                             |       |       |                |       |       |                   |       |
| Property,  Plant and Equipment, net              |       |       | 315,360             |       |       | 429,251                |       |
|                                             |       |       |                |       |       |                   |       |
| Other  Assets:                                   |       |       |                |       |       |                   |       |
| Goodwill                                         |       |       | 16,475              |       |       | 17,652                 |       |
| Intangible  assets                               |       |       | 1,349               |       |       | 1,666                  |       |
| Other  assets                                    |       |       | 20,600              |       |       | 20,927                 |       |
|                                             |       |       |                |       |       |                   |       |
| Total  assets                                    |       |       | $                   | 411,593    |       |                   | $          | 527,207 |   |
|                                             |       |       |                |       |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**    |       |       |                |       |       |                   |       |
|                                             |       |       |                |       |       |                   |       |
| Current  Liabilities:                            |       |       |                |       |       |                   |       |
| Accounts  payable                                |       |       | $                   | 13,745     |       |                   | $          | 16,139 |   |
| Current  portion of long-term debt               |       |       | 2,162               |       |       | 2,213                  |       |
| Other  current liabilities                       |       |       | 18,554              |       |       | 28,370                 |       |
|                                             |       |       |                |       |       |                   |       |
| Total  current liabilities                       |       |       | 34,461              |       |       | 46,722                 |       |
|                                             |       |       |                |       |       |                   |       |
| Other  Liabilities and Deferred Credits:         |       |       |                |       |       |                   |       |
| Long-term  debt, less current portion            |       |       | 149,847             |       |       | 190,578                |       |
| Deferred  income taxes                           |       |       | 27,310              |       |       | 23,750                 |       |
| Advances  for construction                       |       |       | 8,928               |       |       | 8,910                  |       |
| Contributions  in aid of construction            |       |       | 44,967              |       |       | 117,113                |       |
| Other  liabilities and deferred credits          |       |       | 26,502              |       |       | 26,334                 |       |
|                                             |       |       |                |       |       |                   |       |
| Commitments  and Contingencies                   |       |       |                |       |       |                   |       |
|                                             |       |       |                |       |       |                   |       |
| Stockholders’  Equity:                      |       |       |                |       |       |                   |       |
| Preferred  stock                                 |       |       | 458                 |       |       | 458                    |       |
| Common  stock                                    |       |       | 249                 |       |       | 249                    |       |
| Additional  paid-in capital                      |       |       | 147,928             |       |       | 147,775                |       |
| Accumulated  deficit                             |       |       | (29,158             | )          |       | (34,794                | )          |
| Accumulated  other comprehensive income          |       |       | 101                 |       |       | 112                    |       |
|                                             |       |       |                |       |       |                   |       |
| Total  stockholders’ equity                 |       |       | 119,578             |       |       | 113,800                |       |
|                                             |       |       |                |       |       |                   |       |
| Total  liabilities and stockholders’ equity |       |       | $                   | 411,593    |       |                   | $          | 527,207 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

 

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

 
| ** **                                           | ** ** | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** **            |
|------------------------------------------------------|------------|------------|------------------------|------------|----------------------|-----------------------|
| ** **                                           | ** ** | ** ** | **June 30,**           | ** ** | ** **           | **June 30,**          | ** ** |
| ***(In thousands, except per share  data)***         | ** ** | ** ** | **2009**               | ** ** | ** **           | **2008  As Restated** | ** ** | ** ** | **2009** | ** ** | ** ** | **2008  As Restated** | ** ** |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Operating  revenue                                   |       |       | $                      | 52,416     |                 |                  | $ | 54,170 |   |   | $ | 102,508 |   |   | $ | 101,583 |   |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Expenses:                                            |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Operating  expenses                                  |       |       | 50,052                 |       |                 | 48,205                |   |   | 99,959 |   |   | 91,938 |   |
| Depreciation  and amortization                       |       |       | 3,857                  |       |                 | 3,526                 |   |   | 7,690 |   |   | 7,009 |   |
| Impairment  of long-lived assets                     |       |       | 8,115                  |       |                 | 1,075                 |   |   | 8,115 |   |   | 1,075 |   |
| Total  operating expenses                            |       |       | 62,024                 |       |                 | 52,806                |   |   | 115,764 |   |   | 100,022 |   |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Operating  income (loss)                             |       |       | (9,608                 | )          |                 | 1,364                 |   |   | (13,256 | ) |   | 1,561 |   |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Other  income (expense):                             |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Interest  expense                                    |       |       | (2,975                 | )          |                 | (2,092                | ) |   | (4,862 | ) |   | (4,212 | ) |
| Interest  income                                     |       |       | 48                     |       |                 | 60                    |   |   | 84 |   |   | 108 |   |
| Loss  from continuing operations before income taxes |       |       | (12,535                | )          |                 | (668                  | ) |   | (18,034 | ) |   | (2,543 | ) |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Benefit  from income taxes                           |       |       | (4,472                 | )          |                 | (233                  | ) |   | (6,566 | ) |   | (890 | ) |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Loss  from continuing operations                     |       |       | (8,063                 | )          |                 | (435                  | ) |   | (11,468 | ) |   | (1,653 | ) |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Income  from discontinued operations, net of tax     |       |       | 17,559                 |       |                 | 415                   |   |   | 17,731 |   |   | 660 |   |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Net  income (loss)                                   |       |       | 9,496                  |       |                 | (20                   | ) |   | 6,263 |   |   | (993 | ) |
| Preferred  stock dividends                           |       |       | (6                     | )          |                 | (6                    | ) |   | (6 | ) |   | (12 | ) |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Net  income (loss) applicable to common stockholders |       |       | $                      | 9,490      |                 |                  | $ | (26 | ) |   | $ | 6,257 |   |   | $ | (1,005 | ) |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Income  (loss) per common share:                     |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Basic  and Diluted:                                  |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Loss  from continuing operations                     |       |       | $                      | (0.33      | )                    |                  | $ | (0.02 | ) |   | $ | (0.47 | ) |   | $ | (0.07 | ) |
| Income  from discontinued operations                 |       |       | 0.71                   |       |                 | 0.02                  |   |   | 0.72 |   |   | 0.03 |   |
| Net  income (loss) applicable to common stockholders |       |       | $                      | 0.38       |                 |                  | $ | —    |   |   | $ | 0.25 |   |   | $ | (0.04 | ) |
|                                                 |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Weighted  average common shares outstanding:         |       |       |                   |       |                 |                  |   |   |   |   |   |   |   |
| Basic                                                |       |       | 24,608                 |       |                 | 24,507                |   |   | 24,604 |   |   | 24,444 |   |
| Diluted                                              |       |       | 24,608                 |       |                 | 24,507                |   |   | 24,604 |   |   | 24,444 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

 

### **CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’EQUITY AND COMPREHENSIVE INCOME (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                                             |       |       | —    |       | —    |             |       | —    |           | —    |       |       | —    |       |                   | 6,263                    |       |       | —    |   |   | 6,263 |   |
| Other  comprehensive income:                            |       |       |                     |       |                     |             |       |                     |           |                     |       |       |                     |       |                   |                     |       |       |                     |   |   |   |   |
| Amortization  of actuarial gains                        |       |       | —    |       | —    |             |       | —    |           | —    |       |       | —    |       |                   | —    |       |       | (11                      | ) |   | (11 | ) |
| Comprehensive  income                                   |       |       |                     |       |                     |             |       |                     |           |                     |       |       |                     |       |                   |                     |       |       |                     |   |   | 6,252 |   |
| Cancelled  restricted stock awards                      |       |       | —    |       | —    |             |       | (5                       | )              | —    |       |       | —    |       |                   | —    |       |       | —    |   |   | —    |   |
| Post-vest  cancellations of non-qualified stock options |       |       | —    |       | —    |             |       | —    |           | —    |       |       | (178                     | )          |                   | —    |       |       | —    |   |   | (178 | ) |
| Share-based  compensation                               |       |       | —    |       | —    |             |       | —    |           | —    |       |       | 331                      |       |                   | —    |       |       | —    |   |   | 331 |   |
| Cash  dividends declared:                               |       |       |                     |       |                     |             |       |                     |           |                     |       |       |                     |       |                   |                     |       |       |                     |   |   |   |   |
| Preferred  stock—$0.65625                          |       |       | —    |       | —    |             |       | —    |           | —    |       |       | —    |       |                   | (6                       | )          |       | —    |   |   | (6 | ) |
| Common  stock—$0.025                               |       |       | —    |       | —    |             |       | —    |           | —    |       |       | —    |       |                   | (621                     | )          |       | —    |   |   | (621 | ) |
|                                                    |       |       |                     |       |                     |             |       |                     |           |                     |       |       |                     |       |                   |                     |       |       |                     |   |   |   |   |
| **Balance - June 30, 2009**                             | ** ** | ** ** | **9**                    | ** ** | **$**                    | **458**          | ** ** | ** **               | **24,892**     | ** **               | **$**      | **249**    | ** **               | ** ** | **$**                  | **147,928**              | ** ** | ** ** | **$**                    | **(29,158** | **)** | ** ** | **$** | **101** | ** ** | ** ** | **$** | **119,578** | ** ** |

** **

See accompanying notes to condensedconsolidated financial statements.

 

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

 

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

 
|                                                                                                 |   | **Six Months Ended**     |              |
|------------------------------------------------------------------------------------------------------|--------|--------------------------|-------------------|
|                                                                                                 |   |                     | **June 30,** |   |
|                                                                                                 |   |                     |              | **2008** |   |
| *(In thousands)*                                                                                     |   |                     | **2009**          |   | **As Restated** |   |
|                                                                                                 |   |                     |              |   |   |
| Cash  flows from operating activities of continuing operations:                                      |   |                     |              |   |   |
| Net  income (loss)                                                                                   |   | $                        | 6,263             |   | $ | (993 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operating  activities: |   |                     |              |   |   |
| Income  from discontinued operations, net of tax                                                     |   | (17,731                  | )                 | (660 | ) |
| Depreciation  and amortization                                                                       |   | 7,690                    |              | 7,009 |   |
| Deferred  income taxes                                                                               |   | 2,963                    |              | 1,519 |   |
| Provision  for doubtful accounts                                                                     |   | 984                      |              | 1,020 |   |
| Share-based  compensation expense                                                                    |   | 331                      |              | 490 |   |
| Post-vest  cancellations of non-qualified stock options                                              |   | (178                     | )                 | —    |   |
| Impairment  of long-lived assets                                                                     |   | 8,115                    |              | 1,075 |   |
| Gain  on sale of businesses and assets                                                               |   | (598                     | )                 | —    |   |
| Amortization  of deferred financing costs                                                            |   | 341                      |              | 134 |   |
| Other,  net                                                                                          |   | 202                      |              | (75 | ) |
| Changes  in assets and liabilities, net of effects of acquisitions:                                  |   |                     |              |   |   |
| Accounts  receivable                                                                                 |   | (4,052                   | )                 | (5,120 | ) |
| Other  current assets                                                                                |   | 2,829                    |              | 3,189 |   |
| Other  assets                                                                                        |   | 1,043                    |              | (2,511 | ) |
| Accounts  payable                                                                                    |   | (2,872                   | )                 | (7,965 | ) |
| Other  current liabilities                                                                           |   | (484                     | )                 | (4,318 | ) |
| Other  liabilities                                                                                   |   | (1,437                   | )                 | 174 |   |
| Other,  net                                                                                          |   | —    |              | (53 | ) |
| Net  cash provided by (used in) operating activities                                                 |   | 3,423                    |              | (7,085 | ) |
|                                                                                                 |   |                     |              |   |   |
| Cash  flows from investing activities of continuing operations:                                      |   |                     |              |   |   |
| Additions  to property, plant and equipment                                                          |   | (6,306                   | )                 | (13,971 | ) |
| 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                                                 |   | 48,255                   |              | (37,122 | ) |
|                                                                                                 |   |                     |              |   |   |
| Cash  flows from financing activities of continuing operations:                                      |   |                     |              |   |   |
| Borrowings  under lines of credit                                                                    |   | 28,000                   |              | 137,500 |   |
| Repayments  under lines of credit                                                                    |   | (55,600                  | )                 | (90,500 | ) |
| Capital  improvement reimbursements                                                                  |   | 3,389                    |              | 1,367 |   |
| Proceeds  from share-based equity incentive plans and stock purchase plans                           |   | —    |              | 1,763 |   |
| Contributions  in aid of construction                                                                |   | —    |              | 11 |   |
| Dividends  paid                                                                                      |   | (1,256                   | )                 | (2,953 | ) |
| Payments  on long-term debt                                                                          |   | (13,131                  | )                 | (1,046 | ) |
| Repayment  of advances for construction                                                              |   | —    |              | (432 | ) |
| Deferred  financing costs                                                                            |   | (2,579                   | )                 | (532 | ) |
| Net  cash provided by (used in) financing activities                                                 |   | (41,177                  | )                 | 45,178 |   |
|                                                                                                 |   |                     |              |   |   |
| Cash  flows from discontinued operations:                                                            |   |                     |              |   |   |
| Operating  activities                                                                                |   | (8,095                   | )                 | 1,010 |   |
| Investing  activities                                                                                |   | (291                     | )                 | (954 | ) |
| Financing  activities                                                                                |   | (1,647                   | )                 | (94 | ) |
| Net  cash provided by (used in) discontinued operations                                              |   | (10,033                  | )                 | (38 | ) |
|                                                                                                 |   |                     |              |   |   |
| Net  increase in cash and cash equivalents                                                           |   | 468                      |              | 933 |   |
|                                                                                                 |   |                     |              |   |   |
| Cash  and cash equivalents at beginning of period                                                    |   | 1,112                    |              | 2,950 |   |
|                                                                                                 |   |                     |              |   |   |
| Cash  and cash equivalents at end of period                                                          |   | $                        | 1,580             |   | $ | 3,883 |   |
|                                                                                                      |        |                          |                   |  |  |  |  |  |  |

 

See accompanyingnotes to condensed consolidated financial statements.

 

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

 

### **NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

### ** **

**Note 1.  Summaryof Significant Accounting Policies**

** **

**Basis of Presentation**

** **

These condensed consolidated interimfinancial statements are unaudited. SouthWest Water Company (the “Company”)believes the interim financial statements are presented on a basis consistentwith the audited 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. These adjustments include all normal recurring adjustments.

 

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 the Company’s 2008 AnnualReport on Form 10-K. The Company’s businesses are seasonal because theyare affected by weather. As a result, operating results for interim periods arenot necessarily predictive of the operating results for any other interimperiod or for the full year.

 

**Fair ValueMeasurements**

** **

The Company applies the provisions ofStatement of Financial Accounting Standards (SFAS) No. 157, *Fair Value Measurements* (“SFAS 157”). SFAS157 defines fair value and provides guidance for measuring fair value andexpands disclosures about fair value measurements. SFAS 157 does not requireany new fair value measurements, but rather applies to all other accountingpronouncements that require or permit fair value measurements.

 

In February 2008, the FinancialAccounting Standards Board (“FASB”) issued a final Staff Position to allow aone-year deferral of adoption of SFAS 157 for nonfinancial assets and nonfinancialliabilities that are recognized or disclosed at fair value in the financialstatements on a nonrecurring basis. The Company elected this one-year deferraland began applying the provisions of SFAS 157 to nonfinancial assets andnonfinancial liabilities that are recognized at fair value in the financialstatements on a nonrecurring basis in the current fiscal year beginning January 1,2009. The Company had no nonrecurring measurements recognized at fair valueduring the quarter ended June 30, 2009. The Company generally applies fairvalue techniques on a nonrecurring basis associated with (1) valuingpotential impairment loss related to goodwill and indefinite-lived intangibleassets accounted for pursuant to SFAS 142, and (2) valuing potentialimpairment losses related to long-lived assets accounted for pursuant to SFAS144. The FASB also amended SFAS 157 to exclude FASB Statement No. 13 andits related interpretive accounting pronouncements that address leasingtransactions.

 

SFAS 157 enables the reader of thefinancial statements to assess the inputs used to develop those measurements byestablishing a hierarchy for ranking the quality and reliability of theinformation used to determine fair values. SFAS 157 requires that assets andliabilities carried at fair value be classified and disclosed in one of thefollowing three categories:

 

·                  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 the Company’s cashequivalents are based on quoted prices in active markets for identical assets(Level 1).

 

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**SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

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

 

The Company’s revolving credit facilityand long-term debt with aggregate book values of $152.0 million and $192.8million had fair values of approximately $142.7 million and $196.4 million asof June 30, 2009 and December 31, 2008, respectively. The Companybelieves that these changes in fair value from their carrying amounts areprimarily due to current unstable economic conditions and the current state ofthe credit markets for similar debt instruments. The Company determined theestimated fair value amounts by using recent trade activity, available marketinformation and commonly accepted valuation methodologies (Level 2). However,considerable judgment is required in interpreting market data to developestimates of fair value. Accordingly, the fair value estimates presented hereinare not necessarily indicative of the amount that the Company could realize ina current market exchange. The use of different assumptions and/or estimationmethodologies may have a material effect on the estimated fair value.

 

**RecentAccounting Pronouncements**

** **

In March 2008, the FASB issuedSFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133*(“SFAS 161”). This statement amends SFAS 133 by requiring enhanced disclosuresabout a Company’s derivative instruments and hedging activities, but does notchange the scope of, or accounting under, SFAS 133.  SFAS 161 requires increased qualitative,quantitative and credit-risk disclosures about the entity’s derivativeinstruments and hedging activities. The Company adopted SFAS 161 effective January 1,2009. The Company does not currently hold derivative instruments and was notimpacted by the adoption of SFAS 161.

 

In April 2008, the FASB issuedFSP FAS No. 142-3, *Determination of theUseful Life of Intangible Assets* (“FSP 142-3”). FSP 142-3amends the factors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS 142.  The Company adopted FSP142-3 effective January 1, 2009 and the adoption did not have a not havean impact on its results of operations, financial position or cash flows.

 

In December 2008, the FASBissued FSP FAS 132(R)-1, *Employers’ Disclosuresabout Postretirement Benefit Plan Assets*(“FAS 132(R)-1”), whichrequires additional disclosures for employers’ pension and other postretirementbenefit plan assets. As pension and other postretirement benefit plan assetswere not included within the scope of SFAS 157, FSP FAS 132(R)-1 requiresemployers to disclose information about fair value measurements of plan assetssimilar to the disclosures required under SFAS 157, the investment policies andstrategies for the major categories of plan assets, and significantconcentrations of risk within plan assets. FSP FAS 132(R)-1 will be effectivefor the Company at December 31, 2009. As FSP FAS 132(R)-1 provides onlydisclosure requirements, the adoption of this standard will not have an impacton the Company’s results of operations, financial position or cash flows.

 

In April 2009, the FASB issuedFSP FAS 157-4, *Determining Fair Value When the Volume andLevel of Activity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly* (FSP 157-4), and FSPFAS 107-1 and Accounting Principles Board (APB) 28-1, *InterimDisclosures about Fair Value of Financial Instruments* (FSP 107-1).These two staff positions relate to fair value measurements and relateddisclosures. The FASB also issued a third FSP relating to the accounting forimpaired debt securities titled FSP FAS 115-2 and FAS 124-2, *Recognition and Presentation of Other-Than-Temporary Impairments*(FSP 115-2). These standards are effective for interim and annual periodsending after June 15, 2009. The Company has determined that FSP 157-4 andFSP 115-2 do not currently apply to its activities.  The Company has adopted the disclosurerequirements of FSP 107-1 for the quarter ended June 30, 2009.

 

InMay 2009, the FASB issued SFAS No. 165, *Subsequent Events*(“SFAS165”)*.*  SFAS No. 165 establishes generalstandards for accounting for and disclosure of events that occur after thebalance sheet date but before financial statements are issued.  SFAS No. 165 sets forth the periodafter the balance sheet date during which management of a reporting entityshould evaluate events or transactions that may occur for potential recognitionin the financial statements, identifies the circumstances under which an entityshould recognize events or transactions occurring after the balance sheet datein its financial statements, and the disclosures that should be made aboutevents or transactions that occur after the balance sheet date. In preparingthese financial statements, SFAS 165 is effective for financial statementsissued after June 15, 2009.  TheCompany has adapted SFAS 165 for the quarter ended June 30, 2009. The Company has evaluated theexistence of subsequent events through September 17,2009 and has notindentified any significant subsequent events or transactions which wouldrequire recognition or disclosure in the financial statements other than thatdisclosed in Note 11.

 

In June 2009, the FASB issuedSFAS No. 166, *Accounting for Transfersof Financial Assets*, *an amendmentto SFAS No. 140* (“SFAS 166”). SFAS 166 eliminates the conceptof a “qualifying special-purpose entity,” changes the requirements forderecognizing financial assets, and requires additional disclosures in order toenhance information reported to users of financial statements by providinggreater transparency about transfers of financial assets, includingsecuritization transactions, and an entity’s continuing involvement in andexposure to the risks related to 

 

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** **

**SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

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

 

transferred financial assets. SFAS166 is effective for fiscal years beginning after November 15,2009. The Company will adopt SFAS 166 in fiscal 2010 and isevaluating the impact it will have on the consolidated results of the Company.

 

In June 2009, the FASB issuedSFAS No. 167,*Amendments to FASBInterpretation No. 46(R) *(“SFAS 167”). The amendmentsinclude: (1) the elimination of the exemption for qualifying specialpurpose entities, (2) a new approach for determining who shouldconsolidate a variable-interest entity, and (3) changes to when it isnecessary to reassess who should consolidate a variable-interest entity. SFAS167 is effective for the first annual reporting period beginning after November 15,2009 and for interim periods within that first annual reporting period. TheCompany will adopt SFAS 167 in fiscal 2010 and is evaluating the impact it willhave on the consolidated results of the Company.

 

In June 2009, the FASB issuedSFAS No. 168, *The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples* (“SFAS 168”). SFAS 168 replaces FASB Statement No. 162,*The Hierarchy of Generally Accepted AccountingPrinciples*, and establishes the FASB Accounting StandardsCodification (the “Codification”) as the source of authoritative accountingprinciples recognized by the FASB to be applied by nongovernmental entities in thepreparation of financial statements in conformity with generally acceptedaccounting principles (GAAP). SFAS 168 is effective for interim and annualperiods ending after September 15, 2009. The Company will begin to use thenew Codification when referring to GAAP in its quarterly report on Form 10-Qfor the quarter ending September 30, 2009. This will not have an impact onthe consolidated results of the Company.

 

**Reclassifications**

** **

Certain reclassifications have beenmade to the prior year’s financial statements to conform to the current yearpresentation. In June 2009, the Company identified adjustments related to priorperiods not previously recognized and recorded an after-tax charge of $0.2million and $0.5 million for the three- and six-month periods ended June 30,2009, respectively.  Management hasdetermined that the effect of recognizing these adjustments during 2009 is notconsidered material to the Company’s results of operations for the three- andsix-month periods ended June 30, 2009 or for any prior period.

 

**Note 2.  Restatementof Condensed Consolidated Financial Statements**

** **

The Company has restated itscondensed consolidated statement of operations for the three- and six-monthperiods ended June 30, 2008 and its condensed consolidated statement ofcash flows for the six-month period ended June 30, 2008.

 

Descriptions of the significantrestatement adjustments recorded are as follows:

 

***Application of SFAS 71***

 

Management determined that three ofthe Company’s utilities previously applying SFAS 71 in the Texas Utilitiessegment and one utility in the Utilities segment did not meet the criteria forapplication of SFAS 71 because their cost structures have not allowed for fullrecovery of their cost of service. The Company will continue to report theseentities as utilities within the Texas Utilities and Utilities operatingsegments, respectively. The error impacts the related capitalization ofinter-company profit margin, retired assets and certain costs associated withrate filings.

 

Management determined that theremaining utilities in the Texas Utilities segment met the criteria forapplication of SFAS 71; however, management also determined that inter-companyprofit was not eliminated, in error, as it is not probable that the Companywould recover this cost in future rates, as required by SFAS 71.

 

Management also determined that twoof the Company’s Alabama wastewater utilities in the Utilities segment and awholesale water and wastewater business within the Texas Utilities segment didnot meet the criteria for application of SFAS 71 because the rates charged bythese entities are not established, or subject to approval, by an independentthird-party regulator. Accordingly, capitalized inter-company profit marginincluded in certain fixed assets has been expensed.

 

Aggregate net charges to income fromcontinuing operations before income taxes related to SFAS 71 issues, includedthe correction of the inappropriate capitalization of inter-company profit, of$0.5 million, and $1.1 million for the three- and six-month periods ended June 30,2008, respectively.

 

***Accountingfor Acquisitions***

 

The Company determined thatprinciples related to the accounting for certain business combinations weremisapplied and errors were made in establishing the rate of depreciation ofassets acquired, and in performing the initial allocation of the purchase priceto assets and liabilities acquired.  The Company applied a rate ofdepreciation that did not consider the length of time the assets were inservice prior to being acquired, and depreciation expense was 

 

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**SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

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

 

understated. The correction of theseerrors increased depreciation and amortization expense by $0.2 million in boththe three- and six-month periods ended June 30, 2008.

 

***Valuation and AccountingEstimates***

 

As a part of its restatement, theCompany identified errors in the following valuation and accounting estimates:

 

·                   Stock-basedcompensation — Management identified errors in its accounting forstock-based compensation primarily related to the acceleration of vesting upontermination and in the valuation of options granted related to appropriateassumptions used in the Black-Scholes option pricing model.

 

·                   Unrecordedliabilities — Management identified certain liabilities forservices and capital equipment that were not properly accrued at the end ofreported financial periods.

 

In the aggregate, the adjustmentsdescribed above resulted in increased income before taxes of $0.7 million forboth the three- and six-month periods ended June 30, 2008.

 

***Capitalizationof Operating Expenses***

 

The Company determined that itscapitalization accounting treatment for certain water and sewer taps was notappropriate, and accordingly recorded additional expense of $0.1 million and$27,000 for the three- and six-month periods ended June 30, 2008,respectively.

 

***OtherAdjustments***

 

In the restatement the Company alsoadjusted for the impact of other errors that were identified in prior periodsbut were determined to be immaterial to that period’s financial statements andtherefore corrected in the subsequent period. As part of the restatement of theconsolidated financial statements, the Company reversed these related entriesand reflected the correction of the error in the appropriate period. Theseerrors primarily relate to period end revenue and expense accruals, billingadjustments, the calculation of asset impairment charges and income taxes.

 

For the three- and six-month periodsended June 30, 2008 presented in the “Restatement Adjustments- Other”columns in the tables below, the $0.2 million and $0.3 million increase inoperating losses were offset by a $0.2 million and $0.6 million net taxbenefit, respectively.

 

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**SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

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

 

The nature of the restatementadjustments and the impact on the Company’s previously reported condensedconsolidated statement of operations for the three-month period ended June 30,2008 are shown in the following table (in thousands, except per share data):

 
| ** **                                                    | ** ** | ** **                   | ** ** | ** **                   | ** ** | **Restatement Adjustment**     | ** ** | ** **                        | ** ** | ** **                                           | ** ** | ** **                              | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------|------------|
| **Three Months Ended June 30, 2008**                     | ** ** | **As  Previously  Reported** | ** ** | **Reclass-  ifications (1)** | ** ** | **Application  of  SFAS 71**   | ** ** | **Accounting  for  Acquisitions** | ** ** | **Goodwill,  Valuation  and  Accounting  Estimates** | ** ** | **Capitalization  of Operating  Costs** | ** ** | **Other** | ** ** | **As Restated** | ** ** | **Discontinued  Operations  (3)** | ** ** | **As Restated  and Adjusted  for  Discontinued  Operations** | ** ** |
|                                                          |       |                         |       |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Operating  revenue                                            |       | $                            | 57,066     |                         | $          | —     |       | $                                 | 83         |                                                 | $          | —              |       | $ | 296 |   | $ | 69 |   | $ | (586 | ) | $ | 56,928 |   | $ | (2,758 | ) | $ | 54,170 |   |
| Expenses:                                                     |       |                         |       |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Operations  and maintenance                                   |       | 53,692                       |       | (3,362                       | )          | 316                            |       | (65                               | )          | (427                                                 | )          | 131                                     |       | (535 | ) | 49,750 |   | (1,545 | ) | 48,205 |   |
| Depreciation  and amortization                                |       | —        |       | 3,362                        |       | 311                            |       | 230                               |       | (208                                                 | )          | (25                                     | )          | 121 |   | 3,791 |   | (265 | ) | 3,526 |   |
| Impairment  of long-lived assets                              |       | —        |       | —        |       | —          |       | —             |       | 210                                                  |       | —                   |       | —    |   | 210 |   | 865 |   | 1,075 |   |
| Total  expenses                                               |       | 53,692                       |       | —        |       | 627                            |       | 165                               |       | (425                                                 | )          | 106                                     |       | (414 | ) | 53,751 |   | (945 | ) | 52,806 |   |
| Operating  income                                             |       | 3,374                        |       | —        |       | (544                           | )          | (165                              | )          | 721                                                  |       | (37                                     | )          | (172 | ) | 3,177 |   | (1,813 | ) | 1,364 |   |
|                                                          |       |                         |       |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest  expense                                             |       | (2,042                       | )          | (303                         | )          | 41                             |       | (18                               | )          | —                                |       | —                   |       | 41 |   | (2,281 | ) | 189 |   | (2,092 | ) |
| Interest  income                                              |       | 132                          |       | —        |       | —          |       | —             |       | —                                |       | —                   |       | (78 | ) | 54 |   | 6 |   | 60 |   |
| Income  (loss) from continuing operations before income taxes |       | 1,464                        |       | (303                         | )          | (503                           | )          | (183                              | )          | 721                                                  |       | (37                                     | )          | (209 | ) | 950 |   | (1,618 | ) | (668 | ) |
| Provision  for (benefit from) income taxes **(2)**            |       | 573                          |       | —        |       | —          |       | —             |       | —                                |       | —                   |       | (242 | ) | 331 |   | (564 | ) | (233 | ) |
| Income  (loss) from continuing operations                     |       | 891                          |       | (303                         | )          | (503                           | )          | (183                              | )          | 721                                                  |       | (37                                     | )          | 33 |   | 619 |   | (1,054 | ) | (435 | ) |
| Income  (loss) from discontinued operations, net of tax       |       | (1,678                       | )          | 303                          |       | —          |       | —             |       | 1,352                                                |       | —                   |       | —    |   | (23 | ) | 438 |   | 415 |   |
| Net  loss                                                     |       | (787                         | )          | —        |       | (503                           | )          | (183                              | )          | 2,073                                                |       | (37                                     | )          | 33 |   | 596 |   | (616 | ) | (20 | ) |
| Preferred  stock dividends                                    |       | (6                           | )          | —        |       | —          |       | —             |       | —                                |       | —                   |       | —    |   | (6 | ) | —    |   | (6 | ) |
| Net  loss applicable to common stockholders                   |       | $                            | (793       | )                            | $          | —          |       | $                                 | (503       | )                                                    | $          | (183                                    | )          | $ | 2,073 |   | $ | (37 | ) | $ | 33 |   | $ | 590 |   | $ | (616 | ) | $ | (26 | ) |
| Earning  (loss) per common share:                             |       |                         |       |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Basic:                                                        |       |                         |       |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Income  (loss) from continuing operations                     |       | $                            | 0.04       |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   | $ | (0.02 | ) |
| Income  (loss) from discontinued operations                   |       | (0.07                        | )          |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   | 0.02 |   |
| Net  loss applicable to common stockholders                   |       | $                            | (0.03      | )                            |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   | $ | —     |   |
| Diluted:                                                      |       |                         |       |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Income  (loss) from continuing operations                     |       | $                            | 0.04       |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   | $ | (0.02 | ) |
| Income  (loss) from discontinued operations                   |       | (0.07                        | )          |                         |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   | 0.02 |   |
| Net  loss applicable to common stockholders                   |       | $                            | (0.03      | )                            |       |                           |       |                              |       |                                                 |       |                                    |       |   |   |   |   |   |   |   | $ | —     |   |

 
| (1) | Certain reclassifications have been  made to the previously reported amounts to conform to the current  presentation.                                                                                                                                                                                                                                           |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | The tax provisions related to the  restatement adjustments were based on the effective rates of the  jurisdictions affected.                                                                                                                                                                                                                                    |
| (3) | This column is used to reclassify  the Company’s operating statement classification for amounts previously  classified as “Loss from discontinued operations, net of tax” to their  related individual operating statement captions to conform to the current  presentation. See Note 4, “Assets Held for Sale and Dispositions.” |

 

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

The nature of the restatement adjustments and the impact onthe Company’s previously reported condensed consolidated statement ofoperations for the six-month period ended June 30, 2008 are shown in thefollowing table (in thousands, except per share data):

 
| ** **                                                    | ** ** | ** **                   | ** ** | ** **                   | ** ** | **Restatement Adjustment**    | ** ** | ** **                       | ** ** | ** **                                           | ** ** | ** **                              | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------|------------|
| **Six Months Ended June 30, 2008**                       | ** ** | **As  Previously  Reported** | ** ** | **Reclass-  ifications (1)** | ** ** | **Application  of   SFAS 71** | ** ** | **Accounting  for Acquisitions** | ** ** | **Goodwill,  Valuation  and  Accounting  Estimates** | ** ** | **Capitalization  of Operating  Costs** | ** ** | **Other** | ** ** | **As Restated** | ** ** | **Discontinued  Operations  (3)** | ** ** | **As Restated  and Adjusted  for  Discontinued  Operations** | ** ** |
|                                                          |       |                         |       |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Operating revenue                                             |       | $                            | 107,829    |                         | $          | —         |       | $                                | (270       | )                                                    | $          | —                   |       | $ | 276 |   | $ | (97 | ) | $ | (1,197 | ) | $ | 106,541 |   | $ | (4,958 | ) | $ | 101,583 |   |
| Expenses:                                                     |       |                         |       |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Operations and maintenance                                    |       | 102,648                      |       | (8,315                       | )          | 371                           |       | (120                             | )          | (388                                                 | )          | 23                                      |       | (925 | ) | 93,294 |   | (1,356 | ) | 91,938 |   |
| Depreciation and amortization                                 |       | —        |       | 8,315                        |       | 525                           |       | 244                              |       | (207                                                 | )          | (50                                     | )          | 248 |   | 9,075 |   | (2,066 | ) | 7,009 |   |
| Impairment of long-lived assets                               |       | —        |       | —        |       | —         |       | —            |       | 210                                                  |       | —                   |       | —    |   | 210 |   | 865 |   | 1,075 |   |
| Total expenses                                                |       | 102,648                      |       | —        |       | 896                           |       | 124                              |       | (385                                                 | )          | (27                                     | )          | (677 | ) | 102,579 |   | (2,557 | ) | 100,022 |   |
| Operating income                                              |       | 5,181                        |       | —        |       | (1,166                        | )          | (124                             | )          | 661                                                  |       | (70                                     | )          | (520 | ) | 3,962 |   | (2,401 | ) | 1,561 |   |
|                                                          |       |                         |       |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest expense                                              |       | (4,403                       | )          | —        |       | 96                            |       | (37                              | )          | —                                |       | —                   |       | 355 |   | (3,989 | ) | (223 | ) | (4,212 | ) |
| Interest income                                               |       | 254                          |       | —        |       | —         |       | —            |       | —                                |       | —                   |       | (157 | ) | 97 |   | 11 |   | 108 |   |
| Income (loss) from continuing operations before income  taxes |       | 1,032                        |       | —        |       | (1,070                        | )          | (161                             | )          | 661                                                  |       | (70                                     | )          | (322 | ) | 70 |   | (2,613 | ) | (2,543 | ) |
| Provision for (benefit from) income taxes **(2)**             |       | 455                          |       | —        |       | —         |       | —            |       | —                                |       | —                   |       | (643 | ) | (188 | ) | (702 | ) | (890 | ) |
| Income (loss) from continuing operations                      |       | 577                          |       | —        |       | (1,070                        | )          | (161                             | )          | 661                                                  |       | (70                                     | )          | 321 |   | 258 |   | (1,911 | ) | (1,653 | ) |
| Income (loss) from discontinued operations, net of tax        |       | (1,965                       | )          | —        |       | —         |       | —            |       | 1,437                                                |       | —                   |       | (117 | ) | (645 | ) | 1,305 |   | 660 |   |
| Net loss                                                      |       | (1,388                       | )          | —        |       | (1,070                        | )          | (161                             | )          | 2,098                                                |       | (70                                     | )          | 204 |   | (387 | ) | (606 | ) | (993 | ) |
| Preferred stock dividends                                     |       | (12                          | )          | —        |       | —         |       | —            |       | —                                |       | —                   |       | —    |   | (12 | ) | —    |   | (12 | ) |
| Net loss applicable to common stockholders                    |       | $                            | (1,400     | )                            | $          | —         |       | $                                | (1,070     | )                                                    | $          | (161                                    | )          | $ | 2,098 |   | $ | (70 | ) | $ | 204 |   | $ | (399 | ) | $ | (606 | ) | $ | (1,005 | ) |
| Earning (loss) per common share:                              |       |                         |       |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Basic:                                                        |       |                         |       |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                      |       | $                            | 0.02       |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   | $ | (0.07 | ) |
| Income (loss) from discontinued operations                    |       | (0.08                        | )          |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   | 0.03 |   |
| Net loss applicable to common stockholders                    |       | $                            | (0.06      | )                            |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   | $ | (0.04 | ) |
| Diluted:                                                      |       |                         |       |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                      |       | $                            | 0.02       |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   | $ | (0.07 | ) |
| Income (loss) from discontinued operations                    |       | (0.08                        | )          |                         |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   | 0.03 |   |
| Net loss applicable to common stockholders                    |       | $                            | (0.06      | )                            |       |                          |       |                             |       |                                                 |       |                                    |       |   |   |   |   |   |   |   | $ | (0.04 | ) |

 
| (1) | Certain reclassifications have been made to the previously  reported amounts to conform to the current presentation.                                                                                                                                                                                                                                            |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | The tax provisions related to the restatement adjustments  were based on the effective rates of the jurisdictions affected.                                                                                                                                                                                                                                     |
| (3) | This column is used to reclassify the Company’s operating  statement classification for amounts previously classified as “Loss from  discontinued operations, net of tax” to their related individual operating  statement captions to conform to the current presentation. See Note 4,  “Assets Held for Sale and Dispositions.” |

 

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

The following tablepresents the impact of the restatement adjustments on the Company’s previouslyreported condensed consolidated statement of cash flows for the six monthsended June 30, 2008 (in thousands):

 
| ** **                                                                   | ** ** | **Six months ended June 30, 2008** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                   | ** ** | **As Previously  Reported**             | ** ** | **Restatement Adjustment** | ** ** | **As Restated** | ** ** |
| ** **                                                                   | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from operating activities of continuing operations:               |       |                                    |       |   |   |   |   |
| Net loss                                                                     |       | $                                       | (1,388     | ) | $ | 395 |   | $ | (993 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities: |       |                                    |       |   |   |   |   |
|                                                                         |       |                                    |       |   |   |   |   |
| (Income) loss from discontinued operations, net of tax                       |       | 1,965                                   |       | (2,625 | ) | (660 | ) |
| Depreciation and amortization                                                |       | 7,201                                   |       | (192 | ) | 7,009 |   |
| Deferred income taxes                                                        |       | 234                                     |       | 1,285 |   | 1,519 |   |
| Provision for doubtful accounts                                              |       | —              |       | 1,020 |   | 1,020 |   |
| Share-based compensation expense                                             |       | 613                                     |       | (123 | ) | 490 |   |
| Impairment of long-lived assets                                              |       | —              |       | 1,075 |   | 1,075 |   |
| Amortization of deferred financing costs                                     |       | —              |       | 134 |   | 134 |   |
| Other, net                                                                   |       | —              |       | (75 | ) | (75 | ) |
| Changes in assets and liabilities, net of effects of  acquisitions:          |       |                                    |       |   |   |   |   |
| Accounts receivable                                                          |       | (4,176                                  | )          | (944 | ) | (5,120 | ) |
| Other current assets                                                         |       | 782                                     |       | 2,407 |   | 3,189 |   |
| Other assets                                                                 |       | (2,443                                  | )          | (68 | ) | (2,511 | ) |
| Accounts payable                                                             |       | (7,055                                  | )          | (910 | ) | (7,965 | ) |
| Other current liabilities                                                    |       | (1,276                                  | )          | (3,042 | ) | (4,318 | ) |
| Other liabilities                                                            |       | 46                                      |       | 128 |   | 174 |   |
| Other, net                                                                   |       | (278                                    | )          | 225 |   | (53 | ) |
| Net cash used in operating activities                                        |       | (5,775                                  | )          | (1,310 | ) | (7,085 | ) |
|                                                                         |       |                                    |       |   |   |   |   |
| Cash flows from investing activities of continuing  operations:              |       |                                    |       |   |   |   |   |
| Additions to property, plant and equipment                                   |       | (16,129                                 | )          | 2,158 |   | (13,971 | ) |
| Acquisition of businesses, net of cash acquired                              |       | (23,330                                 | )          | —     |   | (23,330 | ) |
| Proceeds from sale of minority interest                                      |       | —              |       | 170 |   | 170 |   |
| Proceeds from sale of land and equipment                                     |       | 179                                     |       | (170 | ) | 9 |   |
| Net cash used in investing activities                                        |       | (39,280                                 | )          | 2,158 |   | (37,122 | ) |
|                                                                         |       |                                    |       |   |   |   |   |
| Cash flows from financing activities of continuing operations:               |       |                                    |       |   |   |   |   |
| Borrowings under lines of credit                                             |       | 131,500                                 |       | 6,000 |   | 137,500 |   |
| Repayments under lines of credit                                             |       | (84,500                                 | )          | (6,000 | ) | (90,500 | ) |
| Capital improvement reimbursements                                           |       | 1,854                                   |       | (487 | ) | 1,367 |   |
| Proceeds from share-based equity incentive plans and stock  purchase plans   |       | 1,762                                   |       | 1 |   | 1,763 |   |
| Contributions in aid of construction                                         |       | 363                                     |       | (352 | ) | 11 |   |
| Dividends paid                                                               |       | (2,953                                  | )          | —     |   | (2,953 | ) |
| Payments on long-term debt                                                   |       | (873                                    | )          | (173 | ) | (1,046 | ) |
| Deferred financing costs                                                     |       | (532                                    | )          | 100 |   | (432 | ) |
| Repayment of advances for construction                                       |       | (1,140                                  | )          | 608 |   | (532 | ) |
| Stock option benefit adjustment                                              |       | (40                                     | )          | 40 |   | —     |   |
| Net cash provided by financing activities                                    |       | 45,441                                  |       | (263 | ) | 45,178 |   |
|                                                                         |       |                                    |       |   |   |   |   |
| Net cash provided by (used in) discontinued operations                       |       | 547                                     |       | (585 | ) | (38 | ) |
|                                                                         |       |                                    |       |   |   |   |   |
| Net increase in cash and cash equivalents                                    |       | 933                                     |       | —     |   | 933 |   |
| Cash and cash equivalents at beginning of the period                         |       | 2,950                                   |       | —     |   | 2,950 |   |
| Cash and cash equivalents at end of the period                               |       | $                                       | 3,883      |   | $ | —     |   | $ | 3,883 |   |

 

**Note3.  Acquisition**

** **

On January 31,2008, the Company acquired substantially all of the assets of a wastewatercollection system and related treatment plant in Birmingham, Alabama. Thepurchase price was $23.3 million in cash which the Company borrowed under itsrevolving line of credit. 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.

 

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

The condensed consolidatedfinancial statements reflect the financial position and results of operationsof the acquired utility subsequent to its acquisition date. Unaudited pro formaconsolidated results of operations are presented in the table below for the sixmonths ended June 30, 2008 as if the acquisition had occurred as of thebeginning of the period presented:

 
| *** ***                                                       | *** *** | ***Six Months***         | *** *** |
|--------------------------------------------------------------------|--------------|--------------------------|--------------|
| *** ***                                                       | *** *** | ***Ended***              | *** *** |
| *** ***                                                       | *** *** | ***June 30, 2008*** | *** *** |
| ***(In  thousands, except per share data)***                       | ** **   | **As Restated**          | ** **   |
|                                                               |         |                     |         |
| Operating  revenue                                                 |         | $                        | 101,990      |   |
| Loss  from continuing operations                                   |         | (1,602                   | )            |
| Loss  from continuing operations applicable to common stockholders |         | (1,614                   | )            |
| Net  loss applicable to common stockholders                        |         | (954                     | )            |
|                                                               |         |                     |         |
| Loss  per common share, basic and diluted:                         |         |                     |         |
| From  continuing operations applicable to common stockholders      |         | $                        | (0.07        | ) |
| Net  loss applicable to common stockholders                        |         | (0.04                    | )            |
|                                                                    |              |                          |              |  |  |

 

The pro forma resultsof operations are not necessarily indicative of the results that would havebeen achieved had the acquisition occurred as of the date indicated or toproject the results of operations for any future periods. The above informationreflects adjustments for historical revenue and expenses prior to theacquisition, as well as incremental operating, general and administrative,depreciation, interest and income tax expense based on the estimated fair valueof assets acquired and additional indebtedness in connection with theacquisition.

 

**Note4.  Assets Held for Sale, Dispositions and Impairments**

** **

*Texas WholesaleWater and Wastewater*

 

During 2007, theCompany committed to a plan to sell its wholesale water and wastewateroperations in Texas.   In December 2008,the Company completed the sale of its wholesale wastewater business for netcash proceeds 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 water component is reflectedin consolidated continuing operations in 2009. The results of operations and cash flows for the wastewater operationsare reflected as discontinued operations for the three- and six-month periodsended June 30, 2008.  Net assetsheld for sale at December 31, 2008 consisted of property, plant andequipment aggregating $6.3 million and deferred revenue liabilities of $3.5million.

 

*New Mexico Utilities, Inc.*

 

As more fullydescribed in Note 6, as part of a settlement of eminent domain proceedingsagainst the Company’s New Mexico utility, New Mexico Utilities Inc., theCompany completed the sale of the New Mexico utility on May 8, 2009.  The Company received $53.9 million in cash atclosing ($60.0 million settlement and $0.9 million net cash settlement primarilyrelated to accounts receivable, less $7.0 million retained by the condemningentity in settlement of sewer treatment fees). The sale reflects a $107.2 million reduction in assets, offset byreduction in liabilities which include $69.0 million of contributions in aid ofconstruction. The results of operations and cash flows for the New Mexicoutility are reflected as discontinued operations for all periods presented.

 

*Discontinued Operations*

 

The following tablesummarizes the results of operations of the Texas wastewater and New Mexicoutility operations included in the condensed consolidated statement ofoperations as discontinued operations:

 

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**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 
| ** **                                                      | ** ** | ** ** | **Three Months Ended**         | ** ** | **Six Months Ended**           | ** ** |
|-----------------------------------------------------------------|------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                                      | ** ** | ** ** | **June 30,**              | ** ** | **June 30,**              | ** ** |
| ** **                                                      | ** ** | ** ** | ** **                     | ** ** | **2008**                       | ** ** | ** ** | ** ** | **2008** | ** ** |
| ***(In thousands)***                                            | ** ** | ** ** | **2009**                       | ** ** | **As Restated**                | ** ** | **2009** | ** ** | **As Restated** | ** ** |
|                                                            |       |       |                           |       |                           |       |   |   |   |   |
| Revenue                                                         |       |       | $                              | 2,425      |                           | $          | 2,891 |   | $ | 4,729 |   | $ | 5,240 |   |
| Expenses                                                        |       |       | (1,034                         | )          | (1,999                         | )          | (2,895 | ) | (3,780 | ) |
| Impairment of long-lived assets                                 |       |       | —     |       | (95                            | )          | —     |   | (95 | ) |
| Interest expense                                                |       |       | (91                            | )          | (190                           | )          | (270 | ) | (379 | ) |
| Income before taxes                                             |       |       | 1,300                          |       | 607                            |       | 1,564 |   | 986 |   |
| Income tax expense                                              |       |       | (469                           | )          | (192                           | )          | (561 | ) | (326 | ) |
| Income before gain on sale of discontinued operations           |       |       | 831                            |       | 415                            |       | 1,003 |   | 660 |   |
| Gain  on sale of discountinued operations, net of $9,361 of tax |       |       | 16,728                         |       | —     |       | 16,728 |   | —     |   |
| Income from discontinued operations, net of tax                 |       |       | $                              | 17,559     |                           | $          | 415 |   | $ | 17,731 |   | $ | 660 |   |

 

In accordance withEITF 87-24, *Allocation of Interest to DiscontinuedOperation*(“EITF 87-24”), as amended, interest expense reflectsinterest on debt that the Company is required to repay as a result of the sale.In addition, and also in accordance with EITF 87-24, costs and expensesexclude the allocation of general corporate overhead.

 

In accordance withSFAS 144,**intangible and other long-livedassets are assessed for recoverability**wheneverevents or changes in circumstances indicate that their carrying value may notbe recoverable through the estimated undiscounted future cash flows resultingfrom the use of the assets. The Company had determined that the carrying valueof the Texas wastewater assets may not be recoverable through the salesprocess. As a result, impairment charges aggregating $0.1 million (all relatedto property, plant and equipment) were recorded during the second quarter of2008, to reduce the carrying value of the long-lived assets to expectedrealizable value.

 

*Southwest EnvironmentalLaboratories, Inc.*

 

**The Companyentered into an agreement to sell certain assets of its Southwest EnvironmentalLaboratories, Inc. subsidiary, part of the Texas MUD Services segment, for$0.5 million paid at closing and up to an additional $0.75 million ofconsideration, consisting of 25% of the buyer’s quarterly aggregate salessubsequent to the sale.  The Company alsoentered into a separate agreement to sell the remaining asset representing realproperty for total consideration of $0.7 million.  These agreements closed on April 1, 2009and April 23, 2009, respectively. The Southwest Environmental Laboratories, Inc. subsidiary was notconsidered a discontinued operation in the accompanying consolidated financialstatements due to on-going business relationship.**

** **

*Cornerstone Internal-use SoftwareDevelopment Project*

 

In May 2009, the Company terminated its previouslysuspended software development project; as a result, an impairment charge of$8.0 million was recorded, net of recoveries from vendors.

 

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**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

**Note5.  Long-Term Debt**

** **

Long-term debtconsists of the following as of June 30, 2009 and December 31, 2008:

 
| *** ***                                                 | *** *** | ***June 30,*** | *** *** | ***December 31,*** | ** ** |
|--------------------------------------------------------------|--------------|---------------------|--------------|-------------------------|------------|
| ***(In  thousands)***                                        | ** **   | **2009**            | ** **   | **2008**                | ** ** |
|                                                         |         |                |         |                    |       |
| Revolving credit  facility                                   |         | $                   | 70,400       |                    | $          | 98,000 |   |
|                                                         |         |                |         |                    |       |
| 6.85% convertible  subordinated debentures due 2021          |         | 11,869              |         | 11,962                  |       |
|                                                         |         |                |         |                    |       |
| $30 million capital  lease facility and other capital leases |         | 3,645               |         | 4,332                   |       |
|                                                         |         |                |         |                    |       |
| Term Loans:                                                  |         |                |         |                    |       |
| Monarch Utilities, Inc.:                                |         |                |         |                    |       |
| 7.37% fixed rate  term loan due 2022                         |         | 9,882               |         | 10,267                  |       |
| 5.77% fixed rate  term loan due 2021                         |         | 680                 |         | 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                    |         | 151,364             |         | 192,155                 |       |
| Unamortized Monarch  term loan fair value adjustments        |         | 645                 |         | 636                     |       |
| Total long-term  debt                                        |         | 152,009             |         | 192,791                 |       |
| Less current  portion of long-term debt                      |         | (2,162              | )            | (2,213                  | )          |
| Long-term debt, less current portion                         |         | $                   | 149,847      |                    | $          | 190,578 |   |

 

On February 15,2008, the Company replaced its previous revolving line of credit by enteringinto a credit agreement with several lenders including Bank of America, aslender and Administrative Agent, KeyBank, CoBank, U.S. Bank, JPMorgan ChaseBank, Comerica Bank, Bank of the West, Citibank and Union Bank of California(the “Bank Group”). The credit agreement provided for a $150.0 millionrevolving credit facility. Proceeds from the initial borrowing under the creditagreement were used to repay borrowings under the Company’s prior $100.0million revolving line of credit.

 

The Company issubject to commitment fees under the facility as well as the maintenance ofcustomary financial ratios, cash flow results and other restrictive covenants.The Company was not in compliance with certain restrictive covenants due to thefailure to deliver timely its September 30, 2008, March 31, 2009 and June 30,2009 Quarterly Reports on Form 10-Q and its 2008 Annual Report on Form 10-K.  In addition, the Company was in violation ofone of its financial covenants, specifically the debt-to-capitalization ratio,at December 31, 2008 and at March 31, 2009.   However, the Company received fiveamendments to the credit agreement from the Bank Group dated November 19,2008, May 28, 2009, June 17, 2009, July 8, 2009 and July 31,2009 which waived existing and anticipated defaults, specifically related toadditional time with regards to financial filings and with regards to thedebt-to-capitalization ratio.

 

The May 28, 2009amendment to the agreement reduced the total credit amount available under theline from $150.0 million to $110.0 million.

 

The revolving line ofcredit commitment ends on February 15, 2013 (if not renewed or extended),at which time all borrowings must be repaid. However, there are certainprovisions within the revolving credit facility agreement that couldpotentially be interpreted as a subjective acceleration clause. Though theCompany does not anticipate any changes in its business practices that wouldresult in any material adjustments to the revolving credit facility, managementcannot be certain how the lender will interpret the subjective accelerationclause.

 

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**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

Borrowings under thecredit facility bear interest, at the Company’s option, based on a margineither over the LIBOR rate or the prime rate. The margins vary depending uponthe Company’s consolidated debt to equity ratio. As of June 30, 2009, theapplicable margins are 3.50% over the LIBOR rate or 2.50% over the prime rate.The nominal weighted-average annual interest rates on all credit facilityborrowings outstanding were 4.41% as of June 30, 2009 and 1.58% as of December 31,2008.

 

The Company hadirrevocable standby letters of credit in the amount of $3.3 million issued andoutstanding under its revolving credit facility as of June 30, 2009. As ofJune 30, 2009 available borrowing was $36.3 million.

 

**Note6.  Commitments and Contingencies**

** **

**LegalProceedings**

** **

*New Mexico Utilities, Inc.*

* *

New Mexico Utilities, Inc.(“NMUI”), one of the Company’s wholly-owned regulated utilities, had anagreement with the Albuquerque Bernalillo County Water Utility Authority, apolitical subdivision of the State of New Mexico (the “ABCWUA”), whereby theABCWUA treated the effluent from NMUI’s wastewater collection system for a fee.The treated effluent is returned to the Rio Grande Underground Basin, creatingreturn flow credits. Return flow credits supplemented NMUI’s existing waterrights, enabling it to pump additional water from the basin.

 

In August 2004,the ABCWUA increased the fee charged to NMUI, using a different formula thanhad been used to calculate fee increases since 1973. The Company believed theincrease violated the terms of a 1973 written agreement between the parties.Subsequently, the ABCWUA also claimed ownership of the return flow credits. On September 13,2004, the Company filed a Complaint for Declaratory Judgment in the SecondJudicial District Court, County of Bernalillo, State of New Mexico (the “Court”),requesting that the Court settle these disputes. In a letter ruling dated May 2,2007, the Court ruled that the ABCWUA could use a new formula to set fees forNMUI. The Company filed a motion for reconsideration and that motion was deniedon October 2, 2007. The Court did not rule on whether the new ratewas appropriate, made no determination as to any amount NMUI may owe to the ABCWUA,and did not rule on the ownership of the return flow credits.

 

Additionally, theABCWUA had asserted that NMUI owed to the ABCWUA an amount of approximately$800,000 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 $500,000.

 

The New Mexico PublicRegulation Commission (the “NMPRC”) ruled that NMUI may commence billing itscustomers for a portion of the sewer fee increase and hold the collectedamounts in escrow (“Rate Rider Escrow”), pending a final court decision.

 

In addition, on January 19,2007, the ABCWUA and the City of Rio Rancho, a home-rule municipalcorporation, as Petitioners, filed a Petition for Condemnation against NMUI andothers, as defendants, in the Court (the “Petition”). The Petition sought toacquire, by condemnation, all of the assets of NMUI, including all realproperty, through the stated power of eminent domain. The Petition also allegedthat the Petitioners need to acquire the NMUI assets for the public purposes ofproviding water and wastewater services to NMUI customers and that theacquisition of NMUI is necessary, appropriate and in the public interest. TheCompany contested the Petition.  In thefourth quarter of 2008, the Company attempted to globally settle thecondemnation and the sewer rate and return flow credit issues, including an$8.0 million cash offer. The settlement offer was not accepted by ABCWUA.

 

On January 29,2009, NMUI and the ABCWUA entered into a Settlement, Arbitration Award, andAcquisition Agreement (the “Agreement”) to resolve all outstanding claims,demands and existing lawsuits between them. The Agreement closed on May 8,2009 (the “Closing”) after the financing was completed.  Under the Agreement, the ABCWUA acquiredcertain of the assets of NMUI necessary for the ABCWUA to own, operate andmaintain the water and wastewater system of NMUI in settlement of condemnation.In consideration of the assets acquired, the ABCWUA agreed to pay to NMUI atthe Closing as full, final and complete consideration the sum of $60.0 millionplus a net cash settlement of an amount equal to the NMUI accounts receivableat the date of Closing and an amount equal to the unbilled services at thedate of Closing.

 

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NMUI also receivedthe right to receive Rate Rider Escrow Funds deposited from the period from November 27,2007 through January 12, 2009.  Thetotal amount received by the Company on May 12, 2009 from the Rate RiderEscrow Funds was $1.4 million.

 

In addition, thesettlement resolves all other legal issues between NMUI and ABCWUA includingthe dispute over the sewer fee the ABCWUA charged NMUI for the treatment ofeffluent from NMUI’s wastewater collection system and the ownership of thereturn flow credits from that treated wastewater, as well as all other disputedamounts of the ABCWUA. As part of the settlement, NMUI agreed to pay $7.0million 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.

 

Net cash proceedsfrom settlement were $53.9 million and the resulting gain, net of directtransactional costs of $0.2 million, was $26.1 million.   Substantially all of the utility plantassets of NMUI were pledged as collateral for $12.0 million in first mortgagebonds with an original maturity of 2024. The Company repaid these bonds in full, including accrued interest of$0.3 million. The remaining cash proceeds of $41.6 million were used to pay thebalance of liabilities of NMUI, and to pay down the Company’s revolving creditfacility. The sale reflects a $107.2 million reduction in assets, offset byreduction in liabilities which includes a $69.0 million reduction in ofcontributions in aid of construction.

 

*Investigations*

* *

On May 18, 2005,the Environmental Protection Agency (“EPA”) executed a search warrant at theCompany’s Texas-based testing laboratory and on July 20, 2006 thelaboratory received a subpoena to provide additional records and information toa grand jury. The Company has cooperated fully with the EPA’s investigation andhas provided the records requested. The Company remains in close cooperationand coordination with EPA’s counsel in an attempt to resolve the matterfavorably. In April 2009, the Company submitted its formal request thatthe EPA not pursue criminal sanctions against the Company.  Given the nature and preliminary status of thismatter, the Company cannot yet determine the amount or even a reasonable rangeof potential loss in these matters, if any.

 

The Company receiveda letter dated January 28, 2008 from the California State Water ResourcesControl Board Office of Enforcement (the “Board”). The letter indicates thatthe Board has conducted an investigation of the operations of a subsidiary ofthe Company with respect to various California wastewater treatment facilitieswhich are operated, but not owned, by the subsidiary. The Board alleges thatthe subsidiary has violated certain provisions of the California Water Code andmay be subject to civil administrative liability in excess of $15.0 million,and possible administrative action against the subsidiary’s status as acontract operator in California.  Sincereceipt of the letter, the Company has conducted an internal investigation andworked in cooperation with the Board to resolve the matter favorably. The Boardhas made an offer of settlement, assuming that the Company implements anacceptable compliance program that would among other things require the Companyto pay fines and penalties of $1.25 million, which is fully accrued at December 31,2008. The Company is currently in discussion with the Board with respect tothis matter.

 

*Class Action Litigation*

* *

*Perrin v.SouthWest Water Company, et al.*,Case No. CV 08-07844 (Central District of California) and related,consolidated cases:  On November 26, 2008, an alleged purchaser ofthe Company’s 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, the Company made false statements or omitted to state facts necessary tomake the Company’s disclosures not misleading.  Five additional andsubstantially similar cases were filed in the same court.  On January 26,2009, motions for consolidation and for the appointment of lead plaintiff andlead counsel were filed by the plaintiffs.  On February 12, 2009, thecourt granted the motion for consolidation and for the appointment of leadplaintiff and lead counsel.  Pursuant to stipulation of the parties, thelead plaintiff has until October 15, 2009, to file a consolidatedcomplaint.  The Company will have 60 days to answer or move to dismiss theconsolidated complaint. Given the nature and preliminary status of these cases,the Company cannot yet determine the amount or even a reasonable range ofpotential loss in these matters, if any.

 

*Derivative Litigation*

* *

*Sherman v.Christie, et al.*,Case No. BC404946 (Los Angeles County Superior Court) and relatedcases:  On January 2, 2009, an alleged shareholder of the Companyfiled a shareholder derivative case on behalf of the Company, alleging breachof fiduciary duty arising from the Company’s announcement of its intent torestate its financial statements against certain of its present and formermembers of the Company’s 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 ordered an initialstatus conference for December 3, 2009.  The cases were 

 

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**

 

consolidated on May 19,2009.  The lead plaintiff has, by stipulation of the parties, until October 8,2009 to file a consolidated complaint.  The Company will then have 60 daysto answer or move to dismiss the consolidated complaint. Given the nature andpreliminary status of these cases, the Company cannot yet determine the amountor even a reasonable range of potential loss in these matters, if any.

 

*Other Matters*

* *

The Company and itssubsidiaries are also involved in other routine legal and administrativeproceedings arising during the ordinary course of business. The Companybelieves that the ultimate disposition of such matters will not have a materialadverse effect on the Company’s consolidated financial position, results ofoperations or cash flows.  Any relatedlegal costs are expensed when incurred.

 

**Note7.  Earnings Per Share**

** **

The following tableis a reconciliation of the numerators (income) and denominators (shares) usedin both the basic and diluted earnings per share calculations.

 
| ** **                                                                                           | ** ** | **Three Months  Ended** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                           | ** ** | **June 30,**       | ** ** |
| ** **                                                                                           | ** ** | ** **              | ** ** | **2008** | ** ** |
| ***(In thousands)***                                                                                 | ** ** | **2009**                | ** ** | **As Restated** | ** ** |
|                                                                                                 |       |                    |       |   |   |
| Numerators—Net loss  applicable to common stockholders:                                         |       |                    |       |   |   |
| Loss from  continuing operations                                                                     |       | $                       | (8,063     | ) | $ | (435 | ) |
| Less preferred  stock dividends                                                                      |       | (6                      | )          | (6 | ) |
| Loss from  continuing operations applicable to common stockholders, net of tax                       |       | (8,069                  | )          | (441 | ) |
| Income from  discontinued operations, net of tax                                                     |       | 17,559                  |       | 415 |   |
| Net income (loss)  applicable to common stockholders                                                 |       | $                       | 9,490      |   | $ | (26 | ) |
|                                                                                                 |       |                    |       |   |   |
| Denominators—Weighted  average shares outstanding:                                              |       |                    |       |   |   |
| Basic and diluted  weighted average common shares outstanding, excluding unearned restricted  shares |       | 24,608                  |       | 24,507 |   |
|                                                                                                 |       |                    |       |   |   |
|                                                                                                 |       |                    |       |   |   |
| ** **                                                                                           | ** ** | **Six Months  Ended**   | ** ** |
| ** **                                                                                           | ** ** | **June 30,**       | ** ** |
| ** **                                                                                           | ** ** | ** **              | ** ** | **2008** | ** ** |
| ***(In thousands)***                                                                                 | ** ** | **2009**                | ** ** | **As Restated** | ** ** |
|                                                                                                 |       |                    |       |   |   |
| Numerators—Net loss  applicable to common stockholders:                                         |       |                    |       |   |   |
| Loss from  continuing operations                                                                     |       | $                       | (11,468    | ) | $ | (1,653 | ) |
| Less preferred  stock dividends                                                                      |       | (6                      | )          | (12 | ) |
| Loss from  continuing operations applicable to common stockholders, net of tax                       |       | (11,474                 | )          | (1,665 | ) |
| Income from  discontinued operations, net of tax                                                     |       | 17,731                  |       | 660 |   |
| Net income (loss)  applicable to common stockholders                                                 |       | $                       | 6,257      |   | $ | (1,005 | ) |
|                                                                                                 |       |                    |       |   |   |
| Denominators—Weighted  average shares outstanding:                                              |       |                    |       |   |   |
| Basic and diluted  weighted average common shares outstanding, excluding unearned restricted  shares |       | 24,604                  |       | 24,444 |   |

 

The Company has $11.9million of 6.85% fixed-rate convertible subordinate debentures outstanding as June 30,2009.  The debentures, due in 2021, areconvertible into common stock at any time prior to maturity at a conversionprice of $11.018 per share (1.1 million shares).  At such time as the assumed conversion of thedebentures has a dilutive effect on earnings per share, the debentures will beincluded in the calculation of diluted earnings per share.

 

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**SOUTHWEST WATER COMPANY ANDSUBSIDIARIES**

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

 

**Note 8.  Consolidated Statements of CashFlows**

** **

Thefollowing information supplements the Company’s consolidated statements of cashflows.

 
| ** **                                    | ** ** | ** ** | **Six Months Ended June 30,** | ** **  |
|-----------------------------------------------|------------|------------|------------------------------------|-------------|
| ** **                                    | ** ** | ** ** | ** **                         | ** **  | ** ** | **2008** | ** ** |
| ***(In thousands)***                          | ** ** | ** ** | **2009**                           | ** **  | ** ** | **As Restated** | ** ** |
| Cash  paid during the period for:             |       |       |                               |        |   |   |   |
| Interest                                      |       |       | $                                  |  4,641 |   |   | $ |  4,387 |   |
| Income  taxes paid, net                       |       |       | 422                                |        |   | 1,937 |   |
|                                          |       |       |                               |        |   |   |   |
| Components  of cash paid for acquisitions:    |       |       |                               |        |   |   |   |
| Fair  value of assets acquired                |       |       | $                                  | —      |   |   | $ |  23,330 |   |
| Liabilities  assumed                          |       |       | —                             |        |   | — |   |
| Cash  paid for acquisitions                   |       |       | $                                  | —      |   |   | $ |  23,330 |   |
|                                          |       |       |                               |        |   |   |   |
| Non-cash  investing and financing activities: |       |       |                               |        |   |   |   |
| Equipment  acquired through capital lease     |       |       | $                                  | —      |   |   | $ |  132 |   |
| Debentures  converted into common stock       |       |       | —                             |        |   | 14 |   |

 

**Note 9.  Dividend Reinvestment andDirect Stock Purchase Plan (“DRIP / DSPP”)**

 

TheCompany has a dividend reinvestment and stock purchase plan that gives 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. The Company may, at itssole discretion, permit purchases above the $10,000 stated maximum. Thediscounts may range from 0% to 5%, as determined from time to time by theCompany. The DRIP and DSPP discounts offered by the Company were 5% for theDRIP and 0% for the DSPP as of June 30, 2009. As of June 30, 2009,there are 3.7 million shares authorized for issuance under the plan of which0.7 million shares remain available for issuance.  However, in November 2008, the Companydetermined that participation in these plans should be suspended due to theCompany’s ineligibility to use its Registration Statement on Form S-3 untilafter the Company is current in all SEC filings and has timely filed allreports due in the preceding 12 months.

 

**Note 10.  Segment Information**

** **

The Company’s principal business activity is to operate andmaintain water and wastewater infrastructure. Through its operating subsidiaries, the Company owns 131 systems andoperates hundreds more under contract to cities, utility districts and privatecompanies. The Company has four reporting segments. The Company separates itssegments first by whether it owns the utility or provides contract services toothers. Its owned water and wastewater utilities are referred to as itsUtilities operations. In its financial statements the Company reports its TexasUtilities operations as a separate segment because of different economiccharacteristics. This is principally due to the fact that Texas Utilities areunder-recovering their current cost of service as the Company has made largeinvestments in these operations that are not yet being recovered through ratesit charges. The Company’s contract operations are segmented by contract typeinto those that are generally larger, stand-alone operations (“O&M Services”)and those 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”).

 

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**SOUTHWEST WATER COMPANY AND SUBSIDIARIES**

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

 

Thefollowing tables present information about the operations of each segment forthe three- and six-month periods ended June 30, 2009 and 2008.  The 2008 amounts have been adjusted tocorrect the errors discussed in Note 2.

 
| ***(In thousands)***                                          | ** ** | ** ** | **Utilities** | ** ** | ** ** | **Texas  Utilities** | ** ** | ** ** | **O&M  Services** | ** ** | ** ** | **Texas MUD  Services** | ** ** | ** ** | **Corp.**  | ** ** | ** ** | **Consol-  idated** | ** ** |
|---------------------------------------------------------------|------------|------------|---------------|------------|------------|----------------------|------------|------------|-----------------------|------------|------------|-------------------------|------------|------------|------------|------------|------------|---------------------|------------|
| ** **                                                    | ** ** | ** ** | ** **    | ** ** | ** ** | ** **           | ** ** | ** ** | ** **            | ** ** | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** |
| **Three Months Ended June 30, 2009**                     | ** ** | ** ** | ** **    | ** ** | ** ** | ** **           | ** ** | ** ** | ** **            | ** ** | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** |
| ** **                                                    | ** ** | ** ** | ** **    | ** ** | ** ** | ** **           | ** ** | ** ** | ** **            | ** ** | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** |
| Operating  revenue                                            |       |       | $             | 16,433     |       |                 | $          | 9,005      |                  |       | $          | 8,981                   |       |       | $          | 17,997     |       |                | $          | — |   |   | $ | 52,416 |   |
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |       |       |       |                |       |
| Expenses:                                                     |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |       |       |       |                |       |
| Operating  expenses                                           |       |       | 8,333         |       |       | 5,785                |       |       | 9,007                 |       |       | 17,617                  |       |       | 9,310      |       |       | 50,052              |       |
| Depreciation  and Amortization                                |       |       | 1,998         |       |       | 1,180                |       |       | 140                   |       |       | 199                     |       |       | 340        |       |       | 3,857               |       |
| Impairment  of long-lived assets                              |       |       | —        |       |       | —               |       |       | —                |       |       | 122                     |       |       | 7,993      |       |       | 8,115               |       |
| Total  expenses                                               |       |       | 10,331        |       |       | 6,965                |       |       | 9,147                 |       |       | 17,938                  |       |       | 17,643     |       |       | 62,024              |       |
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |       |       |       |                |       |
| Operating  income (loss)                                      |       |       | 6,102         |       |       | 2,040                |       |       | (166                  | )          |       | 59                      |       |       | (17,643    | )          |       | (9,608              | )          |
| Interest  expense                                             |       |       | (622          | )          |       | (384                 | )          |       | (28                   | )          |       | (2                      | )          |       | (1,939     | )          |       | (2,975              | )          |
| Interest  income                                              |       |       | 26            |       |       | 16                   |       |       | 1                     |       |       | 2                       |       |       | 3          |       |       | 48                  |       |
| Other  income (expense)                                       |       |       | 156           |       |       | (284                 | )          |       | (85                   | )          |       | (96                     | )          |       | 309        |       |       | —              |       |
| Income (loss) from continuing  operations before income taxes |       |       | $             | 5,662      |       |                 | $          | 1,388      |                  |       | $          | (278                    | )          |       | $          | (37        | )          |                | $          | (19,270 | ) |   | $ | (12,535 | ) |

 
| ***(In thousands)***                                          | ** ** | ** ** | **Utilities** | ** ** | ** ** | **Texas  Utilities** | ** ** | ** ** | **O&M  Services** | ** ** | ** ** | **Texas MUD  Services** | ** ** | ** ** | **Corp.**  | ** ** | ** ** | **Consol-  idated** | ** ** |
|---------------------------------------------------------------|------------|------------|---------------|------------|------------|----------------------|------------|------------|-----------------------|------------|------------|-------------------------|------------|------------|------------|------------|------------|---------------------|------------|
| ** **                                                    | ** ** | ** ** | ** **    | ** ** | ** ** | ** **           | ** ** | ** ** | ** **            | ** ** | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** |
| **Three Months Ended  June 30, 2008   (As Restated)**    | ** ** | ** ** | ** **    | ** ** | ** ** | ** **           | ** ** | ** ** | ** **            | ** ** | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** |
| ** **                                                    | ** ** | ** ** | ** **    | ** ** | ** ** | ** **           | ** ** | ** ** | ** **            | ** ** | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** |
| Operating  revenue                                            |       |       | $             | 16,208     |       |                 | $          | 8,723      |                  |       | $          | 10,449                  |       |       | $          | 18,790     |       |                | $          | — |   |   | $ | 54,170 |   |
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |       |       |       |                |       |
| Expenses:                                                     |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |       |       |       |                |       |
| Operating  expenses                                           |       |       | 8,467         |       |       | 6,018                |       |       | 10,672                |       |       | 18,787                  |       |       | 4,261      |       |       | 48,205              |       |
| Depreciation  and Amortization                                |       |       | 1,810         |       |       | 859                  |       |       | 64                    |       |       | 309                     |       |       | 484        |       |       | 3,526               |       |
| Impairment  of long-lived assets                              |       |       | —        |       |       | 865                  |       |       | —                |       |       | 210                     |       |       | —     |       |       | 1,075               |       |
| Total  expenses                                               |       |       | 10,277        |       |       | 7,742                |       |       | 10,736                |       |       | 19,306                  |       |       | 4,745      |       |       | 52,806              |       |
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |       |       |       |                |       |
| Operating  income (loss)                                      |       |       | 5,931         |       |       | 981                  |       |       | (287                  | )          |       | (516                    | )          |       | (4,745     | )          |       | 1,364               |       |
| Interest  expense                                             |       |       | (546          | )          |       | (334                 | )          |       | (1                    | )          |       | (33                     | )          |       | (1,178     | )          |       | (2,092              | )          |
| Interest  income                                              |       |       | 9             |       |       | 2                    |       |       | 13                    |       |       | 26                      |       |       | 10         |       |       | 60                  |       |
| Other  income (expense)                                       |       |       | 111           |       |       | (821                 | )          |       | (176                  | )          |       | 121                     |       |       | 765        |       |       | —              |       |
| Income (loss) from continuing  operations before income taxes |       |       | $             | 5,505      |       |                 | $          | (172       | )                     |       | $          | (451                    | )          |       | $          | (402       | )          |                | $          | (5,148 | ) |   | $ | (668 | ) |

 

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**SOUTHWEST WATER COMPANY ANDSUBSIDIARIES**

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

 
| ***(In thousands)***                                          | ** ** | ** ** | **Utilities** | ** ** | ** ** | **Texas  Utilities** | ** ** | ** ** | **O&M  Services** | ** ** | ** ** | **Texas MUD  Services** | ** ** | ** ** | **Corp.** | ** ** | ** ** | **Consol-  idated** | ** ** |
|---------------------------------------------------------------|------------|------------|---------------|------------|------------|----------------------|------------|------------|-----------------------|------------|------------|-------------------------|------------|------------|-----------|------------|------------|---------------------|------------|
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| **Six Months Ended June 30, 2009**                       |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| ** **                                                    |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| Operating  revenue                                            |       |       | $             | 29,812     |       |                 | $          | 17,596     |                  |       | $          | 18,128                  |       |       | $         | 36,972     |       |                | $          | — |   |   | $ | 102,508 |   |
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| Expenses:                                                     |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| Operating  expenses                                           |       |       | 16,721        |       |       | 10,837               |       |       | 17,884                |       |       | 35,944                  |       |       | 18,573    |       |       | 99,959              |       |
| Depreciation  and Amortization                                |       |       | 3,951         |       |       | 2,340                |       |       | 273                   |       |       | 413                     |       |       | 713       |       |       | 7,690               |       |
| Impairment  of long-lived assets                              |       |       | —        |       |       | —               |       |       | —                |       |       | 122                     |       |       | 7,993     |       |       | 8,115               |       |
| Total  expenses                                               |       |       | 20,672        |       |       | 13,177               |       |       | 18,157                |       |       | 36,479                  |       |       | 27,279    |       |       | 115,764             |       |
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| Operating  income (loss)                                      |       |       | 9,140         |       |       | 4,419                |       |       | (29                   | )          |       | 493                     |       |       | (27,279   | )          |       | (13,256             | )          |
| Interest  expense                                             |       |       | (1,190        | )          |       | (827                 | )          |       | (56                   | )          |       | (4                      | )          |       | (2,785    | )          |       | (4,862              | )          |
| Interest  income                                              |       |       | 53            |       |       | 20                   |       |       | 2                     |       |       | 5                       |       |       | 4         |       |       | 84                  |       |
| Other  income (expense)                                       |       |       | 264           |       |       | (428                 | )          |       | (147                  | )          |       | (171                    | )          |       | 482       |       |       | —              |       |
| Income (loss) from continuing  operations before income taxes |       |       | $             | 8,267      |       |                 | $          | 3,184      |                  |       | $          | (230                    | )          |       | $         | 323        |       |                | $          | (29,578 | ) |   | $ | (18,034 | ) |

 
| ***(In thousands)***                                          | ** ** | ** ** | **Utilities** | ** ** | ** ** | **Texas  Utilities** | ** ** | ** ** | **O&M  Services** | ** ** | ** ** | **Texas MUD  Services** | ** ** | ** ** | **Corp.** | ** ** | ** ** | **Consol-  idated** | ** ** |
|---------------------------------------------------------------|------------|------------|---------------|------------|------------|----------------------|------------|------------|-----------------------|------------|------------|-------------------------|------------|------------|-----------|------------|------------|---------------------|------------|
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| **Six Months Ended  June 30, 2008  (As Restated)**       |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| ** **                                                    |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| Operating  revenue                                            |       |       | $             | 28,508     |       |                 | $          | 16,731     |                  |       | $          | 20,087                  |       |       | $         | 36,257     |       |                | $          | — |   |   | $ | 101,583 |   |
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| Expenses:                                                     |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| Operating  expenses                                           |       |       | 15,445        |       |       | 10,887               |       |       | 20,459                |       |       | 35,916                  |       |       | 9,231     |       |       | 91,938              |       |
| Depreciation  and Amortization                                |       |       | 3,421         |       |       | 1,967                |       |       | 122                   |       |       | 617                     |       |       | 882       |       |       | 7,009               |       |
| Impairment  of long-lived assets                              |       |       | —        |       |       | 865                  |       |       | —                |       |       | 210                     |       |       | —    |       |       | 1,075               |       |
| Total  expenses                                               |       |       | 18,866        |       |       | 13,719               |       |       | 20,581                |       |       | 36,743                  |       |       | 10,113    |       |       | 100,022             |       |
|                                                          |       |       |          |       |       |                 |       |       |                  |       |       |                    |       |       |      |       |       |                |       |
| Operating  income (loss)                                      |       |       | 9,642         |       |       | 3,012                |       |       | (494                  | )          |       | (486                    | )          |       | (10,113   | )          |       | 1,561               |       |
| Interest  expense                                             |       |       | (1,107        | )          |       | (662                 | )          |       | (1                    | )          |       | (70                     | )          |       | (2,372    | )          |       | (4,212              | )          |
| Interest  income                                              |       |       | 24            |       |       | 12                   |       |       | 13                    |       |       | 49                      |       |       | 10        |       |       | 108                 |       |
| Other  income (expense)                                       |       |       | 264           |       |       | (1,753               | )          |       | (159                  | )          |       | 155                     |       |       | 1,493     |       |       | —              |       |
| Income (loss) from continuing  operations before income taxes |       |       | $             | 8,823      |       |                 | $          | 609        |                  |       | $          | (641                    | )          |       | $         | (352       | )          |                | $          | (10,982 | ) |   | $ | (2,543 | ) |

 

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**SOUTHWEST WATER COMPANY ANDSUBSIDIARIES**

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

 

**Note 11.  Subsequent Events**

** **

On July 16, 2009 the Companydeclared quarterly cash dividends of $0.025 per share of common stock and$0.65625 per share of Series A preferred stock.  The dividends were paid on August 12,2009 to stockholders of record as of July 27, 2009.

 

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## **Table of Contents**

 

## **ITEM 2.**                 MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

## ** **

### **RESTATEMENT**

### ** **

SouthWestWater Company and its subsidiaries’ (“SouthWest Water” or the “Company”)condensed consolidated statements of operations for the three- and six-monthperiods ended June 30, 2008 and condensed consolidated statement of cashflows for the six-month period ended June 30, 2008 and related financialinformation have been restated to correct for certain accounting errors. Forfurther details on the nature of the corrections and the related effects on theCompany’s previously issued consolidated financial statements, see Note 2to our Condensed Consolidated Financial Statements, “Restatement of CondensedConsolidated Financial Statements.” Restated balances have been identified withthe notation “As Restated” where appropriate. Throughout this Quarterly Report,the term “as previously reported” will be used to refer to balances from the2008 condensed consolidated financial statements as reported prior torestatement for the errors.

 

Thecorrections to the reports for the affected prior period are contained in thisreport on Form 10-Q, and we are not filing a separate amended report forsuch period.

 

### **SPECIALNOTE 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 generally intendedto identify forward-looking statements. Forward-looking statements are subjectto risks and uncertainties that could cause actual results to differ materiallyfrom our historical experience and our present expectations or projections. Adetailed discussion of these and other risks and uncertainties that could causeactual results and events to differ materially from such forward-lookingstatements is included in the section entitled “Item 1A. Risk Factors” in our2008 Annual Report on Form 10-K. Caution should be taken not to placeundue reliance on any such forward-looking statements since such statementsspeak only as of the date when made. Other than as required by applicable law,we undertake no obligation to publicly update or revise forward-lookingstatements whether as a result of new information, future events, 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 operateand 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. We maintain our corporateoffices in Los Angeles, California.

 

In the past ten years, we have completed over 19acquisitions of both utility and contract service businesses. Theseacquisitions previously operated largely independent of each other, resultingin a complex business structure with varying business practices. In 2006, ourBoard of Directors appointed a new Chief Executive Officer to, among otherthings, review Company operations and plan for future growth. Beginning in2007, we implemented changes to better integrate the various segments of thebusiness.  In 2007 and 2008, we made amajor change to how we operate; we consolidated many of the departments thatprovide common support functions such as environmental health and safety, ourfinancial and accounting services, information technology and our customer callcenter. These consolidated departments allocate their costs to each operatingsegment where appropriate. In 2008, our operations were divided into four operatingsegments to better focus the distinct strategies of each of our operatingbusinesses. Each segment has imbedded in it the direct operating cost andinfrastructure to deliver on its business plan, relying upon the allocatedcommon support functions discussed above. Each operating segment is led by aManaging Director and a Financial Director. We believe this management structure brings both direct operational andfinancial accountability to each of the operations.

 

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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 (“Utilities”). In our financial statements we report ourTexas Utilities operations (“Texas Utilities”) as a separate segment because ofdifferent economic characteristics. This is principally because the TexasUtilities predominantly under-recovered their current cost of service, whichincludes a reasonable return on equity, as we have made large investments inthese operations since acquisition that are not yet being recovered through therates we charge. Our contract operations are segmented by contract type intothose that are generally larger, stand-alone operations (“O&M Services”)and those 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. Our New Mexico utility was part of this segment prior to its salein May 2009 (see Note 6 to our Condensed Consolidated FinancialStatements, “Legal Proceedings,” for detailed information on the New Mexicoutility sale). Residential customers make up the largest component of ourUtilities customer base, with these customers representing approximately 91% ofour water and wastewater connections. Substantially all of our Utilitiescustomers are metered which allows us to measure and bill for each customer’swater consumption. 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 with 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.

 

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**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 in ourutilities segments is generally characterized by the following drivers; 1)growth in the number of connections served within existing utility certifiedservice areas, or 2) acquisition of new service areas. In our Utilitiessegment, our largest utility is our California utility which is a substantiallybuilt out system that does not generally see much change in connection count.The majority of our other utilities are in markets that experienced significantnew home construction in the past, but, as experienced by the market generally,saw this rate of growth significantly decline throughout 2008 and the first twoquarters of 2009. Growth through acquisitions was most significant in 2008 withthe acquisition of a 4,000 connection wastewater utility system in Alabama inlate January 2008.

 

·                   **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 implemented rate increases inthree smaller Texas utilities and reached all-party settlements with two ofthem in late 2008 and the third in the second quarter of 2009. In Alabama wehave a contractual agreement with the local government over our Shelby Countywastewater utility that provides us with the ability to request rate increasesannually, pursuant to the terms of the contract. Accordingly, we requested andreceived 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 two 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 utility results are largelydependent upon the sale and distribution of water, the amount of which isdependent on seasonal weather fluctuations, particularly during the summermonths when water demand will vary greatly with rainfall and temperaturelevels.  Not only does rainfall vary from season to season, but fromyear to year. The uniform rate design that regulators require for our utilitiescan result in unrecovered fixed costs and lower earnings during periods oflower than expected water use. This can occur during abnormal weatherconditions, such as when summer temperatures are cooler than normal or duringmandatory restrictions on water use because of drought. Also, demand relatedchanges can occur as a result of conservation and socio-economic impacts.  In 2008 and the first six months of 2009, wesaw increased demand in Texas due to drought conditions. We saw lower demand atour California utility in 2008 and in the first two quarters of 2009, largelydue to conservation and general economic conditions.

 

·                   **Supply Related**: The cost of waterand related commodities is a major driver of our results. Utilities thatpurchase water are subject to changes in operations due to the amount and costof 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 quarter of 2009, we saw increasedcost of purchased water in Texas and California but these dynamics weresomewhat mitigated in the second quarter. In Texas, we purchased more water inthe first quarter than the comparable period of 2008 due to more severe droughtconditions in 2009 than in 2008.  In thesecond quarter of 2009 our purchased water costs were similar to those of thesecond quarter of 2008. In California, our average unit cost of water increasedin the first quarter of 2009 due to lower water levels in our main aquifers,resulting in a need to purchase more water, as well as the higher costs ofimported water. In the second quarter of 2009 the amount of purchased water inCalifornia was less than that purchased in the comparable prior year period dueto our customers’ conservation efforts.

 

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·                   **Operation & Maintenance Related**: Ouroperation and maintenance costs include fuel, power, labor, labor benefits,facility costs, and other ordinary costs of producing or treating 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 & Administrative Related**: Our generaland administrative costs include expenses directly incurred by the segment suchas management expense as well as costs for services performed by consolidatedsupport functions that are then allocated to each segment. These support costsinclude information technology (“IT”), shared financial services, customerservice center and environmental health and safety. In 2008, we made largeinvestments in our consolidated support functions that have driven costshigher, but we now have a foundation upon which to drive sustainable continuousimprovement into the organization. As the efficiencies of these investmentstake hold, we have targeted objectives to reduce the fixed costs of supportingour operations.

 

·                   **Other**: Other is reservedfor unusual items that may impact results from time to time. Most significantlyin the first six months of 2009, we saw an increase in costs in our Mississippiutility due to a refund of sales tax in the comparable prior period and areduction in costs in Texas due to a write-off of assets in the comparableprior 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 two quarters of2009 was from expanding the scope of work provided to existing customers.

 

·                   **Lost Work: **Lost work isgenerally driven by lost contracts or a reduction in project work for existingcontracts. The primary driver in the first two quarters of 2009 was reducedproject work as well as the cancellation of two of our contracts in Californiain 2008 due in part to the financial under 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 andenvironmental health and safety.  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 items that may impact resultsfrom time to time, such as legal fees, fines or the elimination of certainnon-core service offerings. Most significantly in the first six months of 2009,we eliminated certain non-core service offerings in Colorado and reduced legalcosts versus the comparable prior period.

 

**Texas MUD Services Segment**: Our TexasMUD Services segment’s 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 two quarters of 2009, our growthwas 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 two quartersof 2009, lost work was primarily driven by lost contracts and the sale of ourenvironmental 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 

 

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functions that are then allocated toeach segment. These support costs include IT, shared financial services,customer service center and environmental health and safety. In 2008, we madelarge investments in our consolidated support functions that have driven costshigher, but we now have a foundation upon which to drive sustainable continuousimprovement into the organization. As the efficiencies of these investmentstake hold, we have targeted objectives to reduce the fixed costs of supportingour operations.

 

·                   **Other: **Other is reserved for unusual items that may impact resultsfrom 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 two quarters of 2009, costs wereprimarily impacted by $10.6 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 supported by the corporate segment. This project upgradedour core IT infrastructure such as phones, servers and communications links. Inaddition, as of January 1, 2008 we are operating on a single company-widefinancial ledger system. In the fourth quarter of 2008, the remaining portionsof the project were put on hold and certain portions of the project were eliminatedand in May 2009, based on additional information, we determined that itwas not probable that the implementation of the remaining uncompleted softwaremodules would be completed which 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, whichaffects the comparability of the historical financial condition and results ofoperations described in the MD&A, is the acquisition of a Birmingham,Alabama-based wastewater collection and treatment system that servesapproximately 4,000 residential and commercial connections in a service areadirectly adjacent to our existing Shelby County collection and treatmentsystem, acquired in late January 2008 (“Riverview”).

 

**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 the watercomponent is reflected in consolidated continuing operations in 2009.

 

Weentered into an agreement to sell the assets of our Southwest EnvironmentalLaboratories, Inc. subsidiary in 2009 for cash consideration of $0.5million paid at close and up to an additional $0.75 million of considerationconsisting of 25% of the buyer’s quarterly aggregate invoice amounts subsequentto the sale.  The sale closed on April 1,2009.

 

InJanuary 2009 we reached a settlement in eminent domain proceedings againstour New Mexico utility, New Mexico Utilities Inc. (“NMUI”). On May 8, 2009we received $53.9  million in cash atclosing ($60.0 million settlement and $0.9 million net cash settlementprimarily related to accounts receivable, less $7.0 million retained by thecondemning entity in settlement of sewer treatment fees).  We used $12.3 million of the net proceeds topay down NMUI bonds and related accrued interest, and the remaining cashproceeds of $41.6 million were used to pay the unassumed liabilities of NMUIand to pay down our revolving credit facility.

 

### **RESULTS OFOPERATIONS**

### ** **

#### **Three monthsended June 30, 2009 Compared to 2008 (as restated)**

#### ** **

Consolidatedoperating revenue from continuing operations decreased $1.8 million, or 3.2%,to $52.4 million for the three-month period ended June 30, 2009 from $54.2million for the same period in the prior year. Consolidated operating expenses increased $9.2 million, or 17.5%, to$62.0 million for the three-month period ended June 30, 2009 from $52.8million for the 2008 period. Resulting operating income decreased $11.0 millionto a loss of $9.6 million for the three-month period ended June 30, 2009,from operating income of $1.4 million for the same period in the prioryear.  The operating loss for the quarterended June 30, 2009 includes the impact to operating income of 

 

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$5.2million 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 following results of operations as it was sold in May 2009and is, therefore, part of discontinued operations.

 
| ** **                                |   | Three Months Ended June 30, |                     |        |   |                     |   |
|-------------------------------------------|--------|----------------------------------|--------------------------|-------------|--------|--------------------------|--------|
| ** **                                |   |                             |                     | 2008        |   | Increase                 |   | Percent of Revenue |   |
| ***(In thousands,  except percentages)*** |   | 2009                             |                     | As Restated |   | (decrease)               |   | 2009 |   | 2008 |   |
| **Utilities**                             |   |                             |                     |        |   |                     |   |   |   |   |   |
| Operating  Revenue                        |   | $                                | 16,433                   |        | $      | 16,208                   |   | $ | 225 |   |   |   |   |   |   |   |
| Operating  Expenses                       |   | 10,331                           |                     | 10,277      |   | 54                       |   | 62.9 | % |   | 63.4 | % |   |
| Operating  Income                         |   | $                                | 6,102                    |        | $      | 5,931                    |   | $ | 171 |   | 37.1 | % |   | 36.6 | % |   |
|                                      |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| **Texas Utilities**                       |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                                | 9,005                    |        | $      | 8,723                    |   | $ | 282 |   |   |   |   |   |   |   |
| Operating  Expenses                       |   | 6,965                            |                     | 7,742       |   | (777                     | )      | 77.3 | % |   | 88.8 | % |   |
| Operating  Income                         |   | $                                | 2,040                    |        | $      | 981                      |   | $ | 1,059 |   | 22.7 | % |   | 11.2 | % |   |
|                                      |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| **O&M Services**                      |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                                | 8,981                    |        | $      | 10,449                   |   | $ | (1,468 | ) |   |   |   |   |   |   |
| Operating  Expenses                       |   | 9,147                            |                     | 10,736      |   | (1,589                   | )      | 101.8 | % |   | 102.7 | % |   |
| Operating  Loss                           |   | $                                | (166                     | )           | $      | (287                     | )      | $ | 121 |   | (1.8 | %) |   | (2.7 | %) |   |
|                                      |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| **Texas MUD Services**                    |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                                | 17,997                   |        | $      | 18,790                   |   | $ | (793 | ) |   |   |   |   |   |   |
| Operating  Expenses                       |   | 17,938                           |                     | 19,306      |   | (1,368                   | )      | 99.7 | % |   | 102.7 | % |   |
| Operating  Income (Loss)                  |   | $                                | 59                       |        | $      | (516                     | )      | $ | 575 |   | 0.3 | % |   | (2.7 | %) |   |
|                                      |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| **Corporate**                             |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                                | —    |        | $      | —    |   | $ | —    |   |   |   |   |   |   |   |
| Operating  Expenses                       |   | 17,643                           |                     | 4,745       |   | 12,898                   |   |   |   |   |   |   |   |
| Operating  Loss                           |   | $                                | (17,643                  | )           | $      | (4,745                   | )      | $ | (12,898 | ) |   |   |   |   |   |   |
|                                      |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| **Total**                                 |   |                             |                     |        |   |                     |   |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                                | 52,416                   |        | $      | 54,170                   |   | $ | (1,754 | ) |   |   |   |   |   |   |
| Operating  Expenses                       |   | 62,024                           |                     | 52,806      |   | 9,218                    |   | 118.3 | % |   | 97.5 | % |   |
| Operating  Income (Loss)                  |   | $                                | (9,608                   | )           | $      | 1,364                    |   | $ | (10,972 | ) | (18.3 | %) |   | 2.5 | % |   |

 

***Utilities***
| ***(In thousands)***                                 | ** ** | **Operating********Revenue** | ** ** | **Operating  Expense** | ** ** | **Operating  Income** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|------------------------|------------|-----------------------|------------|
|                                                 |       |                         |       |                   |       |                  |       |
| Three  months ended June 30, 2008 (As Restated) |       | $                            | 16,208     |                   | $          | 10,277                |       | $ | 5,931 |   |
| Rate  Related                                        |       | 1,496                        |       | —                 |       |                  |       |
| Demand  Related                                      |       | (1,271                       | )          | —                 |       |                  |       |
| Supply  Related                                      |       | —                       |       | (1,324                 | )          |                  |       |
| O&M  Related                                     |       | —                       |       | 185                    |       |                  |       |
| G&A  Related                                     |       | —                       |       | 784                    |       |                  |       |
| Other                                                |       | —                       |       | 409                    |       |                  |       |
| Three  months ended June 30, 2009               |       | $                            | 16,433     |                   | $          | 10,331                |       | $ | 6,102 |   |

 

Operatingrevenue increased $0.2 million, or 1.4 %, to $16.4 million for three monthsended June 30, 2009 from $16.2 million for the same period in prioryear.  The net increase was primarily dueto the following events:

 

·                   Rate Related:A $1.5 million increase due to rate increases in California and Alabama, ofwhich $1.3 million is due to our California utility implementing a step rateincrease in July 2008 and general rate increase in January 2009, and$0.2 million is due to rate increases at two of our Alabama utilities.

 

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·                   DemandRelated: A $1.3 million decrease primarily due to reduced consumption at ourCalifornia utility related to customers’ conservation efforts.

 

Operatingexpenses remained consistent at $10.3 million for the three months ended June 30,2009 and 2008 primarily due to the following events:

 

·                   SupplyRelated: A $1.3 million decrease primarily due to lower purchased water inCalifornia driven by lower demand.

 

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

 

·                   G&ARelated: A $0.8 million increase due to general and administrative costs,primarily due to increased costs associated with the upgrade of IT andfinancial systems as well as lower overhead recovery due to fewer capitalprojects than in the comparable prior period.

 

·                   Other: A $0.4million increase, primarily due to a refund of sales tax at our Mississippiutility that was received in the second quarter of 2008.

 

Asa result of the above events, operating income increased $0.2 million to $6.1million for the three months ended June 30, 2009 from $5.9 million for thesame period in the prior year.

 

***Texas Utilities***

 
| ***(In thousands)***                                 | ** ** | **Operating********Revenue** | ** ** | **Operating  Expense** | ** ** | **Operating  Income** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|------------------------|------------|-----------------------|------------|
|                                                 |       |                         |       |                   |       |                  |       |
| Three  months ended June 30, 2008 (As Restated) |       | $                            | 8,723      |                   | $          | 7,742                 |       | $ | 981 |   |
| Growth  Related                                      |       | (58                          | )          | —                 |       |                  |       |
| Rate  Related                                        |       | (129                         | )          | —                 |       |                  |       |
| Demand  Related                                      |       | 469                          |       | —                 |       |                  |       |
| O&M  Related                                     |       | —                       |       | 378                    |       |                  |       |
| G&A  Related                                     |       | —                       |       | (290                   | )          |                  |       |
| Other                                                |       | —                       |       | (865                   | )          |                  |       |
| Three  months ended June 30, 2009               |       | $                            | 9,005      |                   | $          | 6,965                 |       | $ | 2,040 |   |

 

Operatingrevenue increased $0.3 million, or 3.2%, to $9.0 million for three months endedJune 30, 2009 from $8.7 million for the same period in prior year. The netincrease was primarily due to the following events:

 

·                   GrowthRelated: A $0.1 million decrease due to the slowdown in housing growth reducingtaps and inspection revenue.

 

·                   Rate Related:A $0.1 million decrease comprised of a $0.4 million decrease due to settlementof rates at our Monarch utility which were below proposed rates charged in thesecond quarter of 2008, offset by increases at one utility implemented in thelatter half of 2008 and a step-increase in rates at another utility during thefirst quarter of 2009.

 

·                   DemandRelated: A $0.5 million increase due to increased consumption associated withhot and dry weather patterns.

 

Operatingexpenses decreased $0.8 million, or 10.0%, to $7.0 million for the three monthsended June 30, 2009, from $7.7 million for the same period in the prioryear.  The decrease was primarily due tothe following events:

 

·                   O&MRelated: A $0.4 million increase, primarily driven by an increase indepreciation costs offset by reduced auto, labor, supply expenses and watertreatment costs.

 

·                   G&ARelated: A $0.3 million decrease primarily due to lower IT, rate case and bankcharges.

 

·                   Other: A $0.9million decrease due to the write-off of assets in the second quarter of 2008related to a wholesale water operation.

 

Asa result of the above events, operating income increased $1.0 million, to $2.0million for the three months ended June 30, 2009, from income of $1.0million for the same period in the prior year.

 

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***O&M Services***

 
| ***(In thousands)***                                | ** ** | **Operating********Revenue** | ** ** | **Operating  Expense** | ** ** | **Operating  Loss** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|------------------------|------------|---------------------|------------|
|                                                |       |                         |       |                   |       |                |       |
| Three months ended June 30, 2008 (As Restated) |       | $                            | 10,449     |                   | $          | 10,736              |       | $ | (287 | ) |
| Contract Growth                                     |       | 567                          |       | 380                    |       |                |       |
| Lost Work                                           |       | (1,909                       | )          | (2,026                 | )          |                |       |
| G&A  Related                                    |       | —                       |       | (60                    | )          |                |       |
| Other                                               |       | (126                         | )          | 117                    |       |                |       |
| Three  months ended June 30, 2009              |       | $                            | 8,981      |                   | $          | 9,147               |       | $ | (166 | ) |

 

Operatingrevenue decreased $1.5 million, or 14.0%, to $9.0 million for the three monthsended June 30, 2009 from $10.4 million for the same period in the prioryear. The decrease in revenue was primarily due to the following events:

 

·                   ContractGrowth: A $0.6 million increase, primarily due to price and scope increases.

 

·                   Lost Work: A$1.9 million decrease, primarily due to $1.1 million from lost contracts, whichincludes $0.5 million relating to two underperforming contracts that wereterminated by management in late 2008 and $0.9 million from reduced projectwork.

 

·                   Other: A $0.1million decrease as we stopped certain non-core service offerings in Colorado.

 

Operatingexpenses decreased $1.6 million, or 14.8% to $9.1 million for the three monthsended June 30, 2009, from $10.7 million for the same period in the prioryear.  The net decrease was primarily dueto the following events:

 

·                   ContractGrowth: A $0.4 million increase due to new and expanded scope on contractsidentified above.

 

·                   Lost Work: A$2.0 million decrease due to lost contracts and reduced project work.

 

·                   Other: A $0.1million increase primarily due to a reduction of a legal accrual in the secondquarter of 2008.

 

Asa result of the above events, operating income improved $0.1 million to a lossof $0.2 million, from a loss of $0.3 million in the prior year period.

 

***Texas MUD Services***

 
| ***(In thousands)***                                 | ** ** | **Operating********Revenue** | ** ** | **Operating  Expense** | ** ** | **Operating  Income (Loss)** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|------------------------|------------|------------------------------|------------|
|                                                 |       |                         |       |                   |       |                         |       |
| Three  months ended June 30, 2008 (As Restated) |       | $                            | 18,790     |                   | $          | 19,306                       |       | $ | (516 | ) |
| Contract  Growth                                     |       | 1,601                        |       | 1,362                  |       |                         |       |
| Lost  Work                                           |       | (2,394                       | )          | (1,985                 | )          |                         |       |
| G&A  Related                                     |       | —                       |       | (531                   | )          |                         |       |
| Other                                                |       | —                       |       | (214                   | )          |                         |       |
| Three  months ended June 30, 2009               |       | $                            | 17,997     |                   | $          | 17,938                       |       | $ | 59 |   |

 

Operatingrevenue decreased $0.8 million, or 4.2%, to $18.0 million for three monthsended June 30, 2009 from $18.8 million for the same period in the prioryear. The decrease was primarily due to the following events:

 

·                   ContractGrowth: A $1.6 million increase due to contract pricing increases and increasesin service order work, generally related to repairs and maintenance workassociated with hot and dry weather patterns.

 

·                   Lost Work: A$2.4 million decrease primarily due to a $1.1 million decrease in new housingrelated services, a $0.7 million decrease related to the sale of ourenvironmental testing laboratory on April 1, 2009, and $0.5 million due tolost contracts.

 

Operatingexpenses decreased $1.4 million, or 7.1%, to $17.9 million for the three monthsended June 30, 2009, from $19.3 million for the same period in the prioryear.  The decrease was primarily due tothe following events:

 

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·                   ContractGrowth: A $1.4 million increase in general operating costs related to increasesin service and maintenance work orders.

 

·                   Lost Work: A$2.0 million decrease primarily due to $1.4 million decrease from the sale ofour environmental testing laboratory on April 1, 2009, $0.4 millionrelated to lost contracts and $0.2 million from lower new housing relatedservices.

 

·                   G&ARelated: A $0.5 million decrease, primarily due to various savings in generaland administrative costs.

 

·                   Other:  A $0.2 million decrease primarily related toan impairment of long-lived assets in the 2008 period.

 

Asa result of the above events, operating income improved $0.6 million to $59,000for the three months ended June 30, 2009, compared to a loss of $0.5million for the same period in the prior year.

 

***Corporate***

 

Operatingexpenses increased $12.9 million to $17.6 million for the three months ended June 30,2009, from $4.7 million for the same period in the prior year.

 

Thenet increase was primarily due to the following events:

 

·                   ProjectCosts: A $0.9 million decrease as result of costs incurred in the secondquarter of 2008 related to our Cornerstone internal-use software developmentproject. In May 2009 the project was terminated.

 

·                   G&ARelated: A $0.9 million increase primarily due to increases in medical claims,third-party legal and tax consultation expenses and an accrual for bonusesoffset by reductions in other corporate overhead departments.

 

·                   Other: A$12.9 million increase, primarily driven by $5.2 million of financialrestatement related costs, including audit fees and accounting resourceexpenses to support the restatement of historical financial results, and $8.0million related to a write-off of Cornerstone assets net of recoveries fromvendors, offset by reduced costs associated with expenditures in the comparableprior period related to consulting expenses.

 

**Other Income (Expense)**

 

Aggregateother expenses increased $0.9 million, or 44.0% to $2.9 million for the threemonths ended June 30, 2009, compared to $2.0 million for the same periodin the prior year as follows:

 
| *** ***         | ** ** | ** ** | **Three Months Ended June 30,** | ** ** | ** **      | ** ** |
|----------------------|------------|------------|--------------------------------------|------------|-----------------|------------|
| *** ***         | ** ** | ** ** | ** **                           | ** ** | **2008**        | ** ** | ** ** | ** ** |
| ***(In thousands)*** | ** ** | ** ** | **2009**                             | ** ** | **As Restated** | ** ** | **Change** | ** ** |
| ** **           | ** ** | ** ** | ** **                           | ** ** | ** **      | ** ** | ** ** |
| Interest  expense    |       | $          | (2,975                               | )          | $               | (2,092     | ) | $ | (883 | ) |
| Interest  income     |       | 48         |                                 | 60         |            | (12        | ) |
| Total                |       | $          | (2,927                               | )          | $               | (2,032     | ) | $ | (895 | ) |
|                      |            |            |                                      |            |                 |            |  |  |  |  |  |

 

***Interest Expense.***Interestexpense increased by $0.9 million, or 42.2%, to $3.0 million for the threemonths ended June 30, 2009 from $2.1 million for the same period duringthe prior year primarily as a result of a $0.5 million accelerated amortizationof deferred financing costs as a result of amendments to the credit facility.

 

Thebalance of the change in interest expense is due to increased interest ratesand lower average outstanding debt balances. The effective annual interest rate on total borrowings was approximately6.7% at June 30, 2009 and 4.4% for the same period in the prior year.  The average balance of interest bearing debtoutstanding decreased to $176.8 million during the three months ended June 30,2009 compared to $191.4 million for the same period in the prior year.

 

**Provision for Income Taxes**

 

Oureffective consolidated income tax rate on continuing operations was a benefitof 35.7% for the three months ended June 30, 2009 compared to a benefit of34.9% for the same period in 2008. The lower effective rate in 2008 is theresult of the Texas Franchise Tax reducing the expected overall income taxbenefit.

 

**Income from Discontinued Operations**

 

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Income from discontinued operations, net of tax, of $17.6million during the three month period ended June 30, 2009 reflectsprimarily the $16.7 million gain on sale of our New Mexico utility, net oftaxes.  The sale reflects a $107.2million reduction in assets, offset by reduction in liabilities which include$69.0 million of contributions in aid of construction. Prior year income fromdiscontinued operations includes results of our New Mexico utility, offset bylosses associated with a wholesale wastewater business sold late in that year.

 

#### **Six monthsended June 30, 2009 Compared to 2008 (as restated)**

#### ** **

Consolidatedoperating revenue increased from $0.9 million, or 1.0%, to $102.5 million forthe six-month period ended June 30, 2009 from $101.6 million for the sameperiod in the prior year.  Consolidatedoperating expenses increased $15.7 million, or 15.7%, to $115.8 million for thesix-month period ended June 30, 2009 from $100.0 million for thecomparable 2008 period.  Resultingoperating income decreased $14.8 million to a loss of $13.3 million for thesix-month period ended June 30, 2009, from operating income of $1.6million for the same period in the prior year. The operating loss for the six-month period ended June 30, 2009includes the impact to operating income of $10.6 million of costs associatedwith the restatement of historical financial results, and $8.0 million ofimpairment of assets related to the Cornerstone project, as well as other itemsas described below.  The operations ofour New Mexico utility are not reflected in the results below, as it was soldin May 2009 and is, therefore, part of discontinued operations.

 
| ** **                                |   | Six Months  Ended June 30 |                           |    |        |                           |       |
|-------------------------------------------|--------|--------------------------------|--------------------------------|---------|-------------|--------------------------------|------------|
| ** **                                |   |                           |                           | 2008    |        | Increase                       |       | Percent of  Revenue |   |
| ***(In thousands,  except percentages)*** |   |                           | 2009                           |    | As Restated |                           | (decrease) |   | 2009 |   | 2008 |   |
| **Utilities**                             |   |                           |                           |    |        |                           |       |   |   |   |   |
| Operating  Revenue                        |   | $                              | 29,812                         |    | $           | 28,508                         |       | $ | 1,304 |   |   |   |   |   |   |   |
| Operating  Expenses                       |   | 20,672                         |                           | 18,866  |        | 1,806                          |       | 69.3 | % |   | 66.2 | % |   |
| Operating  Income                         |   | $                              | 9,140                          |    | $           | 9,642                          |       | $ | (502 | ) | 30.7 | % |   | 33.8 | % |   |
|                                      |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| **Texas Utilities**                       |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                              | 17,596                         |    | $           | 16,731                         |       | $ | 865 |   |   |   |   |   |   |   |
| Operating  Expenses                       |   | 13,177                         |                           | 13,719  |        | (542                           | )          | 74.9 | % |   | 82.0 | % |   |
| Operating  Income                         |   | $                              | 4,419                          |    | $           | 3,012                          |       | $ | 1,407 |   | 25.1 | % |   | 18.0 | % |   |
|                                      |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| **O&M Services**                      |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                              | 18,128                         |    | $           | 20,087                         |       | $ | (1,959 | ) |   |   |   |   |   |   |
| Operating  Expenses                       |   | 18,157                         |                           | 20,581  |        | (2,424                         | )          | 100.2 | % |   | 102.5 | % |   |
| Operating  Loss                           |   | $                              | (29                            | )       | $           | (494                           | )          | $ | 465 |   | (0.2 | %) |   | (2.5 | %) |   |
|                                      |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| **Texas MUD Services**                    |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                              | 36,972                         |    | $           | 36,257                         |       | $ | 715 |   |   |   |   |   |   |   |
| Operating  Expenses                       |   | 36,479                         |                           | 36,743  |        | (264                           | )          | 98.7 | % |   | 101.3 | % |   |
| Operating  Income (Loss)                  |   | $                              | 493                            |    | $           | (486                           | )          | $ | 979 |   | 1.3 | % |   | (1.3 | %) |   |
|                                      |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| **Corporate**                             |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                              | —     |    | $           | —     |       | $ | —     |   |   |   |   |   |   |   |
| Operating  Expenses                       |   | 27,279                         |                           | 10,113  |        | 17,166                         |       |   |   |   |   |   |   |
| Operating  Loss                           |   | $                              | (27,279                        | )       | $           | (10,113                        | )          | $ | (17,166 | ) |   |   |   |   |   |   |
|                                      |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| **Total**                                 |   |                           |                           |    |        |                           |       |   |   |   |   |   |   |
| Operating  Revenue                        |   | $                              | 102,508                        |    | $           | 101,583                        |       | $ | 925 |   |   |   |   |   |   |   |
| Operating  Expenses                       |   | 115,764                        |                           | 100,022 |        | 15,742                         |       | 112.9 | % |   | 98.5 | % |   |
| Operating  Income (Loss)                  |   | $                              | (13,256                        | )       | $           | 1,561                          |       | $ | (14,817 | ) | (12.9 | %) |   | 1.5 | % |   |
|                                           |        |                                |                                |         |             |                                |            |  |  |  |  |  |  |  |  |  |  |

 

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* *

***Utilities***

 
| ** **                                        | ** ** | **Operating** | ** ** | **Operating** | ** ** | **Operating** | ** ** |
|---------------------------------------------------|------------|---------------|------------|---------------|------------|---------------|------------|
| ***(In thousands)***                              | ** ** | **Revenue**   | ** ** | **Expense**   | ** ** | **Income**    | ** ** |
|                                              |       |          |       |          |       |          |       |
| Six months ended June 30, 2008 (As Restated) |       | $             | 28,508     |          | $          | 18,866        |       | $ | 9,642 |   |
| Growth Related                                    |       | 490           |       | 278           |       |          |       |
| Rate Related                                      |       | 2,560         |       | —        |       |          |       |
| Demand Related                                    |       | (1,746        | )          | —        |       |          |       |
| Supply Related                                    |       | —        |       | (605          | )          |          |       |
| O&M Related                                   |       | —        |       | 185           |       |          |       |
| G&A Related                                   |       | —        |       | 1,539         |       |          |       |
| Other                                             |       | —        |       | 409           |       |          |       |
| Six  months ended June 30, 2009              |       | $             | 29,812     |          | $          | 20,672        |       | $ | 9,140 |   |

 

Operatingrevenue increased $1.3 million, or 4.6 %, to $29.8 million for six months endedJune 30, 2009 from $28.5 million for the same period in the prioryear.  The net increase was primarily dueto the following events:

 

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

 

·                   Rate Related:A $2.6 million increase due to rate increases in California and Alabama, ofwhich $2.2 million is due to our California utility implementing a step rateincrease in July 2008 and general rate increase in January 2009, and$0.3 million is due to rate increases at two of our Alabama utilities.

 

·                   DemandRelated: A $1.8 million decrease primarily due to reduced consumption at ourCalifornia utility related to customers’ conservation efforts.

 

Operatingexpenses increased $1.8 million, or 9.6%, to $20.7 million for the six monthsended June 30, 2009, from $18.9 million for same period in the prioryear.  The net increase was primarily dueto 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 $0.6 million decrease primarily due to lower purchased water inCalifornia driven by lower demand.

 

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

 

·                   G&ARelated: A $1.5 million increase due to general and administrative costs,primarily due to increased costs associated with the upgrade of IT andfinancial systems as well as lower overhead recovery due to fewer capitalprojects than in the comparable prior period.

 

·                   Other: A$0.4 million increase, primarily due to a refund of sales tax at ourMississippi utility that was received in the second quarter of 2008.

 

Asa result of the above events, operating income decreased $0.5 million, to $9.1million for the six months ended June 30, 2009, from $9.6 million for thesame period in the prior year.

 

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***Texas Utilities***

 
| ** **                                        | ** ** | **Operating** | ** ** | **Operating** | ** ** | **Operating** | ** ** |
|---------------------------------------------------|------------|---------------|------------|---------------|------------|---------------|------------|
| ***(In thousands)***                              | ** ** | **Revenue**   | ** ** | **Expense**   | ** ** | **Income**    | ** ** |
|                                              |       |          |       |          |       |          |       |
| Six months ended June 30, 2008 (As Restated) |       | $             | 16,731     |          | $          | 13,719        |       | $ | 3,012 |   |
| Growth Related                                    |       | (58           | )          | —        |       |          |       |
| Rate Related                                      |       | 454           |       | —        |       |          |       |
| Demand Related                                    |       | 469           |       | —        |       |          |       |
| Supply Related                                    |       | —        |       | 142           |       |          |       |
| O&M Related                                   |       | —        |       | 94            |       |          |       |
| G&A Related                                   |       | —        |       | 87            |       |          |       |
| Other                                             |       | —        |       | (865          | )          |          |       |
| Six  months ended June 30, 2009              |       | $             | 17,596     |          | $          | 13,177        |       | $ | 4,419 |   |

 

Operatingrevenue increased $0.9 million, or 5.2%, to $17.6 million for six months ended June 30,2009 from $16.7 million for the same period in prior year. The net increase wasprimarily due to the following events:

 

·                   GrowthRelated: A $0.1 million decrease due to the slowdown in housing growth reducingtaps and inspection revenue.

 

·                   RateRelated: A $0.5 million increase comprised of increases at three smallutilities implemented in the latter half of 2008 and a step-increase in ratesat one utility during the first quarter of 2009, offset by a decrease due tosettlement of rates at our Monarch utility which were below proposed ratescharged in the second quarter of 2008.

 

·                   DemandRelated: A $0.5 million increase due to increased consumption associated withhot and dry weather patterns.

 

Operatingexpenses decreased $0.5 million, or 3.9%, to $13.2 million for the six monthsended June 30, 2009, from $13.7 million for the same period in the prioryear.  The net decrease was primarily dueto the following events:

 

·                   SupplyRelated: A $0.1 million increase due to increased purchased water as a resultof the inability of our owned sources of ground water to produce enough waterdue to ongoing drought conditions.

 

·                   O&M Related:A $0.1 million increase, primarily driven by increased depreciation, offset byreduced auto, labor and supply expenses.

 

·                   G&ARelated: A $0.1 million increase primarily due to increased costs associatedwith the implementation of our strategy to consolidate support functions.

 

·                   Other: A$0.9 million decrease due to the write-off of assets in the second quarter of2008 related to a wholesale water operation.

 

Asa result of the above events, operating income increased $1.4 million, to $4.4million for the six months ended June 30, 2009, from income of $3.0million for the same period in the prior year.

 

***O&M Services***

 
| ** **                                         | ** ** | **Operating** | ** ** | **Operating** | ** ** | **Operating** | ** ** |
|----------------------------------------------------|------------|---------------|------------|---------------|------------|---------------|------------|
| ***(In thousands)***                               | ** ** | **Revenue**   | ** ** | **Expense**   | ** ** | **Loss**      | ** ** |
|                                               |       |          |       |          |       |          |       |
| Six  months ended June 30, 2008 (As Restated) |       | $             | 20,087     |          | $          | 20,581        |       | $ | (494 | ) |
| Contract  Growth                                   |       | 1,522         |       | 777           |       |          |       |
| Lost  Work                                         |       | (3,054        | )          | (3,061        | )          |          |       |
| G&A  Related                                   |       | —        |       | 59            |       |          |       |
| Other                                              |       | (427          | )          | (199          | )          |          |       |
| Six  months ended June 30, 2009               |       | $             | 18,128     |          | $          | 18,157        |       | $ | (29 | ) |

 

Operatingrevenue decreased $2.0 million, or 9.8%, to $18.1 million for the six monthsended June 30, 2009 from $20.1 million for the same period in the prioryear. The decrease in revenue was primarily due to the following events:

 

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·                   ContractGrowth: A $1.5 million increase, primarily due to increased project work andprice and scope increases.

 

·                   Lost Work:A $3.1 million decrease due to $2.0 million from lost contracts, including $0.9million relating to two underperforming contracts that were terminated bymanagement in late 2008, as well as $1.1 million from reduced project work.

 

·                   Other: A$0.4 million decrease as we stopped certain non-core service offerings in Colorado.

 

Operatingexpenses decreased $2.4 million, or 11.8% to $18.2 million for the six monthsended June 30, 2009, from $20.6 million for the same period in the prioryear.  The net decrease was primarily dueto the following events:

 

·                   ContractGrowth: A $0.8 million increase due to new and expanded scope on contractsidentified above.

 

·                   Lost Work:A $3.1 million decrease due to lost contracts and reduced project work.

 

·                   G&Arelated: A $0.1 million increase due to costs related to our strategy to consolidatesupport facilities.

 

·                   Other: A$0.2 million decrease due primarily to a $0.4 million decrease as we stoppedpursuing certain service offerings in Colorado, offset by net changes in legalimpacts.

 

Asa result of the above events, operating loss decreased $0.5 million to $28,000for the six months ended June 30, 2009, from a loss of $0.5 million forthe same period in the prior year.

 

***Texas MUD Services***

 
| ** **                                         | ** ** | **Operating** | ** ** | **Operating** | ** ** | **Operating**     | ** ** |
|----------------------------------------------------|------------|---------------|------------|---------------|------------|-------------------|------------|
| ***(In thousands)***                               | ** ** | **Revenue**   | ** ** | **Expense**   | ** ** | **Income (Loss)** | ** ** |
|                                               |       |          |       |          |       |              |       |
| Six  months ended June 30, 2008 (As Restated) |       | $             | 36,257     |          | $          | 36,743            |       | $ | (486 | ) |
| Contract  Growth                                   |       | 4,319         |       | 3,015         |       |              |       |
| Lost  Work                                         |       | (3,604        | )          | (2,465        | )          |              |       |
| G&A  Related                                   |       | —        |       | (600          | )          |              |       |
| Other                                              |       | —        |       | (214          | )          |              |       |
| Six  months ended June 30, 2009               |       | $             | 36,972     |          | $          | 36,479            |       | $ | 493 |   |

 

Operatingrevenue increased $0.7 million, or 2.0%, to $37.0 million for six months ended June 30,2009 from $36.3 million for the same period in the prior year. The increase wasprimarily due to the following events:

 

·                   ContractGrowth: A $4.3 million increase due to contract pricing increases and increasesin service order work.

 

·                   Lost Work:A $3.6 million decrease due to lost contracts, a decrease in new housingrelated services and a $0.7 million decrease related to the sale of ourenvironmental testing laboratory on April 1, 2009.

 

Operatingexpenses decreased $0.3 million, or 0.7%, to $36.5 million for the six monthsended June 30, 2009, from $36.7 million for the same period in the prioryear.  The net decrease was primarily dueto the following events:

 

·                   ContractGrowth: A $3.0 million increase in general operating costs primarily related toincreases in service and maintenance work orders.

 

·                   Lost Work:A $2.5 million decrease related to lost work, including $1.4 million due to thesale of our environmental testing laboratory.

 

·                   G&ARelated: A $0.6 million decrease, primarily due to various savings andefficiency gains in general and administrative costs.

 

·                   Other:  A $0.2 million decrease primarily related toimpairment of long-lived assets in the comparable period of 2008.

 

Asa result of the above events, operating income increased $1.0 million to $0.5million for the six months ended June 30, 2009, compared to an operatingloss of $0.5 million for the same period in the prior year.

 

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***Corporate***

 

Operatingexpenses increased $17.2 million, to $27.3 million for the six months ended June 30,2009, from $10.1 million for the same period in the prior year.

 

Thenet increase was primarily due to the following events:

 

·                   ProjectCosts: A $1.6 million decrease as result of costs incurred in the first half of2008 related to our Cornerstone internal-use software development project. In October 2008,we announced the suspension of the project due to the uncertain financialmarkets that led to the decision to minimize all cash expenditures.

 

·                   G&ARelated: A $0.6 million increase primarily due to increases in medical claims,third-party legal and tax consultation expenses and accrued bonuses, offset byreductions in corporate overhead departments.

 

·                   Other: A$18.1 million increase, primarily driven by $10.6 million of financialrestatement related costs, including audit fees and accounting resourceexpenses to support the restatement of historical financial results, and $8.0million related to a write-off of Cornerstone assets net of recoveries fromvendors, off-set by reduced costs associated with expenditures in the comparableprior period related to consulting expenses.

 

**Other Income (Expense)**

 

Aggregateother expenses increased $0.7 million, or 16.4% to $4.8 million for the sixmonths ended June 30, 2009, compared to $4.1 million for the same periodin the prior year as follows:

 
| ** **           | ** ** | ** ** | **Six Months Ended June 30,** | ** ** | ** **      | ** ** |
|----------------------|------------|------------|------------------------------------|------------|-----------------|------------|
| ** **           | ** ** | ** ** | ** **                         | ** ** | ** **      | **2008**   | ** ** | ** ** | ** ** |
| ***(In thousands)*** | ** ** | ** ** | **2009**                           | ** ** | **As Restated** | ** ** | **Change** | ** ** |
|                 |       |       |                               |       |            |       |   |
| Interest  expense    |       | $          | (4,862                             | )          | $               | (4,212     | ) | $ | (650 | ) |
| Interest  income     |       | 84         |                               | 108        |            | (24        | ) |
| Total                |       | $          | (4,778                             | )          | $               | (4,104     | ) | $ | (674 | ) |
|                      |            |            |                                    |            |                 |            |  |  |  |  |  |

 

***Interest Expense.***Interestexpense increased by $0.6 million, or 15.4%, to $4.9 million for the six monthsended June 30, 2009 from $4.2 million for the same period during the prioryear.

 

Thechange in total interest incurred is primarily the result of a $0.5 millionacceleration of deferred financing costs as a result of an amendment to thecredit line in May 2009.  Thebalance of the change is due to increased interest rates.  The weighted average effective annualinterest rate on total borrowings was approximately 5.2% for the six monthsended June 30, 2009 and 4.6% for the same period in the prior year. Theincreased rates of interest were offset by a decrease in borrowing levels. Theaverage balance of interest bearing debt outstanding decreased to $186.2million during the six months ended June 30, 2009 compared to $182.5million for the same period in the prior year.

 

**Provision for Income Taxes**

 

Oureffective consolidated income tax rate on continuing operations was a benefitof 36.4% for the six months ended June 30, 2009 compared to a benefit of35.0% for the same period in 2008.  Thelower effective rate in 2008 is the result of the Texas Franchise Tax reducingthe expected overall income tax benefit.

 

**Income from Discontinued Operations**

 

Income from discontinued operations of $17.7 million duringthe six month period ended June 30, 2009 reflects primarily the $16.7million gain on sale of our New Mexico utility, net of tax. The sale reflects a$107.2 million reduction in assets, offset by a reduction in liabilitiesincluding a $69.0 million reduction in contributions in aid ofconstruction.  Prior year income fromdiscontinued operations includes results of our New Mexico utility, offset bylosses associated with a wholesale wastewater business sold late in 2008.

 

**RECENT ACCOUNTINGPRONOUNCEMENTS**

 

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

 

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### **LIQUIDITY ANDCAPITAL RESOURCES**

### ** **

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

 

·                   Generatesufficient operating cash flows to service our debt and tax obligations, fundcapital improvements and organic growth, and pay dividends to our stockholders;

 

·                   Utilize ourcredit facility for major capital improvements and to manage seasonal cashneeds;

 

·                   Obtainexternal financing for major acquisitions; and

 

·                   Maintainapproximately equal levels of debt and equity consistent with theinvestor-owned water utility industry.

 

Our statements of cash flows are summarized as follows:

 
| ** **                                        | ** ** | **Six Months Ended** | ** ** | ** **      | ** ** |
|---------------------------------------------------|------------|----------------------|------------|-----------------|------------|
| ** **                                        | ** ** | **June 30,**    | ** ** | ** **      | ** ** |
| ** **                                        | ** ** | ** **           | ** ** | **2008**        | ** ** | ** ** | ** ** |
| ***(In thousands)***                              | ** ** | **2009**             | ** ** | **As Restated** | ** ** | **Change** | ** ** |
| Net cash provided by (used in):                   |       |                 |       |            |       |   |   |
| Continuing  operations:                           |       |                 |       |            |       |   |   |
| Operating  activities                             |       | $                    | 3,423      |            | $          | (7,085 | ) | $ | 10,508 |   |
| Investing  activities                             |       | 48,255               |       | (37,122         | )          | 85,377 |   |
| Financing  activities                             |       | (41,177              | )          | 45,178          |       | (86,355 | ) |
| Total  continuing operations                      |       | 10,501               |       | 971             |       | 9,530 |   |
| Discontinued  operations:                         |       |                 |       |            |       |   |   |
| Total  discontinued operations                    |       | (10,033              | )          | (38             | )          | (9,995 | ) |
| Increase  (decrease) in cash and cash equivalents |       | $                    | 468        |            | $          | 933 |   | $ | (465 | ) |

 

**Cash Flows from Operating Activities of Continuing Operations.**Net cashprovided by operating activities was $3.4 million for the six-months ended June 30,2009 versus cash used in operating activities of $7.1 million for the sameperiod last year.  Operational aspects ofour businesses that affected working capital in 2009 versus 2008 arehighlighted below:

 

·                   Net income of$6.3 million, as compared to a net loss of $1.0 million in 2008, as restated;

 

·                   Non-cashoperating expenses of $19.9 million, as compared to $11.2 million in 2008, as restated;

 

·                   Income fromdiscontinued operations of $17.7 million, as compared to $0.7 million in 2008;and,

 

·                   Changes inoperating assets and liabilities decreasing cash by $5.0 million, versus $16.6million in 2008, as restated.

 

**Cash Flows from Investing Activities of Continuing Operations.**Cash providedby investing activities totaled $48.3 million, representing proceeds from thesale of businesses and related property, plant and equipment of $54.6million.  This was offset by capitalinvestments into property, plant and equipment of $6.3 million.

 

**Cash Flows from Financing Activities of Continuing Operations.**Cash used infinancing activities totaled $41.2 million, primarily related to net repaymentsof our long-term debt and credit facility of $40.7 million, offset by capitalimprovement reimbursements of $3.4 million.

 

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 $36.3 million as of June 30, 2009.

 

Duringthe six months ended June 30, 2009, we declared quarterly cash dividendsof $0.025 per share of common stock and $0.65625 per share of Series Apreferred stock on April 9, 2009. The dividends were paid on May 5,2009.  Quarterly cash dividends in thesame amounts were paid on January 22, 2009 for dividends declared in December 2008.

 

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### **FINANCIALCONDITION**

### ** **

Weexpect our existing sources of liquidity to remain sufficient to meet ouranticipated obligations. 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 cash fromoperations and funds from the capital markets as conditions warrant. We expect thatborrowing capacity under our revolving credit facility will continue to beavailable to manage working capital during those periods.

 

Asof June 30, 2009, we had working capital of $29.9 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 timing of payments of vendor invoices.

 

Wehave access to $110 million in financing under a revolving credit facility thatexpires February 15, 2013. A total of nine banks participate in thefacility. As of June 30, 2009, we had $36.3 million of borrowingsavailable under our revolving credit facility. The impact of the prior periodrestatement on our retained earnings, combined with the additional borrowingson the facility during 2008, created a default under the debt-to-capitalizationcovenant at the quarter ended March 31, 2009 and December 31, 2008.The default was cured due to an amendment to the credit agreement dated May 28,2009.  Our credit facility was reducedfrom $150 million to its current availability of $110 million as part of theamendment.  Fees charged in connectionwith securing this amendment were $1.8 million, which were capitalized and willbe amortized over the remaining term of the agreement. Subsequent to the end ofthe quarter, we entered into an additional amendment to our credit agreementwhich waived existing and anticipated defaults, specifically related toadditional time with regards to financial filings. Our ability to comply withfinancial covenants, pay principal or interest and refinance our debtobligations will depend on our future operating performance as well as otherfactors that may be beyond our control.  Continuedopportunity for operating improvements, cash management and suspension ofelective capital expenditures should improve our ability to comply with thecovenants in the revolving credit facility. As of June 30, 2009, ourdebt-to-capitalization ratio was 56%, the agreement requires less than 60%debt-to-capitalization ratio.

 

Aspart of the amended credit agreement with our primary working capital line, wehave agreed to only utilize up to an additional $12.5 million under our capitallease facility.  Our California and NewMexico mortgage bond indentures permit the issuance of an additional $91.2million of first mortgage bonds as of June 30, 2009. However, the terms ofour revolving credit facility do not permit additional first mortgage bondindebtedness without prior consent from the credit facility lenders. Themortgage bond indentures also limit the amount of cash and property dividendsour California utility paid to the parent company. Dividends have averaged $5.0million to $5.6 million per year and are less than the aggregate cumulativedividend restriction threshold of $21.7 million as of June 30, 2009. Wewere in compliance with or obtained waivers for all loan agreement covenantsduring the three-month period ended June 30, 2009.

 

Wehave previously filed a registration statement with the Securities and ExchangeCommission, for the issuance of up to $50.0 million aggregate principal amountof common stock, debt securities and warrants. We issued approximately $43.6million of common stock under the shelf registration. As we were unable totimely file our required SEC filings for the September 30, 2008, March 31,2009 and June 30, 2009 Quarterly Reports on Form 10-Q and our 2008Annual Report on this Form 10-K, we cannot use Registration Statements on Form S-3for registration of our securities with the SEC at this time. Use of Form S-3requires, among other things, that the issuer be current and timely in itsreports under the Exchange Act for at least twelve months. Accordingly, we willhave to meet more demanding requirements to register additional securities,which may make it more difficult for us to effect public offering transactions,and our range of available financing alternatives could be limited and will bemore costly.

 

InJanuary 2009 we reached a settlement of eminent domain proceedings againstour New Mexico utility. On May 8, 2009 we received $53.9 million in cashat closing ($60 million settlement and $0.9 million net cash settlement ofaccounts receivable, less $7.0 million retained by ABCWA in settlement of sewertreatment fees) and incurred $0.2 million of transactional costs.  We used $12.3 million of the net proceeds topay down NMUI bonds and related accrued interest, and we used the remainingcash proceeds of $41.6 million to pay any unassumed liabilities of NMUI and topay down our revolving credit facility.

 

### **CONTRACTUALOBLIGATIONS**

### ** **

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

 

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| ** **                                       | ** ** | **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)                          |       | $                                  | 70,400     |   | $ | — |   | $ | — |   | $ | 70,400 |   | $ | — |   |
| Mortgage bonds (3)                               |       | 33,000                             |       | — |   | — |   | — |   | 33,000 |   |
| Bank term loans (4)                              |       | 30,562                             |       | 411 |   | 1,646 |   | 1,646 |   | 26,859 |   |
| Convertible subordinated debentures (5)          |       | 11,869                             |       | — |   | — |   | — |   | 11,869 |   |
| Capital lease obligations (6)                    |       | 3,645                              |       | 580 |   | 2,147 |   | 918 |   | — |   |
| Economic development revenue bonds (7)           |       | 1,810                              |       | 120 |   | 260 |   | 295 |   | 1,135 |   |
| Note Payable                                     |       | 78                                 |       | 78 |   | — |   | — |   | — |   |
| Total  long-term debt                            |       | 151,364                            |       | 1,189 |   | 4,053 |   | 73,259 |   | 72,863 |   |
|                                             |       |                               |       |   |   |   |   |   |   |   |   |
| Repayment  of advances for construction (8)      |       | 8,928                              |       | 568 |   | 1,366 |   | 827 |   | 6,167 |   |
| Water  purchase commitment (9)                   |       | 6,953                              |       | 230 |   | 920 |   | 920 |   | 4,883 |   |
| Operating  lease obligations                     |       | 21,232                             |       | 2,568 |   | 6,985 |   | 3,703 |   | 7,976 |   |
| Total  obligations as of June 30, 2009 (10) |       | $                                  | 188,477    |   | $ | 4,555 |   | $ | 13,324 |   | $ | 78,709 |   | $ | 91,889 |   |

 

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(1)             Excludes interest payments, whichare described in the following notes. The terms of the long-term debt are morefully described 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 bearinterest at variable rates and therefore the amount of future interest paymentsare uncertain. Borrowings bear interest, at our option, based on a margin overeither: a) the LIBOR rate; or b) the prime rate. The margins vary based on ourconsolidated debt to equity ratio. The weighted-average annual interest rate onour bank line of credit borrowings was 4.41% as of June 30, 2009,excluding amendment and waiver fees.

 

(3)             $12.0 million has been included as apayment in 2009 related to the 2009 NMUI settlement and the resulting repaymentof the NMUI mortgage bonds.

 

(4)             Interest on the bank term loans is fixed at a weighted-averageannual interest rate of 6.52% and is payable semiannually.

 

(5)             Interest on the convertibledebentures is fixed at a 6.85% annual rate and is payable quarterly. Thedebentures are convertible, at the option of the holder, into shares of ourcommon stock at any time prior to their maturity.

 

(6)             Interest on the capital leaseobligations is imputed at a weighted-average annual interest rate of 5.31% andis payable monthly.

 

(7)             Interest on the economic developmentbonds is fixed at a weighted-average annual interest rate of 6.00% and ispayable semiannually.

 

(8)             Advances for construction arenon-interest bearing.  Our repaymentassumptions on certain obligations are based upon forecasted connectiongrowth.  If forecasted connections do notmaterialize, the related payments are not due and corresponding amounts becomecontributed capital.

 

(9)             Reflects the minimum annualcontractual commitment to purchase water through 2024. The amount is subject toincreases in future periods for production costs increases and may alsoincrease, but not decrease, if average actual usage exceeds a specified amount.

 

(10)        Excludes 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 June 30, 2009, we had irrevocable standby letters of credit in theamount of $3.3 million issued and outstanding under our credit facility.

 

Duringour normal course of business, we have entered into agreements containingindemnities pursuant to which we may be required to make payments in thefuture. These indemnities are in connection with facility leases andliabilities and operations and maintenance contracts entered into by our contractservices businesses. The duration of these indemnities, commitments andguarantees varies, and in certain cases, is indefinite. Substantially all ofthese indemnities provide no limitation on the maximum potential futurepayments we could be obligated to make and is not quantifiable. We have notrecorded any liability for these indemnities.

 

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### **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 haverelationships or transactions with persons or entities that derive benefitsfrom their non-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 June 30, 2009, we had $152.0 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 $70.4million 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 4.41% as of June 30, 2009. A hypothetical one percent(100 basis points) increase in the average annual interest rates charged on ourvariable-rate debt would reduce our pre-tax earnings by approximately $0.7million per year.

 

Ourfixed-rate debt, which has a carrying value of $81.6 million, has a fair valueof $73.0 million as of June 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 6.5% as of June 30, 2009. Ahypothetical ten percent decrease in annual interest rates, from 6.5% 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.

 

Asdiscussed in the Explanatory Note at the beginning of this report, we haverestated our previously filed financial statements.  In this Form 10-Q, we are restating ourcondensed consolidated statement of operations and statement of cash flows forthe three- and six-month periods ended June 30, 2008.

 

Detailsof the restatement and its underlying circumstances are discussed in theExplanatory Note at the beginning of this report and in Note 2 of Notes tothe Condensed Consolidated Financial Statements in Part I, Item 1 ofthis report.

 

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### **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 June 30, 2009. Based on our evaluation andthe identification of the material weaknesses in internal control overfinancial reporting described below, our CEO and CFO concluded that, as of June 30,2009, our disclosure controls and procedures were not effective.

 

Inconnection with our assessment of our disclosure controls and procedures, wehave identified the following deficiencies that constituted individually, or inthe aggregate, material weaknesses in our internal control over financialreporting as of June 30, 2009:

 

1.              We did not maintain an effectivecontrol environment because of the following material weaknesses:

 

·                  We did not maintainan environment that consistently emphasized strict adherence to generallyaccepted accounting principles. This control deficiency, in certain instances,led to inappropriate accounting decisions and entries. This control deficiencywas magnified by the decentralized nature of the accounting function thatexisted at our various operating locations.

 

·                  We did not maintainin certain areas of our internal audit, finance and accounting departments, asufficient 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.

 

·                  We did not maintaincomplete and accurate business documentation to support certain transactionsand accounting records. The controls in these areas with respect to thecreation, 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 maintain effectivemonitoring of controls over areas including period end financial reportingprocess, acquisition accounting, goodwill, regulatory accounting, stock-basedcompensation, property, plant and equipment, estimates and accruals.  This deficiency resulted in either not havingadequate controls designed and in place or not achieving the intended operatingeffectiveness of controls.

 

3.              We did not maintain effectivecontrols 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 maintain and communicatesufficient and consistent accounting policies with respect to generally acceptedaccounting principles. This control deficiency, among other things, limited ourability to detect and correct accounting errors in previously issued financialstatements.

 

5.              We did not maintain effectivecontrols 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 maintain effectivecontrols 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.

 

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7.              We did not maintain effectivecontrols over the application of generally accepted accounting principlescommensurate 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 notmaintain effective controls over the completeness and accuracy of ouraccounting for acquisitions. Specifically, we did not design and maintain effective controls withrespect to the application of relevant GAAP and the deficiency resulted inerrors in the allocation of the purchase price to the underlying assetsacquired, including goodwill and the liabilities assumed.  This deficiency affected property, plant andequipment, deferred income tax and liabilities, goodwill and long-termliability accounts.

 

9.              We did notmaintain effective controls over the completeness, accuracy and valuation ofour accounting estimates related to our claims process associated with medical,automobile and workers’ compensation self-insurance.  Specifically, we did not design and maintaineffective controls with respect to the maintenance and reconciliation of claimsand the review of actuarial valuations. This deficiency affected accrued liabilities and expense accounts.

 

10.       We did not maintain effective controls over thecompleteness and accuracy of our accounting for the impairment ofgoodwill.   Specifically, we did notdesign and maintain effective controls to ensure proper identification ofreporting units, triggering events and proper cash flow projections todetermine fair value.  This deficiencyaffected goodwill related accounts.

 

11.       We did not maintain effective controls over thecompleteness and accuracy of our accounting for regulated entities.  Specifically, we did not design and maintaineffective controls with respect to the application of relevant GAAP and thedeficiency resulted in errors in the accounting for intercompany profit,regulatory assets and liabilities.  Thisdeficiency affected revenue, property, plant and equipment, and regulatoryasset and regulatory liability accounts.

 

12.       We did not maintain effective controls over theaccuracy and valuation of stock-based compensation.  Specifically, we did not maintain effectivecontrols over the assumptions used in the calculation of stock-basedcompensation.  This deficiency affectedstock-based compensation related accounts.

 

13.       We did not maintain effective controls over thecompleteness and accuracy of property, plant and equipment and relateddepreciation expense.  Specifically, wedid not design and maintain effective controls to ensure that there was timelytransfer of property, plant and equipment additions from construction work inprogress; that retirements were properly recorded; that depreciation expensewas accurately recorded based on appropriate useful lives assigned to therelated property, plant and equipment; that assets are capitalized properly;and that impairment losses were timely identified and determined.  This deficiency affected property, plant andequipment, depreciation expense and operating expense accounts.

 

14.       We did notmaintain effective controls over the completeness and accuracy of unbilledutilities revenue.  Specifically, we didnot maintain effective controls to standardize a process and methodology ofcalculating and recording unbilled revenue in the proper period.  This deficiency affected utility revenue andunbilled receivable accounts.

 

15.       We did notmaintain effective controls to ensure the completeness of the recording ofaccounts payable and accrued liabilities, operating expenses and property,plant and equipment additions on a timely basis.  Specifically, we did not review and approveinvoices and their supporting documentation on a timely basis.  Material outstanding liabilities were notrecorded for which goods were received or services were rendered by vendorsprior to the balance sheet date. Consequently, our accounts payable and accrued liability balances wereunderstated at the period end by the aggregate value of these unpaid invoiceswhich relate to construction work in progress and other selling andadministrative 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 months ended June 30, 2009that has materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

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### **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.

 

Subsequentto June 30, 2009, we have implemented a remediation plan (“the Plan”) toaddress the material weaknesses for each of the affected areas presented above.The Plan builds upon many of the initiatives we started over the past twoyears, such as development of a centralized financial services platform andconsolidation of financial accounts onto a common system.  The Plan will ensure that each area affectedby a material control weakness is put through a comprehensive remediationprocess.  The remediation process entailsa thorough analysis which includes the following phases:

 

a)             Define and assess the deficiency:ensure a thorough understanding of the “as is” state, process owners, and gaps inthe deficiency. This work is underway for all identified areas.

 

b)             Design and evaluate a remediationaction for each weakness for each affected area: validate or improve therelated policy and procedures, evaluate skills of the process owners with regardsto the policy and adjust as required. The Plan will require an assessment ofall failures; we expect that many of the recent improvements will provide anexcellent starting point for the specific action plans.

 

c)              Implement specific remediationactions: train process owners, allow time for process adoption and adequatetransaction volume for next steps.

 

d)             Test and measure the design andeffectiveness of the remediation plan: internal audit to test and providefeedback on the design and operating effectiveness of the control.

 

e)             Management review and acceptance ofcompletion of the remediation effort.

 

ThePlan will be administered by a Controls Committee comprised of key leaders fromcross functional portions of the organization, including the CFO. The Directorof Internal Control will chair the Committee. Each specific area of actionwithin the Plan will be assigned a project leader to coordinate the resourcesrequired for timely completion of the remediation process. The Committee willreport quarterly and as needed to the Audit Committee of our Board of Directorson progress made.

 

Webelieve the steps taken to date have improved the effectiveness of our internalcontrol over financial reporting, however we have not completed the correctiveprocesses and procedures identified herein, that we believe necessary.Accordingly, as we continue to monitor the effectiveness of our internalcontrol 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 and theutilization of external technical advisors to ensure that our financialstatements continue to be fairly stated in all material respects.

 

Subsequentto June 30, 2009, we have engaged in and are continuing to engage insubstantial efforts to improve our internal control over financial reportingand disclosure controls and procedures related to the preparation of ourfinancial statements and disclosures. We have begun the implementation of someof the measures described above including the establishment of the ControlsCommittee. The Controls Committee has concentrated their efforts on (i) communicating,both internally and externally, our commitment to a strong effective controlenvironment, emphasizing accountability and a strict adherence to generallyaccepted accounting principles and financial reporting integrity, (ii) takingcertain personnel actions, (iii) clarification and documentation of keyaccounting policies and processes, (iv) comprehensive training for Financeand Accounting Department personnel, (v) the implementation of policiesand procedures to ensure that we retain important business and accountingrecords, and (vi) more rigorous period end reporting policies andprocesses involving journal entry approval, account reconciliations andsupporting documentation including manually prepared spreadsheets.  This work will continue during the remainderof 2009 and thereafter.

 

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

### ** **

Wedo not expect that our disclosure controls and procedures will prevent ordetect all errors. A control system, no matter how well designed and operated,can provide 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 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 6 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                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                    |
| 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: September 18, 2009 | /s/ DAVID STANTON                        |   |
|                           | David Stanton                            |   |
|                           | Chief Financial Officer                  |   |

 

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