** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C.  20549**

**FORM 10-Q**

**(Mark One)**

**x             ****Quarterly Report pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of                           1934**

**For the quarterly period ended June 30, 2006**

**or**

**o              ****Transition report pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of                            1934**

**For the transition period from                to                **

**Commission File Number 0-8176**
|  | ** ** |  | ** ** | **Southwest  Water Company**(Exact name of registrant as specified in its charter) | ** ** | ** ** | ** ** | ** ** |
|--|------------|--|------------|------------------------------------------------------------------------------------|------------|------------|------------|------------|

 

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

 

**One Wilshire Building624 South Grand Avenue, Suite 2900Los Angeles, California 90017-3782**(Address of principalexecutive offices, including zip code)

**(213)929-1800**(Registrant’stelephone, including area code)

**None**(Former name, formeraddress and former fiscal year, if changed since last report)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes x  No o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  (Check one):
| Large accelerated  filer  o | Accelerated filer  x | Non-Accelerated filer  o |
|---------------------------------------|--------------------------------|------------------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theAct).  Yes o  No x

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

| Class                                  |   | Outstanding as  of August 4, 2006 |
|----------------------------------------|--------|-----------------------------------|
| Common Stock, $.01 par value per share |   | 22,908,703  shares                |

 

 

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**Table of Contents**
|                | ** ** | ** **                                                                                                             | ** ** | ** ** | ** ** |
|----------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| **Part  I**    | ** ** | **Financial  Information**                                                                                             | ** ** | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                             | ** ** | ** ** | ** ** |
| Item  1.       |       | Financial  Statements (Unaudited)                                                                                      |       |       |       |
|           |       |                                                                                                                   |       |       |       |
|           |       | Report of Independent Registered Public Accounting  Firm                                                               |       |       |       |
|           |       |                                                                                                                   |       |       |       |
|           |       | Condensed Consolidated Balance Sheets as of  June 30, 2006 and December 31, 2005                                  |       |       |       |
|           |       |                                                                                                                   |       |       |       |
|           |       | Condensed Consolidated Statements of Income for the  three months and six months ended June 30, 2006 and 2005     |       |       |       |
|           |       |                                                                                                                   |       |       |       |
|           |       | Condensed Consolidated Statement of Changes in  Stockholders’ Equity for the  six months ended June 30, 2006 |       |       |       |
|           |       |                                                                                                                   |       |       |       |
|           |       | Condensed Consolidated Statements of Cash Flows for  the  six months ended June 30, 2006 and 2005                 |       |       |       |
|           |       |                                                                                                                   |       |       |       |
|           |       | Condensed Notes to Consolidated Financial Statements                                                                   |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| Item 2.        |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                            |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| Item 3.        |       | Quantitative and Qualitative Disclosures About Market  Risk                                                            |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| Item 4.        |       | Controls and Procedures                                                                                                |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| **Part  II**   | ** ** | **Other  Information**                                                                                                 | ** ** | ** ** | ** ** |
| ** **     | ** ** | ** **                                                                                                             | ** ** | ** ** | ** ** |
| Item  1.       |       | Legal  Proceedings                                                                                                     |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| Item  1A.      |       | Risk  Factors                                                                                                          |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| Item 2.        |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                           |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| Item 4.        |       | Submission of Matters to a Vote of Security Holders                                                                    |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| Item 6.        |       | Exhibits                                                                                                               |       |       |       |
|           |       |                                                                                                                   |       |       |       |
| **Signatures** |       |                                                                                                                   |       |

 

i

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**PARTI — FINANCIAL INFORMATION**

**ITEM 1.**                    FINANCIALSTATEMENTS

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

The Board of Directorsand StockholdersSouthwest Water Company:

We have reviewedthe accompanying condensed consolidated balance sheet of Southwest WaterCompany and subsidiaries (“the Company”) as of June 30, 2006, the relatedcondensed consolidated statements of income for the three-month and six monthperiods ended June 30, 2006 and 2005, the related condensed consolidatedstatement of changes in stockholders’ equity for the six-month period endedJune 30, 2006, and the related condensed consolidated statements of cashflows for the six-month periods ended June 30, 2006 and 2005.  These condensed consolidated financialstatements are the responsibility of the Company’s management.

We conducted ourreviews in accordance with the standards of the Public Company AccountingOversight Board (United States).  Areview of interim financial information consists principally of applyinganalytical procedures and making inquiries of persons responsible for financialand accounting matters.  It issubstantially less in scope than an audit conducted in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theobjective of which is the expression of an opinion regarding the financialstatements taken as a whole. Accordingly, we do not express such an opinion.

Based on ourreviews, we are not aware of any material modifications that should be made tothe condensed consolidated financial statements referred to above for them tobe in conformity with U.S. generally accepted accounting principles.

We have previouslyaudited, in accordance with standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheet of the Companyas of December 31, 2005, and the related consolidated statements of income,changes in stockholders’ equity, and cash flows for the year then ended (notpresented herein); and in our report dated March 13, 2006, we expressed anunqualified opinion on those consolidated financial statements.  In our opinion, the information set forth inthe accompanying condensed consolidated balance sheet as of December 31, 2005,is fairly stated, in all material respects, in relation to the consolidatedbalance sheet from which it has been derived.

/s/  KPMG LLP

Los Angeles, CaliforniaAugust 7, 2006

1

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**SOUTHWEST WATERCOMPANY AND SUBSIDIARIESCondensed Consolidated Balance Sheets(Unaudited)**
| ** **                                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In thousands)**                        | ** ** | ** **        | ** ** | **2006**              | ** ** | **2005** | ** ** |
| **ASSETS**                                     |       |              |       |                  |       |
| Current Assets:                                |       |              |       |                  |       |
| Cash and cash equivalents                      |       | $                 | 3,797      |                  | $          | 2,764 |   |
| Restricted cash                                |       | 241               |       | 241                   |       |
| Accounts receivable, net                       |       | 29,046            |       | 26,517                |       |
| Other current assets                           |       | 15,915            |       | 18,224                |       |
| Total current assets                           |       | 48,999            |       | 47,746                |       |
| Property, Plant  and Equipment, Net:           |       |              |       |                  |       |
| Regulated utilities                            |       | 350,267           |       | 333,027               |       |
| Non-regulated operations                       |       | 11,418            |       | 11,794                |       |
| Total property, plant and equipment, net       |       | 361,685           |       | 344,821               |       |
| Other Assets:                                  |       |              |       |                  |       |
| Goodwill                                       |       | 33,660            |       | 32,977                |       |
| Intangible assets                              |       | 2,666             |       | 2,965                 |       |
| Other assets                                   |       | 16,990            |       | 16,216                |       |
|                                           |       | $                 | 464,000    |                  | $          | 444,725 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY** |       |              |       |                  |       |
| Current  Liabilities:                          |       |              |       |                  |       |
| Current portion of long-term debt              |       | $                 | 9,409      |                  | $          | 9,492 |   |
| Accounts payable                               |       | 10,837            |       | 10,018                |       |
| Other current liabilities                      |       | 21,519            |       | 21,069                |       |
| Total current liabilities                      |       | 41,765            |       | 40,579                |       |
| Other  Liabilities and Deferred Credits:       |       |              |       |                  |       |
| Long-term debt                                 |       | 122,490           |       | 117,603               |       |
| Deferred income taxes                          |       | 23,777            |       | 22,609                |       |
| Advances for construction                      |       | 8,167             |       | 8,478                 |       |
| Contributions in aid of construction           |       | 99,747            |       | 94,660                |       |
| Other liabilities and deferred credits         |       | 15,624            |       | 15,543                |       |
| Commitments and  Contingencies                 |       |              |       |                  |       |
| Stockholders’  Equity:                    |       |              |       |                  |       |
| Preferred stock                                |       | 461               |       | 461                   |       |
| Common stock                                   |       | 229               |       | 222                   |       |
| Additional paid-in capital                     |       | 129,339           |       | 122,368               |       |
| Retained earnings                              |       | 22,401            |       | 22,202                |       |
| Total stockholders’ equity                |       | 152,430           |       | 145,253               |       |
|                                           |       | $                 | 464,000    |                  | $          | 444,725 |   |
|                                                |            |                   |            |                       |            |  |  |  |  |

 

The accompanying notesare an integral part of the consolidated financial statements.

2

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIESCondensed Consolidated Statements of Income(Unaudited)**
| ** **                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(In thousands, except share data)**        | ** ** | ** **                       | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues:                                                        |       |                             |       |                           |       |   |   |   |   |
| Utility Group                                                    |       | $                                | 20,790     |                           | $          | 20,295 |   | $ | 38,763 |   | $ | 35,754 |   |
| Services Group                                                   |       | 34,570                           |       | 30,987                         |       | 67,399 |   | 60,759 |   |
| Total revenues                                                   |       | 55,360                           |       | 51,282                         |       | 106,162 |   | 96,513 |   |
| Expenses:                                                        |       |                             |       |                           |       |   |   |   |   |
| Utility Group operating expenses                                 |       | 10,506                           |       | 10,678                         |       | 20,903 |   | 20,657 |   |
| Services Group operating expense                                 |       | 30,018                           |       | 26,689                         |       | 59,021 |   | 52,573 |   |
| Selling, general and administrative                              |       | 9,208                            |       | 7,425                          |       | 17,593 |   | 15,308 |   |
| Impairment of goodwill                                           |       | 668                              |       | —                         |       | 668 |   | — |   |
| Total expenses                                                   |       | 50,400                           |       | 44,792                         |       | 98,185 |   | 88,538 |   |
| Operating income                                                 |       | 4,960                            |       | 6,490                          |       | 7,977 |   | 7,975 |   |
| Other income  (expense):                                         |       |                             |       |                           |       |   |   |   |   |
| Interest expense                                                 |       | (2,121                           | )          | (1,896                         | )          | (4,252 | ) | (3,668 | ) |
| Interest income                                                  |       | 174                              |       | 107                            |       | 255 |   | 214 |   |
| Other, net                                                       |       | (150                             | )          | 71                             |       | (11 | ) | 58 |   |
| Income from  continuing operations before income taxes           |       | 2,863                            |       | 4,772                          |       | 3,969 |   | 4,579 |   |
| Provision for  income taxes                                      |       | (1,047                           | )          | (1,727                         | )          | (1,452 | ) | (1,662 | ) |
| Income from continuing operations                                |       | 1,816                            |       | 3,045                          |       | 2,517 |   | 2,917 |   |
| Cumulative effect of change in accounting principle,  net of tax |       | —                           |       | —                         |       | 71 |   | — |   |
| Loss from discontinued operations, net of tax                    |       | —                           |       | (4,788                         | )          | — |   | (4,902 | ) |
| Net income (loss)                                                |       | 1,816                            |       | (1,743                         | )          | 2,588 |   | (1,985 | ) |
| Preferred stock dividends                                        |       | (6                               | )          | (6                             | )          | (12 | ) | (12 | ) |
| Net income  (loss) applicable to common stockholders             |       | $                                | 1,810      |                           | $          | (1,749 | ) | $ | 2,576 |   | $ | (1,997 | ) |
| Earnings per  common share:                                      |       |                             |       |                           |       |   |   |   |   |
| Basic:                                                           |       |                             |       |                           |       |   |   |   |   |
| Income (loss) from continuing operations                         |       | $                                | 0.08       |                           | $          | 0.15 |   | $ | 0.11 |   | $ | 0.14 |   |
| Cumulative effect of change in accounting principle              |       | —                           |       | —                         |       | — |   | — |   |
| Loss from discontinued operations                                |       | —                           |       | (0.24                          | )          | — |   | (0.24 | ) |
| Net income (loss) applicable to common stockholders              |       | $                                | 0.08       |                           | $          | (0.09 | ) | $ | 0.11 |   | $ | (0.10 | ) |
| Diluted:                                                         |       |                             |       |                           |       |   |   |   |   |
| Income (loss) from continuing operations                         |       | $                                | 0.08       |                           | $          | 0.14 |   | $ | 0.11 |   | $ | 0.14 |   |
| Cumulative effect of change in accounting principle              |       | —                           |       | —                         |       | — |   | — |   |
| Loss from discontinued operations                                |       | —                           |       | (0.22                          | )          | — |   | (0.23 | ) |
| Net income (loss) applicable to common stockholders              |       | $                                | 0.08       |                           | $          | (0.08 | ) | $ | 0.11 |   | $ | (0.09 | ) |
| Weighted average  common shares outstanding:                     |       |                             |       |                           |       |   |   |   |   |
| Basic                                                            |       | 22,713                           |       | 20,490                         |       | 22,501 |   | 20,436 |   |
| Diluted                                                          |       | 23,451                           |       | 21,276                         |       | 23,338 |   | 21,142 |   |
|                                                                  |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of theconsolidated financial statements.

3

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIESCondensed Consolidated Statement of Changes in Stockholders’ Equity(Unaudited)**
| ** **                                      | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Additional**     | ** ** | ** ** | ** ** | **Total**   | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|--------------------|------------|------------|------------|-------------|------------|
| ** **                                      | ** ** | **Number of**       | ** ** | ** **            | ** ** | **Number of** | ** ** | ** ** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Stockholders’** | ** ** |
| **(In thousands)**                         | ** ** | ** **               | ** ** | **Shares**            | ** ** | **Amount**         | ** ** | **Shares** | ** ** | **Amount**  | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Equity** | ** ** |
| Balance at December 31, 2005                    |       | 9                        |       | $                     | 461        |               | 22,185     |       | $          | 222         |       | $ | 122,368 |   | $ | 22,202 |   | $ | 145,253 |   |
| Dividend reinvestment and stock purchase plans  |       | —                   |       | —                |       | 132                |       | 1          |       | 1,765       |       | — |   | 1,766 |   |
| Proceeds from stock options exercised           |       | —                   |       | —                |       | 272                |       | 3          |       | 1,345       |       | — |   | 1,348 |   |
| Excess tax benefit from stock options exercised |       | —                   |       | —                |       | —             |       | —     |       | 598         |       | — |   | 598 |   |
| Stock-based compensation                        |       | —                   |       | —                |       | —             |       | —     |       | 585         |       | — |   | 585 |   |
| Cumulative effect of change in principle        |       | —                   |       | —                |       | —             |       | —     |       | (110        | )          | — |   | (110 | ) |
| Debenture conversions                           |       | —                   |       | —                |       | 266                |       | 3          |       | 2,788       |       | — |   | 2,791 |   |
| Net income                                      |       | —                   |       | —                |       | —             |       | —     |       | —      |       | 2,588 |   | 2,588 |   |
| Cash dividends declared                         |       | —                   |       | —                |       | —             |       | —     |       | —      |       | (2,389 | ) | (2,389 | ) |
| Balance at  June 30, 2006                  |       | 9                        |       | $                     | 461        |               | 22,855     |       | $          | 229         |       | $ | 129,339 |   | $ | 22,401 |   | $ | 152,430 |   |
|                                                 |            |                          |            |                       |            |                    |            |            |            |             |            |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notesare an integral part of the consolidated financial statements.

4

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIESCondensed Consolidated Statements of Cash Flows(Unaudited)**
| ** **                                                                                | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                | ** ** | **June 30,**              | ** ** |
| **(In thousands)**                                                                   | ** ** | ** **                     | **2006**   | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | ** **                     | ** ** | **(Revised —  See Note 1)** | ** ** |
| **Cash flows from operating  activities of continuing operations:**                       |       |                           |       |   |   |
| Net income (loss)                                                                         |       | $                              | 2,588      |   | $ | (1,985 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                           |       |   |   |
| Cumulative effect of change in accounting principle,  net of tax                          |       | (71                            | )          | — |   |
| Loss from discontinued operations, net of tax                                             |       | —                         |       | 4,902 |   |
| Depreciation and amortization                                                             |       | 5,358                          |       | 5,044 |   |
| Deferred income taxes                                                                     |       | 1,694                          |       | 1,535 |   |
| Stock-based compensation expense                                                          |       | 585                            |       | 466 |   |
| Impairment of goodwill                                                                    |       | 668                            |       | — |   |
| Gain on sales of land                                                                     |       | (407                           | )          | — |   |
| Changes in  assets and liabilities, net of effects of acquisitions:                       |       |                           |       |   |   |
| Restricted cash                                                                           |       | —                         |       | 212 |   |
| Accounts receivable                                                                       |       | (2,516                         | )          | (2,510 | ) |
| Other current assets                                                                      |       | 2,310                          |       | 2,664 |   |
| Other assets                                                                              |       | (1,112                         | )          | (956 | ) |
| Accounts payable                                                                          |       | 826                            |       | (1,204 | ) |
| Other current liabilities                                                                 |       | (97                            | )          | 1,195 |   |
| Other liabilities                                                                         |       | (142                           | )          | (236 | ) |
| Other, net                                                                                |       | (37                            | )          | (297 | ) |
| Net cash provided by operating activities                                                 |       | 9,647                          |       | 8,830 |   |
| **Cash flows from investing  activities of continuing operations:**                       |       |                           |       |   |   |
| Additions to property, plant and equipment                                                |       | (18,245                        | )          | (14,284 | ) |
| Acquisitions of businesses, net of cash acquired                                          |       | (1,247                         | )          | (2,008 | ) |
| Purchase of minority interest                                                             |       | (1,012                         | )          | — |   |
| Proceeds from sale of discontinued operations                                             |       | —                         |       | 9,852 |   |
| Proceeds from sales of land                                                               |       | 427                            |       | — |   |
| Net cash used in investing activities                                                     |       | (20,077                        | )          | (6,440 | ) |
| **Cash flows from financing  activities of continuing operations:**                       |       |                           |       |   |   |
| Borrowings under lines of credit                                                          |       | 8,500                          |       | 24,965 |   |
| Proceeds from stock option and stock purchase plans                                       |       | 3,114                          |       | 1,341 |   |
| Excess tax benefit from stock options exercised                                           |       | 598                            |       | — |   |
| Capital improvement reimbursements                                                        |       | 1,346                          |       | 139 |   |
| Contributions in aid of construction                                                      |       | 1,311                          |       | 1,118 |   |
| Dividends paid                                                                            |       | (2,389                         | )          | (1,962 | ) |
| Payments on long-term debt                                                                |       | (699                           | )          | (15,341 | ) |
| Repayment of advances for construction                                                    |       | (312                           | )          | (201 | ) |
| Deferred financing costs                                                                  |       | (6                             | )          | — |   |
| Net cash provided by financing activities                                                 |       | 11,463                         |       | 10,059 |   |
| **Cash flows from discontinued  operations (Revised — See Note 1):**                 |       |                           |       |   |   |
| Operating activities                                                                      |       | —                         |       | (788 | ) |
| Investing activities                                                                      |       | —                         |       | (73 | ) |
| Financing activities                                                                      |       | —                         |       | (532 | ) |
| Net cash used in discontinued operations                                                  |       | —                         |       | (1,393 | ) |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 1,033                          |       | 11,056 |   |
| Cash and cash  equivalents at beginning of year                                           |       | 2,764                          |       | 1,388 |   |
| Cash and cash  equivalents at end of year                                                 |       | $                              | 3,797      |   | $ | 12,444 |   |
|                                                                                           |            |                                |            |  |  |  |  |  |

 

The accompanyingnotes are an integral part of the consolidated financial statements.

5

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIESCondensed Consolidated Statements of Cash Flows (Continued)(Unaudited)**
| ** **                                                                                                     | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                     | ** ** | **June 30,**              | ** ** |
| **(In thousands)**                                                                                        | ** ** | ** **                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Supplemental cash flow  information:**                                                                       |       |                           |       |   |   |
| Cash paid during  the year for:                                                                                |       |                           |       |   |   |
| Interest                                                                                                       |       | $                              | 4,081      |   | $ | 3,859 |   |
| Income taxes paid (refunded), net                                                                              |       | (1,956                         | )          | (1,360 | ) |
| Components of  cash paid for acquisitions:                                                                     |       |                           |       |   |   |
| Fair value of assets acquired                                                                                  |       | $                              | 1,250      |   | $ | 3,214 |   |
| Liabilities assumed                                                                                            |       | (3                             | )          | (1,206 | ) |
| Cash paid for acquisitions                                                                                     |       | $                              | 1,247      |   | $ | 2,008 |   |
| Components of  proceeds from sale of discontinued operations:                                                  |       |                           |       |   |   |
| Fair value of assets sold                                                                                      |       | $                              | —     |   | $ | 12,748 |   |
| Liabilities assumed by buyer                                                                                   |       | —                         |       | (598 | ) |
| Selling price                                                                                                  |       | —                         |       | 12,150 |   |
| Transaction expenses                                                                                           |       | —                         |       | (1,228 | ) |
| Held in escrow and included in other receivables                                                               |       | —                         |       | (1,070 | ) |
| Net cash proceeds from sale of discontinued  operations                                                        |       | $                              | —     |   | $ | 9,852 |   |
| Non-cash  investing and financing activities:                                                                  |       |                           |       |   |   |
| Non-cash contributions in aid of construction and  advances for construction conveyed to Company by developers |       | $                              | 4,113      |   | $ | 1,110 |   |
| Debentures  converted into common stock                                                                        |       | 2,929                          |       | 20 |   |
|                                                                                                                |            |                                |            |  |  |  |  |  |  |

 

The accompanying notesare an integral part of the consolidated financial statements.

6

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**SOUTHWESTWATER COMPANY AND SUBSIDIARIESCondensed Notes to Consolidated Financial Statements(Unaudited)**

**Note 1.**          Summary of SignificantAccounting Policies

**Basis ofPresentation**

These consolidatedinterim financial statements are unaudited. The Company believes the interim financial statements are presented on abasis consistent with the audited financial statements and include all adjustmentsnecessary for a fair presentation of the financial condition, results ofoperations and cash flows for such interim periods.  All of these adjustments are normal recurringadjustments.

Preparation of theseconsolidated financial statements in conformity with U.S. generally acceptedaccounting principles (“GAAP”) requires the Company to make estimates andjudgments that affect the reported amounts of assets, liabilities anddisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting periods.  Actual resultscould differ from those estimates.

Some information anddisclosures normally included in financial statements prepared in accordancewith GAAP have been omitted in accordance with Securities and ExchangeCommission’s rules and regulations for interim financial reporting.  These interim consolidated financialstatements should be read in conjunction with Management’s Discussion andAnalysis of Financial Condition and Results of Operations and the auditedfinancial statements and related notes included in the Company’s 2005 AnnualReport on Form 10-K.  The Company’sbusinesses are seasonal because they are affected by weather.  As a result, operating results for interimperiods do not necessarily predict the operating results for any other interimperiod or for the full year.

**Revised 2005Statement of Cash Flows Presentation**

In 2006 the Company haselected to separately disclose the operating, investing and financing portionsof the cash flows attributable to discontinued operations, which in 2005 werereported within the operating cash flow category.

**Balancing Accounts**

In April 2006, theCalifornia Public Utilities Commission (the “CPUC”) issued a decision whicheliminates a required earnings test that had prevented some utilities fromrecovering balancing account under-collections, or receivables, fromcustomers.  Because of the uncertaintiesassociated with under-collections this earnings test had created, the Company’sCalifornia utility had established a practice of not recording balancingaccount under-collections (receivables) but instead recording these costs asexpenses until such time the CPUC actually authorized their recovery.  This decision mitigates thatuncertainty.  In the second quarter of2006, the Company recorded $1.4 million of balancing account under-collections($0.7 million attributable to 2005 and $0.7 million attributable to 2006) thatare now reasonably assured of recovery from customers.

**Gain on Sale ofLand**

During the first quarterof 2006, the Company recorded a $0.4 million gain on the sale of land that wasno longer used or useful to its California utility’s operations.  The gain is reflected as a reduction ofUtility Group operating expenses in the consolidated financial statements.

7

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**Changein Accounting Principle**

Effective January 1,2006, the Company adopted the provisions of Statement of Financial AccountingStandards (“SFAS”) No. 123(R), *Share-Based Payment*using the modified prospective method. Generally, SFAS No. 123(R) is similar in approach to SFASNo. 123, which the Company adopted in 2002, and requires that compensationcost relating to share-based payments be recognized in the financial statementsbased on the fair value of the equity or liability instruments issued.  The adoption of SFAS No. 123(R) requiredthe Company to change from recognizing the effect of forfeitures as they occurto estimating the number of outstanding instruments for which the requisiteservice is not expected to be rendered. As a result, the Company recorded a benefit of $0.1 million ($0.07million, net of tax) on January 1, 2006, which is reported as a cumulativeeffect of a change in accounting principle. See Note 8 for additional information.

**Recent AccountingPronouncement**

In July 2006, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation No.48, *Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109* (“FIN 48”).  This interpretation clarifies the accountingfor uncertainty in income taxes recognized in a company’s financial statementsin accordance with FASB 109, “Accounting for Income Taxes.”  FIN 48 prescribes a recognition threshold andmeasurement model for tax positions taken or expected to be taken in taxreturns.  FIN 48 requires a company torecognize in its financial statements the impact of a tax position if it is “more-likely-than-not”(more than 50%) the position will be sustained upon examination, based on thetechnical merits of the position.  Theinterpretation also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure, andtransition.  The provisions of FIN 48 areeffective as of the beginning of the Company’s 2007 fiscal year, with thecumulative effect of the change in accounting principle, if any, recorded as anadjustment to opening retained earnings. The Company does not expect the adoption of FIN 48 will have a materialeffect on its consolidated financial statements.

**Note 2.**          Acquisitions andDispositions

**Acquisitions**

During the first quarterof 2006, the Company’s acquired a small water utility and the rights to providewater and wastewater utility service in another area, both located near Austin,Texas.  The aggregate purchase price forthese acquisitions was $1.3 million in cash; liabilities assumed in connectionwith the acquisitions were negligible. The assets acquired and liabilities assumed have been recorded at theirestimated fair values based upon preliminary valuations, including $0.3 millionof goodwill.  The consolidated financialstatements reflect the acquired utilities subsequent to their respectiveacquisition dates.  The acquisitions arenot material, either individually or in the aggregate, to the Company’sconsolidated results of operations.

On March 21, 2006, the10% minority interest stockholder in Operations Technology, Inc. (“OpTech”), aGeorgia-based non-regulated business in the Company’s Services Group, exercisedits right to require the Company to purchase the remaining 10% of OpTech stockthat it did not already own for $1.0 million in cash (Note 6).  In connection with this acquisition, theCompany has preliminarily allocated the entire purchase price to goodwillpending completion of fair value appraisals.

The acquisitions werefunded with borrowings under the Company’s revolving line of credit.  The Company expects to finalize the purchaseprice allocations during 2006.

8

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**Dispositionof Master Tek**

During the second quarterof 2005, the Company sold Master Tek International, Inc., a subsidiary in itsServices Group that provided utility submetering and billing and collectionservices for multi-family residential properties.  The Company sold Master Tek for $12.2 millionand received $11.1 million in cash at closing with the remaining $1.1 milliondeposited into an escrow account which was to be released to the Company inApril 2006 at the end of a specified representation and warranty period.

On March 29, 2006, theCompany received a $1.65 million claim from the buyer for indemnification ofalleged breach of certain specified representations and warranties.  The Company subsequently reached a tentativesettlement with the buyer and has agreed to release $0.6 million from theescrow account to the buyer with the remaining escrow balance being released tothe Company.  The $0.6 million releasedfrom escrow to the buyer was applied against a liability established at closingfor certain retained liabilities and estimated post-closing obligations thatwere expected to be paid by the Company pursuant to the purchase and saleagreement.  At June 30, 2006, theremaining $0.5 million escrow account balance is included in other currentassets in the accompanying consolidated balance sheets.  The settlement agreement is being finalizedand the Company expects to have final resolution during the third quarter of2006.

As a result of the sale,Master Tek is presented as a discontinued operation in the accompanyingconsolidated financial statements and the results of operations and cash flowsfor 2005 have been reclassified to segregate Master Tek’s results for thatperiod.

The following tablessummarize the results of operations of Master Tek included in the consolidatedfinancial statements.
| ** **                             | ** ** | **Period Ended**       | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **June 30, 2005** | ** ** |
| ** **                             | ** ** | **Three**                   | ** ** | **Six** | ** ** |
| **(In thousands)**                | ** ** | ** **                  | ** ** | **Months** | ** ** | **Months** | ** ** |
| Services Group  revenues               |       | $                           | 2,044      |   | $ | 3,679 |   |
| Expenses:                              |       |                        |       |   |   |
| Services Group operating expense       |       | 2,759                       |       | 3,947 |   |
| Selling, general and administrative    |       | 877                         |       | 1,330 |   |
| Total expenses                         |       | 3,636                       |       | 5,277 |   |
| Operating loss                         |       | (1,592                      | )          | (1,598 | ) |
| Interest expense                       |       | (191                        | )          | (369 | ) |
| Interest income                        |       | 1                           |       | 1 |   |
| Loss before  income taxes              |       | (1,782                      | )          | (1,966 | ) |
| Income tax  benefit                    |       | 618                         |       | 688 |   |
| Loss from  operations                  |       | (1,164                      | )          | (1,278 | ) |
| Loss on sale,  net of $345 tax benefit |       | (3,624                      | )          | (3,624 | ) |
| Loss from discontinued  operations     |       | $                           | (4,788     | ) | $ | (4,902 | ) |
|                                        |            |                             |            |  |  |  |  |  |  |

 

**Note 3.**          Accounts Receivable

The Company’s ServicesGroup provides contract operations and maintenance services to clients inMississippi and Texas, among other states. Hurricanes Katrina and Rita caused significant damage in the Gulf Coastregion of the United States during the third quarter of 2005.  The water and wastewater infrastructures forfive clients in Mississippi were disabled by Hurricane Katrina.  The contracts with these clients provide thatthe Company can incur and bill additional expenses during an emergencysituation to restore water supply and wastewater treatment services tocustomers.  In addition, the clientsrequested our assistance with the removal of debris to enable access foremergency vehicles and residents.

9

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The Company incurred $0.8million of overtime labor costs and emergency out-of-pocket operating expensesin 2005 and $0.1 million in 2006, related to these recovery efforts for theseclients, which are reflected as operating expenses during those periods.  The Company has billed its clients $0.9million for these emergency services and is assisting its clients in requestingreimbursement from the Federal Emergency Management Agency (“FEMA”) pursuant toguidelines established in FEMA’s Applicant Handbook with respect to thesecosts.  The Company recognized revenuesof $0.8 million during 2005 and $0.1 million during the first quarter of 2006based on the revenue recognition criteria set forth in Staff AccountingBulletin No. 104, *Revenue Recognition*.  Through June 30, 2006, the Company hascollected $0.4 million of the $0.9 million billed to date and the remaining$0.5 million is reflected in accounts receivable as of June 30, 2006.  Subsequent to June 30, 2006, the Companycollected an additional $0.2 million of the outstanding receivable balance.

**Note4.**          Goodwill

The table belowsummarizes the changes in the carrying amount of goodwill, by business segment(Note 11), during the six months ended June 30, 2006.
| ** **                           | ** ** | **Utility** | *** *** | **Services** | *** *** | *** *** | *** *** |
|--------------------------------------|------------|-------------|--------------|--------------|--------------|--------------|--------------|
| **(In thousands)**              | ** ** | ** **  | ** **   | **Group**    | ** **   | **Group**    | ** **   | **Total** | ** ** |
| Balance,  December 31, 2005          |       | $           | 15,609       |         | $            | 17,368       |         | $ | 32,977 |   |
| Businesses  acquired during the year |       | 339         |         | —       |         | 339          |         |
| Acquisition of  minority interest    |       | —      |         | 1,012        |         | 1,012        |         |
| Impairment of  goodwill              |       | —      |         | (668         | )            | (668         | )            |
| Balance, June 30, 2006               |       | $           | 15,948       |         | $            | 17,712       |         | $ | 33,660 |   |
|                                      |            |             |              |              |              |              |              |  |  |  |  |  |

The Company has acquiredseveral businesses during 2006, all of which were accounted for as purchases(Note 2).  As a result, the assetsacquired and liabilities assumed have been recorded at their estimated fairvalues based on preliminary valuations with the difference between theaggregate purchase price and the fair value of the identifiable net assetsacquired recorded as goodwill.

The Company testsgoodwill annually for impairment at the reporting unit level, on October 31st of each year, or when events or circumstancesindicate the carrying values may not be recoverable.  The Company evaluates goodwill for impairmentusing discounted cash flow methodologies, transaction values for comparablecompanies, and other valuation techniques for its reporting units with goodwillbalances.  The realizability of theCompany’s long-lived assets, including goodwill, is dependent on expectedfuture cash flows from the underlying operations.

During the second quarterof 2006, management reviewed the business strategy for its water andwaste-water testing laboratory reporting unit. This review resulted in management’s decision to realign the operationsby reducing the size and scope of its business activities and focusing on itscore operations and customers.  Thecarrying value of the entity was tested for impairment using the revised cashflow projections and it was determined that carrying values were notrecoverable.  As a result, $0.6 millionof goodwill associated with the laboratory reporting unit was deemed to beimpaired and was charged to expense in the second quarter of 2006.

Also during the secondquarter of 2006, management determined that the renewal of a primary contractfor another reporting unit was not likely to occur, significantly reducing thefuture estimated cash flows of the reporting unit.  As a result, $0.1 million of goodwillassociated with this reporting unit was deemed to be impaired and was chargedto expense during the period.

 

10

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**Note 5.**          Long-Term Debt

Long-term debt consistsof the following as of June 30, 2006 and December 31, 2005:
| ** **                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In thousands)**                              | ** ** | ** **        | ** ** | **2006**              | ** ** | **2005** | ** ** |
| $100 million  revolving credit facility              |       | $                 | 38,500     |                  | $          | 30,000 |   |
| 6.85% convertible subordinated debentures due 2021   |       | 13,179            |       | 16,108                |       |
| Term Loans:                                          |       |              |       |                  |       |
| Monarch  Utilities, Inc.:                            |       |              |       |                  |       |
| 7.37% fixed rate term loan due 2022                  |       | 12,192            |       | 12,577                |       |
| 5.77% fixed rate term loan due 2022                  |       | 837               |       | 864                   |       |
| 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                 |       |
| 7.61% series C first mortgage bond due 2006          |       | 8,000             |       | 8,000                 |       |
| 5.64% series D first mortgage bond due 2024          |       | 15,000            |       | 15,000                |       |
| New Mexico  Utilities, Inc.:                         |       |              |       |                  |       |
| 6.10% series C first mortgage bond due 2024          |       | 12,000            |       | 12,000                |       |
| Economic  Development Revenue Bonds:                 |       |              |       |                  |       |
| ECO Resources,  Inc.:                                |       |              |       |                  |       |
| 6.0% series 1998A due 2018                           |       | 1,810             |       | 1,810                 |       |
| 5.5% series 1998A due 2008                           |       | 320               |       | 320                   |       |
| Acquisition-related indebtedness                     |       | 1,108             |       | 1,395                 |       |
| Total long-term debt payment obligations             |       | 130,946           |       | 126,074               |       |
| Unamortized Monarch term loan fair value adjustments |       | 953               |       | 1,021                 |       |
| Total long-term debt                                 |       | 131,899           |       | 127,095               |       |
| Less current portion of long-term debt               |       | (9,409            | )          | (9,492                | )          |
| Long-term debt,  less current portion                |       | $                 | 122,490    |                  | $          | 117,603 |   |
|                                                      |            |                   |            |                       |            |  |  |  |  |

The $100 millionrevolving line of credit commitment ends on April 1, 2010, at which time allborrowings must be repaid.  Borrowingsunder the credit facility bear interest, at the Company’s option, based on amargin either: a) over the LIBOR rate; or b) under the prime rate.  The margins vary depending upon the Company’sconsolidated debt to equity ratio. Currently, the applicable margins are 1.00% over the LIBOR rate or 0.25%under the prime rate.  Theweighted-average interest rates on all credit facility borrowings outstandingwere 6.15 % as of June 30, 2006 and 5.37% as of December 31, 2005.

The Company hadirrevocable standby letters of credit in the amount of $4.1 million issued andoutstanding under its revolving credit facility as of June 30, 2006,reducing available borrowings under the credit facility to $57.4 million as ofthat date.

11

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**Note6.**          Commitmentsand Contingencies

**Commitments UnderLong-Term Service Contracts**

In 2002, the Company wasretained to facilitate the engineering and construction of a $23.0 millionreverse osmosis water treatment plant in the city of San Juan Capistrano,California for the Capistrano Valley Water District (“CVWD”).  In 2003, the Company obtained a $3.4 millionstandby letter of credit as collateral to insure its performance during thedesign and construction of the water treatment plant.  Construction was completed during 2005 andupon final acceptance of the completed project by the CVWD, which is expectedin 2006, the standby letter of credit will be terminated.

The Company now operatesthe completed plant under a twenty-year operating agreement.  The CVWD service contract contains certainguarantees related to the performance of the Company and a subsidiary,including certain liquidated damages in the event of failure on the part of theCompany to perform not caused by uncontrollable circumstances as defined in theservice contract.  Also, the Company hasmade other guarantees to CVWD, including guarantees with respect to the qualityand quantity of the finished water and the production efficiency of thefacility.

As part of the financingfor this project, the CVWD sold insured municipal bonds.  The Company entered into an agreement withthe bond insurer to guarantee the Company’s performance under the servicecontract, subject to certain liability caps to the bond insurer in the event ofa default.  During the twenty-yearoperation of the facility, such liability caps will not exceed an amount equalto $4.0 million plus an amount no greater than the replacement cost of theactual reverse osmosis filtration unit within the facility, estimated to beapproximately $1.5 million.

**Legal Proceedings**

Southwest Water and asubsidiary were named as defendants in several lawsuits alleging variousinjuries as a result of water contamination in the San Gabriel Valley MainBasin.  The California Supreme Courtruled in February 2002 that the plaintiffs could not challenge the adequacy ofthe water quality standards established by California Department of HealthServices.  In August 2004, the caseagainst Southwest Water and its subsidiary was dismissed; however, theplaintiffs appealed the dismissal to the Court of Appeals for the State ofCalifornia, Second Appellate District.  Acourt date has not been set and, to date, liability insurance carriers haveabsorbed the costs of defense of the lawsuits. Based upon information available at this time, the Company does notexpect that this action will have a material adverse effect on its consolidatedfinancial position, results of operations or cash flows.

The Company and itssubsidiaries are also involved in other routine legal and administrativeproceedings incident to the normal conduct of business.  The Company believes the ultimate dispositionof such matters will not have a material adverse effect on its business,consolidated financial position, results of operations or cash flows.

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**MinorityInterest Put and Call Rights**

Prior to March 20, 2006,the Company owned 90% of the outstanding common stock of OperationsTechnologies, Inc. (“OpTech”).  Theminority stockholder had the right to require the Company to purchase theremaining 10% of OpTech for the greater of $1.0 million or a formula-determinedamount based on the profitability of OpTech. The Company had the right to purchase the remaining 10% of OpTechbeginning in August 2006 at the same terms. On March 20, 2006, the minority stockholder elected to exercise itsright and the Company acquired the shares based on the formula determinedamount which was slightly more than the $1.0 million minimum amount (Note2).

Prior to December 2005,the Company had an 80% interest in Windermere Utility Company.  The stockholders rights agreement providedthat the Company had the right to acquire the remaining 20% of Windermere atany time for $6.0 million payable in common stock of the Company providedcertain market value thresholds were attained. The minority stockholder of Windermere had the right to require theCompany to purchase the shares beginning in October 2005 on essentially thesame terms, depending on the prevailing market value of the common stock.  In December 2005, the minority stockholderelected to exercise its right and the Company issued 450,644 shares of its commonstock in exchange for the remaining Windermere shares.

**EPA Investigations**

On May 5, 2005, one ofthe Company’s operating subsidiaries received a subpoena to provide records toa grand jury.  The requested recordsrelate to the operations of the San Simeon wastewater treatment plant inCalifornia for the period January 2002 to present.  The subsidiary has operated this facilitysince September 2004.  The facility wasalso served with search warrants executed by the EPA.  The Company is cooperating fully with theinvestigation.

On May 18, 2005, the EPAexecuted a search warrant at the Company’s Texas-based testing laboratory andon July 20, 2006 the laboratory received a subpoena to provide additionalrecords and information to a grand jury. The Company is cooperating fully with the investigation.

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**Note7.**          EarningsPer Share

The following table is areconciliation of the numerators (income or loss) and denominators (shares)used in both the basic and diluted earnings per share calculations.
| ** **                                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                  | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(In thousands, except share data)**                   | ** ** | ** **                       | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Numerators—Net income  (loss) applicable to common stockholders:       |       |                             |       |                           |       |   |   |   |   |
| Income (loss) from continuing operations                                    |       | $                                | 1,816      |                           | $          | 3,045 |   | $ | 2,517 |   | $ | 2,917 |   |
| Less preferred stock dividends                                              |       | (6                               | )          | (6                             | )          | (12 | ) | (12 | ) |
| Income (loss) from continuing operations applicable  to common stockholders |       | 1,810                            |       | 3,039                          |       | 2,505 |   | 2,905 |   |
| Cumulative effect of change in accounting principle                         |       | —                           |       | —                         |       | 71 |   | — |   |
| Loss from discontinued operations                                           |       | —                           |       | (4,788                         | )          | — |   | (4,902 | ) |
| Net income (loss) applicable to common stockholders                         |       | $                                | 1,810      |                           | $          | (1,749 | ) | $ | 2,576 |   | $ | (1,997 | ) |
| Denominators—Weighted  average common shares outstanding:              |       |                             |       |                           |       |   |   |   |   |
| Basic weighted average common shares outstanding                            |       | 22,713                           |       | 20,490                         |       | 22,501 |   | 20,436 |   |
| Plus shares issued on assumed exercise of stock  options and warrants       |       | 738                              |       | 786                            |       | 837 |   | 706 |   |
| Diluted weighted average common shares outstanding                          |       | 23,451                           |       | 21,276                         |       | 23,338 |   | 21,142 |   |
| Earning (loss) per  share applicable to common stockholders:                |       |                             |       |                           |       |   |   |   |   |
| Basic:                                                                      |       |                             |       |                           |       |   |   |   |   |
| Continuing operations                                                       |       | $                                | 0.08       |                           | $          | 0.15 |   | $ | 0.11 |   | $ | 0.14 |   |
| Cumulative effect of change in accounting principle                         |       | —                           |       | —                         |       | — |   | — |   |
| Discontinued operations                                                     |       | —                           |       | (0.24                          | )          | — |   | (0.24 | ) |
| Net income (loss) applicable to common stockholders                         |       | $                                | 0.08       |                           | $          | (0.09 | ) | $ | 0.11 |   | $ | (0.10 | ) |
| Diluted:                                                                    |       |                             |       |                           |       |   |   |   |   |
| Continuing operations                                                       |       | $                                | 0.08       |                           | $          | 0.14 |   | $ | 0.11 |   | $ | 0.14 |   |
| Cumulative effect of change in accounting principle                         |       | —                           |       | —                         |       | — |   | — |   |
| Discontinued operations                                                     |       | —                           |       | (0.22                          | )          | — |   | (0.23 | ) |
| Net income (loss)  applicable to common stockholders                        |       | $                                | 0.08       |                           | $          | (0.08 | ) | $ | 0.11 |   | $ | (0.09 | ) |
|                                                                             |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |

The difference betweenbasic and diluted earnings per share is the effect of stock options that, underthe treasury share method, give rise to potentially dilutive common shares.  As described in Note 5, the Company has $13.2million of 6.85% fixed-rate convertible subordinate debentures outstanding asof June 30, 2006.  The debenturesare convertible into common stock at any time prior to maturity, unlesspreviously redeemed, at a conversion price of $11.018 per share which totals1.2 million shares as of June 30, 2006. At such time as the assumed conversion of the debentures has a dilutiveeffect on earnings per share, the debentures will be included in thecalculation of diluted earnings per share after adjusting net income for theafter-tax effect of the debenture interest expense.

Both basic and dilutedearnings per common share and the related weighted average common sharesoutstanding for the three months and six months ended June 30, 2005 havebeen retroactively adjusted to reflect a 5% stock distribution declared onJanuary 2, 2006.

**Note 8.**          Stock Based IncentiveCompensation Plans

Prior to May 2006, theCompany had three stock-based incentive compensation plans: a Stock OptionPlan, a Director Stock Option Plan, and an Employee Stock Purchase Plan.  At the May 2006 annual meeting ofstockholders, the stockholders approved a new Equity Incentive Plan whichreplaced the previously existing Stock Option Plan and Director Stock OptionPlan.  The table below summarizes thenumber of shares authorized and available for issuance under the twostock-based plans as of June 30, 2006.

14

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** **
| ** **                    | ** ** | **Number of shares** | ** ** |
|-------------------------------|------------|--------------------------------|------------|
| **(In  thousands)**           | ** ** | ** **                     | ** ** | **Authorized** | ** ** | **Available** | ** ** |
| Equity Incentive  Plan        |       | 5,434                          |       | 1,055 |   |
| Employee Stock  Purchase Plan |       | 1,256                          |       | 904 |   |
| Total                         |       | 6,690                          |       | 1,959 |   |
|                               |            |                                |            |  |  |  |  |

Effective January 1,2006, the Company adopted the provisions of Statement of Financial AccountingStandards (“SFAS”) No. 123(R), “*Share-Based Payment*”using the modified prospective method. Generally, SFAS No. 123(R) is similar in approach to SFASNo. 123, which the Company adopted in 2002, and requires that compensationcost relating to share-based payments be recognized in the financial statementsbased on the fair value of the equity or liability instruments issued.  Because the Company has been recognizingcompensation cost related to share-based payments since its 2002 adoption ofSFAS No. 123, the adoption of SFAS No. 123(R) did not have a materialeffect on the consolidated financial statements.

The adoption of SFASNo. 123(R) required the Company to change from recognizing the effect offorfeitures as they occur to estimating the number of options for which therequisite service is not expected to be rendered and reducing the periodiccompensation cost recorded accordingly. As a result, the Company recorded a benefit of $0.1 million ($0.07million, net of tax) on January 1, 2006, which is reported as the cumulativeeffect of a change in accounting principle, to reflect the amount of compensationcost previously recognized related to outstanding options as of December 31,2005 that are not expected to vest based on an estimate of forfeitures derivedfrom historical data.

The following tableillustrates the pro forma effect if the Company had applied the provisions ofSFAS No. 123(R) as of January 1, 2005:
| ** **                                              | ** ** | **Period Ended**       | ** ** |
|---------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                              | ** ** | **June 30, 2005** | ** ** |
| ** **                                              | ** ** | **Three**                   | ** ** | **Six** | ** ** |
| **(In thousands)**                                 | ** ** | ** **                  | ** ** | **Months** | ** ** | **Months** | ** ** |
| Compensation cost:                                      |       |                        |       |   |   |
| Recorded in 2005 recognizing forfeitures as they  occur |       | $                           | 214        |   | $ | 466 |   |
| Net change                                              |       | 31                          |       | 33 |   |
| Pro forma for  2005 estimating expected forfeitures     |       | $                           | 245        |   | $ | 499 |   |
|                                                         |            |                             |            |  |  |  |  |  |  |

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | **June 30, 2005**      | ** ** | **June 30, 2005**    | ** ** |
| **(In thousands, except share data)** | ** ** | ** **                       | ** ** | **As Reported**           | ** ** | **Pro Forma** | ** ** | **As Reported** | ** ** | **Pro Forma** | ** ** |
| Income from  continuing operations                        |       | $                                | 3,045      |                           | $          | 3,014 |   | $ | 2,917 |   | $ | 2,884 |   |
| Net loss                                                  |       | (1,743                           | )          | (1,774                         | )          | (1,985 | ) | (2,018 | ) |
| Net loss  applicable to common stockholders               |       | (1,749                           | )          | (1,780                         | )          | (1,997 | ) | (2,030 | ) |
| Basic income  (loss) per common share: (1)                |       |                             |       |                           |       |   |   |   |   |
| Income from continuing operations                         |       | 0.15                             |       | 0.15                           |       | 0.14 |   | 0.14 |   |
| Net income (loss) applicable to common                    |       | (0.09                            | )          | (0.09                          | )          | (0.10 | ) | (0.10 | ) |
| Diluted income  (loss) per common share: (2)              |       |                             |       |                           |       |   |   |   |   |
| Income from continuing operations                         |       | 0.14                             |       | 0.14                           |       | 0.14 |   | 0.13 |   |
| Net income (loss)  applicable to common                   |       | (0.08                            | )          | (0.08                          | )          | (0.09 | ) | (0.10 | ) |
|                                                           |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |

----

(1)             Basedon approximately 20.5 million and 20.4 million weighted average common sharesoutstanding during the three months and six months ended June 30, 2005,respectively (Note 7).

(2)             Basedon approximately 21.3 million and 21.1 million weighted average common sharesoutstanding during the three months and six months ended June 30, 2005,respectively (Note 7).

15

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**StockOption Plans**

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholes optionpricing model with the following weighted average assumptions used for grantsin 2006 and 2005:
| ** **               | ** ** | **Six Months Ended** | ** ** |
|--------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **June 30,**              | ** ** |
| ** **               | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Dividend yield           |       | 1.4                            | %          | 1.7 | % |
| Expected  volatility     |       | 33.5                           | %          | 24.3 | % |
| Risk-free  interest rate |       | 4.8                            | %          | 4.1 | % |
| Expected life in years   |       | 4.6                            |       | 5.7 |   |

The weighted averagegrant date fair value of options granted during the three months endedJune 30, 2006 and 2005 was $4.84 and $2.83 per share, respectively, and$4.99 and $2.98 per share for the six months ended June 30, 2006 and 2005,respectively.  Compensation expensearising from stock option grants was $0.3 million and $0.2 million during thethree months ended June 30, 2006 and 2005, respectively, and $0.6 millionand $0.5 million during the six months ended June 30, 2006 and 2005,respectively.  As of June 30, 2006,aggregate unrecognized compensation costs, before estimated forfeitures, totals$2.2 million and is expected to be recognized over the next five years (2.3years on a weighted average basis).

The following tablesummarizes all stock option plan activity during the six months endedJune 30, 2006:
| ** **                                                     | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|---------------|------------|
| ** **                                                     | ** ** | **Number** | ** ** | **Average**   | ** ** |
| ** **                                                     | ** ** | **of**     | ** ** | **Exercise**  | ** ** |
| **(In thousands, except exercise prices)** | ** ** | ** ** | ** ** | **Shares**    | ** ** | **Price** | ** ** |
| Outstanding at December  31, 2005                              |       | 2,641      |       | $             | 8.30       |   |
| Granted                                                        |       | 436        |       | 16.24         |       |
| Exercised                                                      |       | (381       | )          | 7.77          |       |
| Forfeited                                                      |       | (135       | )          | 10.79         |       |
| Expired                                                        |       | (5         | )          | 2.38          |       |
| Outstanding at  June 30, 2006                             |       | 2,556      |       | 9.50          |       |
|                                                                |            |            |            |               |            |  |  |  |

The total intrinsic valueof options exercised during the three months ended June 30, 2006 and 2005was $1.1 million and $0.3 million, respectively, and $2.8 million and $0.3million for the six months ended June 30, 2006 and 2005, respectively.

The following tablessummarize information about stock options outstanding and exercisable as ofJune 30, 2006.
| ** **                                                              | ** ** | ** ** | *** *** | **Expected**    | *** *** | *** ***     | *** *** |
|-------------------------------------------------------------------------|------------|------------|--------------|-----------------|--------------|------------------|--------------|
| **(In thousands, except as indicated)**             | ** ** | ** ** | ** **   | **Outstanding** | ** **   | **to Vest** | ** **   | **Exercisable** | ** ** |
| Number of shares                                                        |       | 2,556      |         | 2,412           |         | 1,564            |         |
| Weighted average  remaining contractual life in years                   |       | 4.03       |         | 3.94            |         | 2.75             |         |
| Weighted average  exercise price per share                              |       | $          | 9.50         |            | $            | 9.28             |         | $ | 7.15 |   |
| Aggregate intrinsic  value (at closing stock price of $11.97 per share) |       | $          | 8,308        |            | $            | 8,203            |         | $ | 7,561 |   |
|                                                                         |            |            |              |                 |              |                  |              |  |  |  |  |  |

 

16

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| ** **                                                         | ** ** | **Outstanding**   | ** ** | **Exercisable** | ** ** |
|--------------------------------------------------------------------|------------|-------------------|------------|-----------------|------------|
| ** **                                                         | ** ** | **Number**        | ** ** | **Weighted-**   | ** ** | ** ** | ** ** | **Number** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Outstanding**   | ** ** | **Average**     | ** ** | **Weighted-** | ** ** | **Exercisable** | ** ** | **Weighted-** | ** ** |
| ** **                                                         | ** ** | **as of**    | ** ** | **Remaining**   | ** ** | **Average** | ** ** | **as of** | ** ** | **Average** | ** ** |
| ** **                                                         | ** ** | **June 30,** | ** ** | **Contractual** | ** ** | **Exercise** | ** ** | **June 30,** | ** ** | **Exercise** | ** ** |
| **(In thousands, except per share data)** | ** ** | ** **        | ** ** | **2006**        | ** ** | **Life** | ** ** | **Price** | ** ** | **2006** | ** ** | **Price** | ** ** |
| Range of per share  exercise prices:                               |       |              |       |            |       |   |   |   |   |   |   |
| $1.69 to $3.99                                                     |       | 53                |       | 0.78 years      |       | $ | 3.31 |   | 53 |   | $ | 3.31 |   |
| $4.00 to $7.99                                                     |       | 962               |       | 2.80 years      |       | 5.95 |   | 954 |   | 5.93 |   |
| $8.00 to $11.99                                                    |       | 906               |       | 4.07 years      |       | 9.70 |   | 529 |   | 9.43 |   |
| $12.00 to $17.75                                                   |       | 635               |       | 6.12 years      |       | 15.12 |   | 28 |   | 12.89 |   |
| $1.69 to $17.75                                                    |       | 2,556             |       | 4.03 years      |       | 9.50 |   | 1,564 |   | 7.15 |   |
|                                                                    |            |                   |            |                 |            |  |  |  |  |  |  |  |  |  |  |

 

**Employee StockPurchase Plan (“ESPP”)**

The Company has astockholder-approved employee stock purchase plan (“ESPP”) that allows eligibleemployees to purchase 1.3 million shares of common stock through payrolldeductions of up to 10% of their salary, not to exceed $25,000 per year.  The purchase price of the stock is 90% of thelower of the three-day average share price calculated at the beginning and endof each three-month offering period. Under the ESPP, the Company issued 4,615 and 9,153 shares to employeesduring the three months and six months ended June 30, 2006,respectively.  Compensation expenserecognized by the Company resulting from employee stock purchases pursuant tothis plan was nominal for the three months and six months ended June 30,2006 and 2005.  As of June 30, 2006,0.9 million shares remain available for future purchases.

**Note 9.**          Stock Purchase Plan

**DividendReinvestment and Direct Stock Purchase Plan (“DRIP / DSPP”)**

The Company has adividend reinvestment and stock purchase plan that gives common stockholdersthe option of receiving their dividends in cash or in common stock at adiscount from prevailing market prices (“DRIP”).  The plan also permits existing stockholdersto purchase additional common stock, up to a maximum of $10,000 per month, at adiscount (“DSPP”); new investors may participate in the plan, subject to a $250minimum initial investment.  The Companymay, at its sole discretion, permit purchases above the $10,000 statedmaximum.  The discounts may range from 0%to 5%, as determined from time to time by the Company.  The DRIP and DSPP discount offered by theCompany are 3% for the DRIP and 3% for the DSPP as of June 30, 2006.  During 2006, the Company registered anadditional 1,200,000 shares of common stock that were authorized to be issuedunder the plan.  As of June 30,2006, there are 3.7 million shares authorized for issuance under the plan ofwhich 1.4 shares remain available for issuance.

17

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**Note10. Employee Retirement Plan**

The Company has anon-qualified supplemental executive retirement plan (“SERP”) for certain keyexecutive officers for the purpose of providing supplemental income benefits toplan participants or their survivors upon retirement or death.  The following table details the components ofthe net periodic benefit costs:
| ** **                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                 | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(In thousands)**    | ** ** | ** **                       | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Service cost               |       | $                                | 16         |                           | $          | 16 |   | $ | 32 |   | $ | 32 |   |
| Interest cost              |       | 19                               |       | 20                             |       | 38 |   | 40 |   |
| Recognized  actuarial loss |       | 13                               |       | 22                             |       | 26 |   | 44 |   |
| Total                      |       | $                                | 48         |                           | $          | 58 |   | $ | 96 |   | $ | 116 |   |
|                            |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |

 

**Note 11. SegmentInformation**

The Company’s businessesare segmented into two operating groups: the Utility Group and the ServicesGroup.  Each segment is a strategicbusiness unit that offers different services. They are managed separately since each business requires differentoperating and growth strategies.  Theaccounting policies of the segments are described in the summary of significantaccounting policies in Note 1 to the audited financial statements included inthe Company’s 2005 Form 10-K.

The Utility Group ownsand operates public water and wastewater utilities in Alabama, California, NewMexico, Oklahoma and Texas.  State andfederal agencies issue regulations regarding standards of water quality, safety,environmental and other matters which affect these operations.  In the regulated utility subsidiaries, therates that they charge for water and wastewater services are established bystate or local authorities.  The serviceareas in which the Utility Group operates constitute monopolies with allowablerates determined by state or county regulatory agencies.

The Services Groupoperates and manages water and wastewater treatment facilities owned by cities,public agencies, municipal utility districts, private entities and investor-ownedutilities, including some of the companies in the Utility Group.  Revenue is also derived through operationsand maintenance contracts with smaller municipalities.  The Services Group also provides constructionand construction management services, and certified water and wastewaterlaboratory testing services.  TheServices Group, while subject to certain environmental standards, is notregulated in its pricing, marketing or rates of return.

The following tablepresents information about the operations of each segment for the three monthsand six months ended June 30, 2006 and 2005.

18

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** **
| ** **                                                    | ** ** | ** **  | ** ** | ** **   | ** ** | **Total**          | ** ** | **Corporate** | ** ** | ** **         | ** ** |
|---------------------------------------------------------------|------------|-------------|------------|--------------|------------|--------------------|------------|---------------|------------|--------------------|------------|
| ** **                                                    | ** ** | **Utility** | ** ** | **Services** | ** ** | **Operating**      | ** ** | **and**       | ** ** | **Consolidated**   | ** ** |
| **(In thousands)**                                       | ** ** | ** **  | ** ** | **Group**    | ** ** | **Group (1)** | ** ** | **Segments**  | ** ** | **Other (2)** | ** ** | **Total** | ** ** |
| Three months ended  June 30, 2006:                       |       |        |       |         |       |               |       |          |       |               |       |
| Revenues (1)                                                  |       | $           | 20,790     |         | $          | 34,570             |       | $             | 55,360     |               | $          | — |   | $ | 55,360 |   |
| Operating income (loss)                                       |       | $           | 8,447      |         | $          | 604                |       | $             | 9,051      |               | $          | (4,091 | ) | $ | 4,960 |   |
| Interest expense                                              |       | (1,559      | )          | (491         | )          | (2,050             | )          | (71           | )          | (2,121             | )          |
| Interest income                                               |       | 20          |       | 96           |       | 116                |       | 58            |       | 174                |       |
| Other income (expense)                                        |       | (13         | )          | (139         | )          | (152               | )          | 2             |       | (150               | )          |
| Income (loss) from continuing operations before  income taxes |       | $           | 6,895      |         | $          | 70                 |       | $             | 6,965      |               | $          | (4,102 | ) | $ | 2,863 |   |
| Three months  ended June 30, 2005:                       |       |        |       |         |       |               |       |          |       |               |       |
| Revenues (1)                                                  |       | $           | 20,295     |         | $          | 30,987             |       | $             | 51,282     |               | $          | — |   | $ | 51,282 |   |
| Operating income (loss)                                       |       | $           | 7,665      |         | $          | 1,660              |       | $             | 9,325      |               | $          | (2,835 | ) | $ | 6,490 |   |
| Interest expense                                              |       | (1,209      | )          | (483         | )          | (1,692             | )          | (204          | )          | (1,896             | )          |
| Interest income                                               |       | 11          |       | 96           |       | 107                |       | —        |       | 107                |       |
| Other income (expense)                                        |       | 34          |       | 37           |       | 71                 |       | —        |       | 71                 |       |
| Income (loss) from continuing operations before  income taxes |       | $           | 6,501      |         | $          | 1,310              |       | $             | 7,811      |               | $          | (3,039 | ) | $ | 4,772 |   |
| Six months ended  June 30, 2006:                         |       |        |       |         |       |               |       |          |       |               |       |
| Revenues (1)                                                  |       | $           | 38,763     |         | $          | 67,399             |       | $             | 106,162    |               | $          | — |   | $ | 106,162 |   |
| Operating income (loss)                                       |       | $           | 13,777     |         | $          | 1,668              |       | $             | 15,445     |               | $          | (7,468 | ) | $ | 7,977 |   |
| Interest expense                                              |       | (3,073      | )          | (978         | )          | (4,051             | )          | (201          | )          | (4,252             | )          |
| Interest income                                               |       | 29          |       | 164          |       | 193                |       | 62            |       | 255                |       |
| Other income (expense)                                        |       | (25         | )          | —       |       | (25                | )          | 14            |       | (11                | )          |
| Income (loss) from continuing operations before  income taxes |       | $           | 10,708     |         | $          | 854                |       | $             | 11,562     |               | $          | (7,593 | ) | $ | 3,969 |   |
| Six months ended  June 30, 2005:                         |       |        |       |         |       |               |       |          |       |               |       |
| Revenues (1)                                                  |       | $           | 35,754     |         | $          | 60,759             |       | $             | 96,513     |               | $          | — |   | $ | 96,513 |   |
| Operating income (loss)                                       |       | $           | 11,673     |         | $          | 2,877              |       | $             | 14,550     |               | $          | (6,575 | ) | $ | 7,975 |   |
| Interest expense                                              |       | (2,403      | )          | (996         | )          | (3,399             | )          | (269          | )          | (3,668             | )          |
| Interest income                                               |       | 22          |       | 189          |       | 211                |       | 3             |       | 214                |       |
| Other income (expense)                                        |       | 13          |       | 59           |       | 72                 |       | (14           | )          | 58                 |       |
| Income (loss)  from continuing operations before income taxes |       | $           | 9,305      |         | $          | 2,129              |       | $             | 11,434     |               | $          | (6,855 | ) | $ | 4,579 |   |
|                                                               |            |             |            |              |            |                    |            |               |            |                    |            |  |  |  |  |  |  |  |

----

(1)             Inaddition to services provided to external customers, some companies in theServices Group provide construction, operations and maintenance services tocompanies in the Utility Group.  Inaccordance with SFAS No. 71, the Company does not eliminate theintersegment profit on sales to affiliated utilities when the sales price isreasonable and it is probable that, through the rate making process, futurerevenue approximately equal to the sales price will result from the regulatedaffiliate’s use of the services. Intersegment profit was $2.9 million and $2.2 million for three monthsended June 30, 2006 and 2005, respectively, and $5.3 million and $4.3million for six months ended June 30, 2006 and 2005, respectively.

19

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(2)             Consistsof costs that include headquarters expenses and any corporate functionaldepartments whose costs are not allocated to the reportable segments.  Corporate and other assets reflect corporateheadquarters assets, excluding investments in and receivables fromsubsidiaries.

The following table presents information aboutidentifiable assets by segment as of June 30, 2006 and December 31, 2005.
| ** **               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In thousands)**  | ** ** | ** **        | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Utility Group            |       | $                 | 390,704    |                  | $          | 371,714 |   |
| Services Group           |       | 68,485            |       | 68,546                |       |
| Corporate and  Other (2) |       | 4,811             |       | 4,465                 |       |
| Total assets             |       | $                 | 464,000    |                  | $          | 444,725 |   |
|                          |            |                   |            |                       |            |  |  |  |  |

 

20

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

**SPECIAL NOTE ABOUTFORWARD-LOOKING STATEMENTS**

Certain statements inManagement’s Discussion and Analysis of Financial Condition and Results ofOperations (the “MD&A”), other than purely historical information,including estimates, projections, statements relating to our business plans,objectives, and expected operating results, and the assumptions upon whichthose statements are based, are “forward-looking statements” within the meaningof the Private Securities Litigation Reform Act of 1995, Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  These forward-looking statementsgenerally are identified by the words “believes,” “project,” “expects,” “anticipates,”“estimates,” “intends, “strategy,” “plan,” “may,” “will,” “would,” “will be,” “willcontinue,” “will likely result,” and similar expressions.  Forward-looking statements are based oncurrent expectations and assumptions that are subject to risks anduncertainties which may cause actual results to differ materially from theforward-looking statements.  We undertakeno obligation to update or revise publicly any forward-looking statements,whether as a result of new information, future events or otherwise.

The following discussionsshould be read in conjunction with the consolidated financial statements andaccompanying notes included in this quarterly report and in our 2005 annualreport on Form 10-K.

**OVERVIEW**

Southwest Water Companyprovides a broad range of services including water production, treatment anddistribution; wastewater collection and treatment; utility billing andcollection; utility infrastructure construction management; and public worksservices.  We own regulated publicutilities and also serve cities, utility districts and private companies undercontract.  Our subsidiaries are segmentedinto two operating groups: our Utility Group and our Services Group.

**Acquisitions and Dispositions**

Our consolidatedfinancial position, results of operations and cash flows have been affected byour history of acquisitions and, in 2005, a disposition.  Our most recent significant acquisitions,which affect the comparability of the historical financial condition andresults of operations described in the MD&A, are:

*UtilityGroup*

·                  an Alabama-basedwastewater collection and treatment system, which we operate as Southwest WaterAlabama, in September 2005; and

*ServicesGroup*

·                  Novus Utilities,an Alabama based contract operations company, acquired in March 2005.

In June 2005 we soldMaster Tek International, Inc., our submetering business that providedmulti-family residential utility metering, billing and collection services forresidential properties.  The sale of thisbusiness, which was part of our Services Group, is not expected to affect theoperations of our remaining businesses in the Services Group or our UtilityGroup.  As a result of the sale, thebusiness we sold is reflected as a discontinued operation in our consolidatedfinancial statements and the discussion below is focused on continuingoperations for all periods.

21

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**RESULTSOF OPERATIONS**

**ThreeMonths Ended June 30, 2006 Compared to 2005**

**Revenues.**  Revenues increased $4.1 million, or 8.0%, to$55.4 million for the three months ended June 30, 2006 from $51.3 millionfor the same period during the prior year. By segment, revenues increased as follows:
| ** **                                                     | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **                        | ** ** | ** **     | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|--------------|------------|-----------------------------------|------------|----------------|------------|
| ** **                                                     | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | **Percent of Revenues** | ** ** |
| **(In thousands, except percentage data)** | ** ** | ** **                       | ** ** | **2006**     | ** ** | **2005**                          | ** ** | **(Decrease)** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Utility Group                                                  |       | $                                | 20,790     |         | $          | 20,295                            |       | $              | 495        |   | 37.6 | % | 39.6 | % |
| Services Group                                                 |       | 34,570                           |       | 30,987       |       | 3,583                             |       | 62.4           |       | 60.4 |   |
| Total                                                          |       | $                                | 55,360     |         | $          | 51,282                            |       | $              | 4,078      |   | 100.0 | % | 100.0 | % |
|                                                                |            |                                  |            |              |            |                                   |            |                |            |  |  |  |  |  |  |  |

***UtilityGroup.***  Revenuesincreased $0.5 million, or 2.4%, to $20.8 million for the three months endedJune 30, 2006, from $20.3 million for the same period during the prioryear.  The increase was primarily due tothe following:

·                  a $0.6 millionincrease related to our acquisition of a wastewater treatment facility inAlabama at the end of the third quarter of 2005; and

·                  a $0.6 millionincrease at our New Mexico and Texas utilities primarily resulting from anincrease in the number of connections, a fourth quarter 2005 rate increase atour Texas utilities and, to a lesser extent, increased consumption; offset by

·                  a $0.7 milliondecrease at our California utility due to lower consumption as a result ofcooler temperatures and higher rainfall in April and May versus the prior year.

***ServicesGroup.***  Revenuesincreased $3.6 million, or 11.6%, to $34.6 million for the three months endedJune 30, 2006 from $31.0 million for the same period during the prioryear.  The increase in revenues wasprimarily due to the following:

·                  a $2.5 millionincrease in contract operations, maintenance, public works and construction dueto new contracts (including the cities of Burbank, California and SandySprings, Georgia) and an increase in the customer base for existing contracts;

·                  a $1.4 millionincrease resulting from contract operations and maintenance growth in theHouston, Texas area related to new contracts and increased housing starts forexisting contracts; offset by

·                  a $0.3 milliondecrease in revenues from our testing laboratory operation.

**Expenses.**  Expenses increased $5.6 million, or 12.5%, to$50.4 million for the three months ended June 30, 2006 from $44.8 millionfor the same period during the prior year as follows:
| ** **                                                     | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **                               | ** ** | ** **     | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|--------------|------------|------------------------------------------|------------|----------------|------------|
| ** **                                                     | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | **Percent of Revenues *** | ** ** |
| **(In thousands, except percentage data)** | ** ** | ** **                       | ** ** | **2006**     | ** ** | **2005**                                 | ** ** | **(Decrease)** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Utility Group  operating expenses                              |       | $                                | 10,506     |         | $          | 10,678                                   |       | $              | (172       | ) | 50.5 | % | 52.6 | % |
| Services Group  operating expenses                             |       | 30,018                           |       | 26,689       |       | 3,329                                    |       | 86.8           |       | 86.1 |   |
| Selling, general  and administrative expenses                  |       | 9,208                            |       | 7,425        |       | 1,783                                    |       | 16.6           |       | 14.5 |   |
| Impairment of  goodwill                                        |       | 668                              |       | —       |       | 668                                      |       | 1.2            |       | — |   |
| Total                                                          |       | $                                | 50,400     |         | $          | 44,792                                   |       | $              | 5,608      |   | 91.0 |   | 87.3 |   |
|                                                                |            |                                  |            |              |            |                                          |            |                |            |  |  |  |  |  |  |  |

----

*                    UtilityGroup and Services Group operating expenses are computed as a percent of theirrespective revenues.  Selling general andadministrative expenses, impairment of goodwill and total expenses are computedas a percent of total revenues.

***UtilityGroup Operating Expenses.*** Operating expenses decreased $0.2 million, or 1.6%, to $10.5 million forthe three months ended June 30, 2006, from $10.7 million for the sameperiod during the prior year.  Thedecrease in operating expenses was primarily due to the following:

·                  a $1.4 milliondecrease resulting from our California utility recording a balancing accountreceivable pursuant to a California Public Utilities Commission (“CPUC”)decision which eliminated a required earnings test; offset by

22

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·                  a $0.5 millionincrease in expenses at our Texas utilities related to higher production costsas a result of higher revenues and increased costs for chemicals, lab fees andsludge hauling;

·                  a $0.4 millionincrease at our California utility resulting from an increase in otheroperating expenses, including line repair costs and depreciation; and

·                  a $0.3 millionincrease related to our acquisition of a wastewater treatment facility inAlabama at the end of the third quarter of 2005.

Operating expenses were50.5% and 52.6% of related revenues for the three months ended June 30,2006 and 2005, respectively.  Operatingexpenses as a percent of revenues for 2006 were 57.3% excluding the effect ofthe favorable CPUC decision.  Thisincrease was primarily due to higher operating costs at our California andTexas utilities.

***ServicesGroup Operating Expenses.*** Operating expenses increased $3.3 million, or 12.5%, to $30.0 millionfor the three months ended June 30, 2006 from $26.7 million for the sameperiod during the prior year.  Theincrease in operating expenses was due to the following:

·                  a$2.1 million increase related to the cost of serving new contracts (includingthe cities of Burbank, California and Sandy Springs, Georgia) and the growth inexisting contracts including the impact of rising fuel and fleet relatedexpenses; and

·                  a$1.2 million increase related to the cost of serving new contacts and thegrowth in existing contracts within the Houston, Texas area, including theimpact of rising fuel and fleet related expenses.

Operating expenses as apercentage of the related revenues increased to 86.8% for the three monthsended June 30, 2006 and are comparable to 86.1% for the same period duringthe prior year.

***Selling,General and Administrative Expenses.***  Selling, general and administrative expensesincreased $1.8 million, or 24.0%, to $9.2 million for the three months endedJune 30, 2006 compared to $7.4 million for the same period during theprior year.  The increase in selling,general and administrative expenses was primarily due to the following:

·                  a $0.8 millionincrease in salaries, wages and related benefits resulting from workforceincreases to support our business growth;

·                  a $0.7 millionincrease related to nonrecurring charges for relocation assistance extended toour new CEO;

·                  a $0.2 millionincrease in stock based compensation expense; and

·                  a $0.1 millionincrease attributable to acquisitions which occurred during 2005.

Selling, general andadministrative expenses, as a percent of revenue, were 16.6% and 14.5% for thethree months ended June 30, 2006 and 2005, respectively.  Selling, general and administrative expensesas a percent of revenue excluding the non-recurring CEO relocation assistancecosts were 15.4% for the three months ended June 30, 2006.

***Impairmentof Goodwill.*** During the three months ended June 30, 2006, a $0.7 million charge wasrecorded to reflect the impairment of goodwill in accordance with theimpairment testing provision of SFAS No. 142, *Goodwill andOther Intangible Assets*(“SFAS 142”).  As required by SFAS No. 142, we test goodwillannually for impairment at the reporting unit level, on October 31st ofeach year, or when events or circumstances indicate the carrying values may notbe recoverable.  We evaluate goodwill forimpairment using discounted cash flow methodologies, transaction values forcomparable companies, and other valuation techniques for its reporting unitswith goodwill balances.  Therealizability of the Company’s long-lived assets, including goodwill, isdependent on expected future cash flows from the underlying operations.

During the second quarterof 2006, we reviewed the business strategy for our water and waste-watertesting laboratory reporting unit.  Thisreview resulted in our decision to realign the operations by reducing the sizeand scope of its business activities and focusing on its core operations andcustomers.  This realignment is intendedto create a strong foundation for providing high-quality laboratory testing andreporting services to municipal utility districts and targeted commercialcustomers, enhancing future growth and performance.  The carrying value of the 

23

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entity was tested for impairment using the revisedcash flow projections and it was determined that carrying values were notrecoverable.  As a result, $0.6 millionof goodwill associated with the laboratory reporting unit was deemed to beimpaired and was charged to expense in the second quarter of 2006.

Also during the secondquarter of 2006, we determined that the renewal of a primary contract foranother reporting unit was not likely to occur, significantly reducing thefuture estimated cash flows of the reporting unit.  As a result, $0.1 million of goodwillassociated with this reporting unit was deemed to be impaired and was chargedto expense during the period.

**Other Income (Expense).**  Other expense increased $0.4 million, or22.0%, to $2.1 million for the three months ended June 30, 2006 from $1.7million for the same period during the prior year as follows:
| ** **              | ** ** | **Three Months Ended** | *** *** | *** *** | *** *** |
|-------------------------|------------|----------------------------------|--------------|--------------|--------------|
| ** **              | ** ** | **June 30,**                | ** **   | ** **   | ** **   |
| **(In thousands)** | ** ** | ** **                       | ** **   | **2006**     | ** **   | **2005** | ** ** | **Change** | ** ** |
| Interest expense        |       | $                                | (2,121       | )            | $            | (1,896 | ) | $ | (225 | ) |
| Interest income         |       | 174                              |         | 107          |         | 67 |   |
| Other                   |       | (150                             | )            | 71           |         | (221 | ) |
| Total                   |       | $                                | (2,097       | )            | $            | (1,718 | ) | $ | (379 | ) |
|                         |            |                                  |              |              |              |  |  |  |  |  |  |  |

***InterestExpense.***  Interestexpense increased $0.2 million, or 11.8%, for the three months endedJune 30, 2006 compared to the same period during the prior year.  The major components of interest expense wereas follows:
| ** **                          | ** ** | **Three Months Ended** | ** **   | ** **   | ** **   |
|-------------------------------------|------------|----------------------------------|--------------|--------------|--------------|
| ** **                          | ** ** | **June 30,**                | *** *** | **Increase** | *** *** |
| **(In thousands)**             | ** ** | ** **                       | ** **   | **2006**     | ** **   | **2005** | ** ** | **(Decrease)** | ** ** |
| Interest expense:                   |       |                             |         |         |         |   |   |
| Revolving lines of credit           |       | $                                | 607          |         | $            | 574 |   | $ | 33 |   |
| Mortgage bonds and bank term loans  |       | 1,202                            |         | 1,032        |         | 170 |   |
| Convertible subordinated debentures |       | 227                              |         | 295          |         | (68 | ) |
| Other indebtedness                  |       | 216                              |         | 7            |         | 209 |   |
| Total interest incurred             |       | 2,252                            |         | 1,908        |         | 344 |   |
| Less capitalized interest           |       | (131                             | )            | (12          | )            | (119 | ) |
| Total interest  expense             |       | $                                | 2,121        |         | $            | 1,896 |   | $ | 225 |   |
|                                     |            |                                  |              |              |              |  |  |  |  |  |  |  |

The increase in totalinterest incurred is primarily due to an increase in borrowings levels on ourmortgage bonds and bank term loans and an increase in interest rates related toour revolving line of credit, which was partially offset by lower borrowinglevels on the revolving line of credit. Average borrowings on the line of credit decreased to $38.4 million forthe three months ended June 30, 2006 from $47.5 million for the sameperiod during the prior year.  Theweighted average interest rate on those borrowings increased to 6.3% for thethree months ended June 30, 2006 from 4.8% for the same period during theprior year.  Interest related to ourmortgage bonds and bank term loans increased as a result of a net increase inaverage borrowings between the periods; average borrowings increased to $94.2million for the three months ended June 30, 2006 from $87.6 million forthe same period during the prior year.

 Our average balances of interest bearing debtoutstanding were approximately $132.0 million and $129.0 million for the threemonths ended June 30, 2006 and 2005, respectively.  Our effective weighted average interest rateincreased to 6.4% for the three months ended June 30, 2006 from 5.9% forthe same period during the prior year.

**Provision for Income Taxes.**  Our effective consolidated income tax ratewas 36.6% for the three months ended June 30, 2006 and is comparable to37.1% for the same period during the prior year (based on combined pre-taxincome and related income taxes for both continuing and discontinuedoperations).

**Loss from DiscontinuedOperations.**  Loss fromdiscontinued operations, which pertains to our submetering business we soldduring the second quarter of 2005, was $4.8 million for the three months endedJune 30, 2005.  The loss iscomprised of a $1.2 million operating loss and a $3.6 million loss on the saleof the business.

24

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#### **Six Months Ended June 30, 2006 Compared to2005**

**Revenues.**  Revenues increased $9.6 million, or 10.0%, to$106.2 million for the six months ended June 30, 2006 from $96.5 millionfor the same period during the prior year. By segment, revenues increased as follows:
| ** **                                                     | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **                        | ** ** | ** **     | ** ** |
|----------------------------------------------------------------|------------|--------------------------------|------------|--------------|------------|-----------------------------------|------------|----------------|------------|
| ** **                                                     | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | **Percent of Revenues** | ** ** |
| **(In thousands, except percentage data)** | ** ** | ** **                     | ** ** | **2006**     | ** ** | **2005**                          | ** ** | **(Decrease)** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Utility Group                                                  |       | $                              | 38,763     |         | $          | 35,754                            |       | $              | 3,009      |   | 36.5 | % | 37.0 | % |
| Services Group                                                 |       | 67,399                         |       | 60,759       |       | 6,640                             |       | 63.5           |       | 63.0 |   |
| Total                                                          |       | $                              | 106,162    |         | $          | 96,513                            |       | $              | 9,649      |   | 100.0 | % | 100.0 | % |
|                                                                |            |                                |            |              |            |                                   |            |                |            |  |  |  |  |  |  |  |

***UtilityGroup.***  Revenuesincreased $3.0 million, or 8.4%, to $38.8 million for the six months endedJune 30, 2006, from $35.8 million for the same period during the prioryear.  The increase was primarily due tothe following:

·                  a $1.7 millionincrease at our New Mexico and Texas utilities primarily resulting from anincrease in the number of connections, a fourth quarter 2005 rate increase atour Texas utilities and, to a lesser extent, increased consumption; and

·                  a $1.3 millionincrease related to our acquisition of a wastewater treatment facility inAlabama at the end of the third quarter of 2005.

***ServicesGroup.***  Revenuesincreased $6.6 million, or 10.9%, to $67.4 million for the six months endedJune 30, 2006 from $60.8 million for the same period during the prioryear.  The increase in revenues wasprimarily due to the following:

·                  a$3.1 million increase in contract operations, maintenance, public works andconstruction due to new contracts (including the cities of Burbank, Californiaand Sandy Springs, Georgia) and an increase in the customer base for existingcontracts;

·                  a$2.7 million increase resulting from contract operations and maintenance growthin the Houston, Texas area related to new contracts and increased housingstarts for existing contracts;

·                  a$1.4 million increase resulting from the acquisition of an Alabama-basedcontract operations company in March 2005; offset by

·                  a$0.6 million decrease in revenues in our testing laboratory operation.

**Expenses.**  Expenses increased $9.6 million, or 10.9%, to$98.2 million for the six months ended June 30, 2006 from $88.5 millionfor the same period during the prior year as follows:
| ** **                                                     | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **                         | ** ** | ** **     | ** ** |
|----------------------------------------------------------------|------------|--------------------------------|------------|--------------|------------|------------------------------------|------------|----------------|------------|
| ** **                                                     | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | **Percent of Revenues*** | ** ** |
| **(In thousands, except percentage data)** | ** ** | ** **                     | ** ** | **2006**     | ** ** | **2005**                           | ** ** | **(Decrease)** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Utility Group  operating expenses                              |       | $                              | 20,903     |         | $          | 20,657                             |       | $              | 246        |   | 53.9 | % | 57.8 | % |
| Services Group  operating expenses                             |       | 59,021                         |       | 52,573       |       | 6,448                              |       | 87.6           |       | 86.5 |   |
| Selling, general  and administrative expenses                  |       | 17,593                         |       | 15,308       |       | 2,285                              |       | 16.6           |       | 15.9 |   |
| Impairment of  goodwill                                        |       | 668                            |       | —       |       | 668                                |       | 0.6            |       | — |   |
| Total                                                          |       | $                              | 98,185     |         | $          | 88,538                             |       | $              | 9,647      |   | 92.5 |   | 91.7 |   |
|                                                                |            |                                |            |              |            |                                    |            |                |            |  |  |  |  |  |  |  |

----

*                    UtilityGroup and Services Group operating expenses are computed as a percent of theirrespective revenues.  Selling general andadministrative expenses, impairment of goodwill and total expenses are computedas a percent of total revenues.

***UtilityGroup Operating Expenses.*** Operating expenses increased $0.2 million, or 1.2%, to $20.9 million forthe six months ended June 30, 2006, from $20.7 million for the same periodduring the prior year.  The increase inoperating expenses was primarily due to the following:

·                  a $0.8 millionincrease in operating expenses at our California utility resulting from higherwater production costs;

·                  a $0.7 millionincrease related to our acquisition of a wastewater treatment facility inAlabama at the end of the third quarter of 2005;

25

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·                  a $0.5 millionincrease in expenses at our Texas utilities resulting from an increase in thenumber of connections we serve for water productions costs, chemicals, lab feesand sludge hauling; offset by

·                  a $1.4 milliondecrease resulting from our California utility recording a balancing accountreceivable pursuant to a CPUC decision which eliminated a required earningstest; and

·                  a $0.4 millionreduction in expenses at our California utility resulting from a gain on thesale of land that was no longer needed to support its operations.

Operating expenses were53.9% and 57.8% of related revenues for the six months ended June 30, 2006and 2005, respectively.  Operatingexpenses as a percent of revenues for 2006 was 58.6% excluding the effect ofthe gain on the sale of land and the favorable CPUC decision.  The adjusted increase is primarily due tohigher operating costs in our California and Texas utilities.

***ServicesGroup Operating Expenses.*** Operating expenses increased $6.4 million, or 12.3%, to $59.0 millionfor the six months ended June 30, 2006 from $52.6 million for the sameperiod during the prior year.  Theincrease in operating expenses was due to the following:

·                  a$2.9 million increase related to the cost of serving new contracts (includingthe cities of Burbank, California and Sandy Springs, Georgia) construction andthe growth in existing contracts including the impact of rising fuel and fleetrelated expenses;

·                  a$2.4 million increase related to the cost of serving new contacts and thegrowth in existing contracts within the Houston, Texas area, including theimpact of rising fuel and fleet related expenses;

·                  a$1.1 million increase from our acquisition of an Alabama-based contract operationscompany in March 2005.

Operating expenses as apercentage of the related revenues increased to 87.6% for the six months endedJune 30, 2006 compared to 86.5% for the same period during the prioryear.  The increase in the operatingexpense percentage is due primarily to higher fleet operating costs.

***Selling,General and Administrative Expenses.***  Selling, general and administrative expensesincreased $2.3 million, or 14.9%, to $17.6 million for the six months endedJune 30, 2006 compared to $15.3 million for the same period during theprior year.  The increase in selling,general and administrative expenses was primarily due to the following:

·                  a $1.1 millionincrease in salaries, wages and related benefits resulting from workforceincreases to support our business growth;

·                  a $0.7 millionincrease related to nonrecurring charges for relocation assistance extended toour new CEO;

·                  a $0.3 millionincrease in legal fees, most of which is attributable to routine legal andadministrative proceedings incident to the normal conduct of business;

·                  a $0.2 millionincrease related to increase stock-based compensation expense; and

·                  a $0.2 millionincrease attributable to acquisitions which occurred in 2005; offset by

·                  a $0.2 milliondecrease in Sarbanes-Oxley compliance-related costs.

Selling, general andadministrative expenses, as a percent of revenue, were 16.6% and 15.9% for thesix months ended June 30, 2006 and 2005, respectively.  Selling, general and administrative expensesas a percent of revenue excluding the non-recurring CEO relocation assistancecosts were 16.0% for the three months ended June 30, 2006.

***Impairmentof Goodwill.*** During the second quarter of 2006, a $0.7 million charge was recorded toreflect the impairment of goodwill as more fully described above under theresults of operations for the three months ended June 30, 2006.

26

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**Other Income (Expense).**  Other expense increased $0.6 million, or18.0%, to $4.0 million for the six months ended June 30, 2006 from $3.4million for the same period during the prior year as follows:
| ** **              | ** ** | **Six Months Ended** | *** *** | *** *** | *** *** |
|-------------------------|------------|--------------------------------|--------------|--------------|--------------|
| ** **              | ** ** | **June 30,**              | ** **   | ** **   | ** **   |
| **(In thousands)** | ** ** | ** **                     | ** **   | **2006**     | ** **   | **2005** | ** ** | **Change** | ** ** |
| Interest expense        |       | $                              | (4,252       | )            | $            | (3,668 | ) | $ | (584 | ) |
| Interest income         |       | 255                            |         | 214          |         | 41 |   |
| Other                   |       | (11                            | )            | 58           |         | (69 | ) |
| Total                   |       | $                              | (4,008       | )            | $            | (3,396 | ) | $ | (612 | ) |
|                         |            |                                |              |              |              |  |  |  |  |  |  |  |

***InterestExpense.***  Interestexpense increased $0.6 million, or 15.9%, for the six months endedJune 30, 2006 compared to the same period during the prior year.  The major components of interest expense wereas follows:
| ** **                          | ** ** | **Six Months Ended** | ** **   | ** **   | ** **   |
|-------------------------------------|------------|--------------------------------|--------------|--------------|--------------|
| ** **                          | ** ** | **June 30,**              | *** *** | **Increase** | *** *** |
| **(In thousands)**             | ** ** | ** **                     | ** **   | **2006**     | ** **   | **2005** | ** ** | **(Decrease)** | ** ** |
| Interest expense:                   |       |                           |         |         |         |   |   |
| Revolving lines of credit           |       | $                              | 1,129        |         | $            | 876 |   | $ | 253 |   |
| Mortgage bonds and bank term loans  |       | 2,433                          |         | 2,146        |         | 287 |   |
| Convertible subordinated debentures |       | 505                            |         | 591          |         | (86 | ) |
| Other indebtedness                  |       | 408                            |         | 137          |         | 271 |   |
| Total interest incurred             |       | 4,475                          |         | 3,750        |         | 725 |   |
| Less capitalized interest           |       | (223                           | )            | (82          | )            | (141 | ) |
| Total interest  expense             |       | $                              | 4,252        |         | $            | 3,668 |   | $ | 584 |   |
|                                     |            |                                |              |              |              |  |  |  |  |  |  |  |

The increase in totalinterest incurred is primarily due to an increase in borrowings levels on ourmortgage bonds and bank term loans and an increase in interest rates related toour revolving line of credit.  Averageborrowings on the line of credit decreased to $36.0 million for the six monthsended June 30, 2006 from $38.2 million for the same period during theprior year.  The weighted averageinterest rate on those borrowings increased to 6.3% for the six months endedJune 30, 2006 from 4.6% for the same period during the prior year.  Interest related to our mortgage bonds andbank term loans increased as a result of a net increase in average borrowingsbetween the periods; average borrowings increased to $95.2 million for the sixmonths ended June 30, 2006 from $90.4 million for the same period duringthe prior year.

Our average balances ofinterest bearing debt outstanding were approximately $130.4 million and $125.5million for the six months ended June 30, 2006 and 2005,respectively.  Our effective weightedaverage interest rate increased to 6.5% for the six months ended June 30,2006 from 5.8% for the same period during the prior year.

**Provision for Income Taxes.**  Our effective consolidated income tax ratewas 36.6% for the six months ended June 30, 2006 and is comparable to37.3% for the same period during the prior year (based on combined pre-taxincome and related income taxes for both continuing and discontinuedoperations).

**Cumulative Effect of Change inAccounting Principle.** Effective January 1, 2006, we adopted the provisions of Statement ofFinancial Accounting Standards (“SFAS”) No. 123(R), *Share-BasedPayment*.  The adoption of SFASNo. 123(R) required us to change from recognizing the effect offorfeitures as they occur to estimating the number of outstanding instrumentsfor which the requisite service is not expected to be rendered.  As required by SFAS No. 123(R) werecorded a $0.07 million (net of tax) benefit on January 1, 2006 to reflect thereduction in compensation expense that would have resulted had we beenestimating the effect of forfeitures in prior periods.

**Loss from DiscontinuedOperations.**  Loss fromdiscontinued operations, which pertains to our submetering business we soldduring the second quarter of 2005, was $4.9 million for the six months endedJune 30, 2005.  The loss iscomprised of a $1.3 million operating loss and a $3.6 million loss on the saleof the business.

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**RECENTLY ISSUED ACCOUNTINGPRONOUNCEMENT**

In July 2006, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation No.48, *Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109* (“FIN 48”).  This interpretation clarifies the accountingfor uncertainty in income taxes recognized in a company’s financial statementsin accordance with FASB 109, “Accounting for Income Taxes.”  FIN 48 prescribes a recognition threshold andmeasurement model for tax positions taken or expected to be taken in taxreturns.  FIN 48 requires a company torecognize in its financial statements the impact of a tax position if it is “more-likely-than-not”(more than 50%) the position will be sustained upon examination, based on thetechnical merits of the position.  Theinterpretation also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure, andtransition.  The provisions of FIN 48 areeffective as of the beginning of our 2007 fiscal year, with the cumulativeeffect of the change in accounting principle, if any, recorded as an adjustmentto opening retained earnings.  We do notexpect the adoption of FIN 48 will have a material effect on our consolidated financialstatements.

**LIQUIDITY AND CAPITALRESOURCES**

Our overall objectiveswith 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;

·                  obtain externalfinancing for major acquisitions; and

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

Our statements of cashflows are summarized as follows:
| ** **                             | ** ** | **Six Months Ended** | ** ** | ** **   | *** *** |
|----------------------------------------|------------|--------------------------------|------------|--------------|--------------|
| ** **                             | ** ** | **June 30,**              | ** ** | **Increase** | *** *** |
| **(In thousands)**                | ** ** | ** **                     | ** ** | **2006**     | ** **   | **2005** | ** ** | **(Decrease)** | ** ** |
| Net cash provided by  (used in):       |       |                           |       |         |         |   |   |
| Continuing operations:                 |       |                           |       |         |         |   |   |
| Operating activities                   |       | $                              | 9,647      |         | $            | 8,830 |   | $ | 817 |   |
| Investing activities                   |       | (20,077                        | )          | (6,440       | )            | (13,637 | ) |
| Financing activities                   |       | 11,463                         |       | 10,059       |         | 1,404 |   |
| Total continuing operations            |       | 1,033                          |       | 12,449       |         | (11,416 | ) |
| Discontinued  operations:              |       |                           |       |         |         |   |   |
| Operating activities                   |       | —                         |       | (788         | )            | 788 |   |
| Investing activities                   |       | —                         |       | (73          | )            | 73 |   |
| Financing activities                   |       | —                         |       | (532         | )            | 532 |   |
| Total discontinued operations          |       | —                         |       | (1,393       | )            | 1,393 |   |
| Increase in cash  and cash equivalents |       | $                              | 1,033      |         | $            | 11,056 |   | $ | (10,023 | ) |
|                                        |            |                                |            |              |              |  |  |  |  |  |  |  |

**Cash Flows From OperatingActivities. **Net cashprovided by operating activities increased by $0.8 million during the sixmonths ended June 30, 2006 compared to the same period during the prioryear.  Operational aspects of ourbusinesses that affected our cash flows in 2006 versus 2005 are highlightedbelow:

·                  increasedrevenues generated by our Utility Group, resulting from customer connectiongrowth at our New Mexico and Texas utilities; and

·                  positive cashflows from companies acquired in the later part of 2005 and the first quarterof 2006.

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**Cash Flows From InvestingActivities.**  Cash usedin investing activities totaled $20.1 million for the six months endedJune 30, 2006 compared to $6.4 million for the same period during 2005 asfollows:
| ** **                                              | ** ** | **Six Months Ended** | ** ** | ** **   | *** *** |
|---------------------------------------------------------|------------|--------------------------------|------------|--------------|--------------|
| ** **                                              | ** ** | **June 30,**              | ** ** | **Increase** | *** *** |
| **(In thousands)**                                 | ** ** | ** **                     | ** ** | **2006**     | ** **   | **2005** | ** ** | **(Decrease)** | ** ** |
| Cash flows used in  (provided by) investing activities: |       |                           |       |         |         |   |   |
| Additions to property, plant and equipment              |       | $                              | 18,245     |         | $            | 14,284 |   | $ | 3,961 |   |
| Acquisition of businesses, net of cash acquired         |       | 1,247                          |       | 2,008        |         | (761 | ) |
| Purchase of minority interest                           |       | 1,012                          |       | —       |         | 1,012 |   |
| Proceeds from sale of discontinued operations           |       | —                         |       | (9,852       | )            | 9,852 |   |
| Proceeds from sales of land                             |       | (427                           | )          | —       |         | (427 | ) |
| Net cash used  for investing activities                 |       | $                              | 20,077     |         | $            | 6,440 |   | $ | 13,637 |   |
|                                                         |            |                                |            |              |              |  |  |  |  |  |  |  |

The followingtable summarizes additions to property, plant and equipment additions for 2006and 2005.
| ** **                                             | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                             | ** ** | **June 30,**              | ** ** |
| **(In thousands)**                                | ** ** | ** **                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| Company-financed  additions                            |       | $                              | 15,588     |   | $ | 13,027 |   |
| Capital  improvement reimbursements                    |       | 1,346                          |       | 139 |   |
| Cash  contributions received in aid of construction    |       | 1,311                          |       | 1,118 |   |
| Total cash additions to property, plant and  equipment |       | 18,245                         |       | 14,284 |   |
| Non-cash contributions in aid of construction          |       | 4,113                          |       | 1,110 |   |
| Total additions  to property, plant and equipment      |       | $                              | 22,358     |   | $ | 15,394 |   |
|                                                        |            |                                |            |  |  |  |  |  |  |

Capital projectsprimarily relate to the expansion, replacement and renovation of our water andwastewater systems, particularly at our Texas and New Mexico utilities.  Contributions in Aid of Construction (“CIAC”)represent contributions in the form of cash, services or property received fromdevelopers, governmental agencies, municipalities or individuals for thepurpose of constructing utility plant and is not refundable.  In 2006, we expect to spend approximately$30.0 million on company-financed additions, principally within our UtilityGroup, and expect to receive $11.0 million of CIAC resulting in total expectedadditions to property, plant and equipment of about $41.0 million.

In March 2006, weacquired the remaining 10% interest in Operations Technology, Inc. (“OpTech”)that we did not already own for $1.0 million in cash.  We also made substantial investments inacquisitions during 2006 and 2005 and expect we will continue to do so in thefuture.

**Cash Flows From Financing Activities.**  During first six months of 2006, we financedour growth through a broad range of capital initiatives:

·                  borrowed $8.5million under our revolving line of credit;

·                  received $3.1million of proceeds from our direct stock purchase plan, our employee stockpurchase and option plans and our director option plan; and

·                  received $2.7million of capital improvement reimbursements and contributions in aid ofconstruction.

Aggregate borrowingsunder our revolving line of credit increased by a net $8.5 million during thesix months ended June 30, 2006 and were primarily used to fund ourinvesting activities.  Additionalborrowing availability under our revolving credit facility was $57.4 million asof June 30, 2006.

During the six monthsended June 30, 2006, we have paid dividends totaling $2.4 million and ourquarterly dividend rate is currently $0.0524 per common share.

**Cash Flows From DiscontinuedOperations.**  Net cashused in discontinued operations was $1.4 million during the six months endedJune 30, 2005 and reflects the cash flows of the discontinued operationprior to date it was sold.

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**CONTRACTUAL OBLIGATIONS**

The following tablesummarizes our known contractual obligations to make future cash payments as ofJune 30, 2006, as well as an estimate of the periods during which thesepayments are expected to be made.
| ** **                                  | ** ** | ** ** | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | **Remainder**                               | ** ** | **2007** | ** ** | **2009** | ** ** | **2011** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | **of**                                      | ** ** | **and** | ** ** | **and** | ** ** | **and** | ** ** |
| **(In thousands)**                     | ** ** | ** ** | ** ** | **Total**                                   | ** ** | **2006** | ** ** | **2008** | ** ** | **2010** | ** ** | **Beyond** | ** ** |
| Long-term debt (1):                         |       |       |       |                                        |       |   |   |   |   |   |   |
| Bank line of credit (2)                     |       | $          | 38,500     |                                        | $          | — |   | $ | — |   | $ | 38,500 |   | $ | — |   |
| Mortgage bonds (3)                          |       | 43,000     |       | 8,000                                       |       | — |   | — |   | 35,000 |   |
| Bank term loans (4)                         |       | 33,029     |       | 411                                         |       | 1,645 |   | 1,646 |   | 29,327 |   |
| Convertible subordinated debentures (5)     |       | 13,179     |       | —                                      |       | — |   | — |   | 13,179 |   |
| Economic development revenue bonds (6)      |       | 2,130      |       | 100                                         |       | 220 |   | 245 |   | 1,565 |   |
| Notes payable (7)                           |       | 1,108      |       | 282                                         |       | 826 |   | — |   | — |   |
| Total long-term debt                        |       | 130,946    |       | 8,793                                       |       | 2,691 |   | 40,391 |   | 79,071 |   |
| Repayment of advances for construction (8)  |       | 9,219      |       | 693                                         |       | 1,196 |   | 720 |   | 6,610 |   |
| Lease assignment  obligations (9)           |       | 2,582      |       | 143                                         |       | 2,439 |   | — |   | — |   |
| Operating lease  obligations                |       | 33,212     |       | 3,361                                       |       | 10,569 |   | 5,729 |   | 13,553 |   |
| Total  obligations as of June 30, 2006 |       | $          | 175,959    |                                        | $          | 12,990 |   | $ | 16,895 |   | $ | 46,840 |   | $ | 99,234 |   |
|                                             |            |            |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)             Excludesinterest payment obligations, which are described in the following notes.  The terms of the long-term debt are morefully described in the notes to the consolidated financial statements includedin this report.

(2)             Thebank lines of credit bear interest at variable rates and therefore the amountof future interest payments are uncertain. Borrowings bear interest, at our option, based on a margin either: a)over the LIBOR rate; or b) under the prime rate.  The margins vary based on our consolidateddebt to equity ratio.  Theweighted-average interest rate on our bank line of credit borrowings was 6.15%as of June 30, 2006.

(3)             Intereston the mortgage bonds is fixed at a weighted-average annual interest rate of6.78% and is payable semiannually.

(4)             Intereston the bank term loans is fixed at a weighted-average annual interest rate of6.56% and is payable semiannually.

(5)             Intereston the convertible debentures is fixed at a 6.85% annual rate and is payablequarterly.  The debentures areconvertible, at the option of the holder, into shares of our common stock atany time prior to their maturity.

(6)             Intereston the economic development bonds is fixed at a weighted-average annualinterest rate of 5.92% and is payable semiannually.

(7)             Interestis payable either monthly or quarterly at rates ranging from 5.0% to 7.5% peryear.

(8)             Advancesfor construction are non-interest bearing.

(9)             Intereston the lease assignment obligations is fixed at a weighted-average interestrate of 8.39% and is payable monthly.

 

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**FINANCIAL CONDITION ANDLIQUIDITY**

As of June 30, 2006, wehad working capital of approximately $7.2 million and $57.4 million ofadditional borrowings available under our line of credit facility which expireson April 1, 2010.  In addition to our lineof credit, our California and New Mexico mortgage bond indentures permit theissuance of an additional $76.1 million of first mortgage bonds as ofJune 30, 2006.  However, the termsof our credit facility do not permit additional first mortgage bond indebtednesswithout prior consent from the credit facility lenders.  The mortgage bond indentures also limit theamount of cash and property dividends our California and New Mexico utilitiesmay pay to the parent company to fund its payment obligations.  Dividends have averaged $3.0 to $4.0 millionper year and are less than the aggregate cumulative dividend restrictionthreshold by $42.2 million as of June 30, 2006.

We also have on file aregistration statement with the Securities and Exchange Commission, which is effectivefor the issuance of up to $50.0 million aggregate principal amount of commonstock, debt securities and warrants.  Todate we have issued approximately $44.0 million of common stock under the shelfregistration, and about $6.0 million remains available for issuance as ofJune 30, 2006.  We may offer any ofthese securities for sale at any time and from time to time.

As of June 30, 2006,we have contractual obligations totaling $176.0 million (excluding interest),$13.0 million of which is due during the remainder of 2006.  We were in compliance with all loan agreementcovenants during the six months ended June 30, 2006.  We have $8.0 million of mortgage bondsmaturing in the fourth quarter of 2006 which we expect we will be able torefinance through the sale of new mortgage bonds or retire with funds borrowedunder our credit facility.

We believe that ourexpected operating cash flows, together with borrowings under our revolvingcredit facility ($57.4 million of which was available as of June 30, 2006and expires on April 1, 2010) will be sufficient to meet our operatingexpenses, working capital and capital expenditure requirements as well as ourdebt service obligations for the next twelve months.  However, our ability to comply with debtfinancial covenants, pay principal or interest and refinance our debtobligations will depend on our future operating performance as well ascompetitive, legislative, regulatory, business and other factors beyond ourcontrol.

**CERTAIN CONTRACTUALCOMMITMENTS AND INDEMNITIES**

In 2002, we were retainedto facilitate the engineering and construction of a $23.0 million reverseosmosis water treatment plant in the city of San Juan Capistrano, Californiafor the Capistrano Valley Water District (“CVWD”).  In 2003, we obtained a $3.4 million standbyletter of credit as collateral to insure our performance during the design andconstruction of the water treatment plant. Construction was completed during 2005 and upon final acceptance of thecompleted project by the CVWD, which is expected in 2006, the standby letter ofcredit will be terminated.

We now operate thecompleted plant under a twenty-year operating agreement.  The CVWD service contract contains certainguarantees related to our performance, including certain liquidated damages inthe event of failure on our part to perform not caused by uncontrollablecircumstances as defined in the service contract.  Also, we have made other guarantees to CVWD,including guarantees with respect to the quality and quantity of the finishedwater and the production efficiency of the facility.

As part of the financingfor this project, the CVWD sold insured municipal bonds.  We entered into an agreement with the bondinsurer to guarantee our performance under the service contract, subject tocertain liability caps to the bond insurer in the event of a default.  During the twenty-year operation of thefacility, such liability caps will not exceed an amount equal to $4.0 millionplus an amount no greater than the replacement cost of the actual reverseosmosis filtration unit within the facility, estimated to be approximately $1.5million.

We had irrevocablestandby letters of credit in the amount of $4.1 million issued and outstandingunder our credit facility, including the CVWD letter of credit described above,as of June 30, 2006.

During our normal courseof business, we have entered into agreements containing indemnities pursuant towhich we may be required to make payments in the future.  These indemnities are in connection withfacility leases and liabilities and operations and maintenance and constructioncontracts entered into by our Services Group. The

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duration of these indemnities, commitments andguarantees varies, and in certain cases, is indefinite.  Substantially all of these indemnitiesprovide no limitation on the maximum potential future payments we could beobligated to make and is not quantifiable. We have not recorded any liability for these indemnities.

In connection with thesale of Master Tek, we indemnified the buyer with respect to representationsand warranties.  Our indemnities withrespect to these matters are limited in terms of duration to periods rangingfrom one year to the expiration of the applicable statue of limitations.

On March 29, 2006, theCompany received a $1.65 million claim from the buyer for indemnification ofalleged breach of certain specified representations and warranties.  The Company subsequently reached a tentativesettlement with the buyer and has agreed to release $0.6 million from an escrowaccount established for this purpose. See Note 2 to the notes accompanying our consolidated financialstatements for additional information.

**OFF-BALANCE SHEET ARRANGEMENTS**

Through the date of thisreport, we did not have any relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, which would have been established for thepurpose of facilitating off-balance sheet arrangements or other contractuallynarrow or limited purposes.  In addition,we do not engage in trading activities involving non-exchange tradedcontracts.  We are not materially exposedto any financing, liquidity, market or credit risk that could arise if we hadengaged in these relationships.  We donot have relationships or transactions with persons or entities that derivebenefits from their non-independent relationship with us or our subsidiaries.

We lease some of ourequipment and office facilities under operating leases which are deemed to beoff-balance sheet arrangements.  Ourfuture operating lease payment obligations are more fully described under thecaption “—Contractual Obligations” above.

**ITEM 3.**                             QUANTITATIVE ANDQUALITATIVE DISCLOSURE ABOUT MARKET RISK

As of June 30, 2006,we had $131.9 million of long-term variable and fixed-rate debt.  We are exposed to market risk based onchanges in prevailing interest rates.

Market risk related toour variable-rate debt is estimated as the potential decrease in pre-taxearnings resulting from an increase in interest rates.  We have $38.5 million of long-term debt thatbears interest at variable rates based on either the prime rate or LIBOR.  Our variable-rate debt had a weighted averageinterest rate of 6.15% as of June 30, 2006.  A hypothetical one percent (100 basis points)increase in the average interest rates charged on our variable-rate debt wouldreduce our pre-tax earnings by approximately $0.4 million per year.

Our fixed-rate debt,which had a carrying value of $93.4 million as of June 30, 2006, had afair value of $88.2 million as of that date. Market risk related to our fixed-rate debt is deemed to be the potentialincrease in fair value resulting from a decrease in prevailing interest rates.  Our fixed-rate debt had a weighted averageinterest rate of 6.7% as of June 30, 2006. A hypothetical ten percent decrease in interest rates, from 6.7% to6.0%, would increase the fair value of our fixed-rate debt by approximately$5.7 million.

We do not use derivativefinancial instruments to manage or reduce these risks although we may elect doso in the future.

**ITEM 4.**                             CONTROLS AND PROCEDURES

Under the supervision andwith the participation of our management, including the Chief Executive Officerand Chief Financial Officer, we have evaluated the effectiveness of ourdisclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) asof the end of the period covered by this report.  Based on that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer have concluded that these disclosurecontrols and procedures are effective. There were no changes in our internal control over financial reportingduring the quarter ended June 30, 2006 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

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**PART II — OTHER INFORMATION**

**ITEM 1.**                          LEGAL PROCEEDINGS

See Note 6 to theconsolidated financial statements included in this report.

**ITEM 1A.**                    RISK FACTORS

There have been nomaterial changes to the risk factor we disclosed in “Item 1A.  Risk Factors” in Part I of our 2005 AnnualReport on Form 10-K.

**ITEM 2.**                             UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS

The following tablesummarizes the Company’s repurchases of its common stock during the quarterended June 30, 2006.
| **Period**                           | ** ** | ** ** | ** ** | **Total Number  of Shares  Purchased (1)** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number of Shares Purchased as  Part of Publicly Announced Plans  or Programs** | ** ** | **Maximum Number (or Approximate Dollar  Value) of Shares that May Yet Be Purchased Under the Plans or Programs** | ** ** |
|--------------------------------------|------------|------------|------------|-----------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
| April 1, 2006 —  April 30, 2006 |       |       | None       |                                                      |       |                                         | None       |                                                                                             |       |                                                                                                              | None       |   |   | None |   |
| May 1, 2006 —  May 31, 2006     |       |       | None       |                                                      |       |                                         | None       |                                                                                             |       |                                                                                                              | None       |   |   | None |   |
| June 1, 2006 —  June 30, 2006   |       |       | 55,690     |                                                      |       |                                         | $          | 13.28                                                                                            |       |                                                                                                              |       | None |   |   | None |   |
| Total                                |       |       | 55,690     |                                                      |       |                                         | $          | 13.28                                                                                            |       |                                                                                                              |       | None |   |   | None |   |

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(1)             Allof the shares purchased during the period were shares attested to the Companyin satisfaction of the exercise price and tax withholding obligations byholders of employee stock options, who exercised options granted pursuant tothe Company’s stock option plan.

**ITEM 3 IS NOT APPLICABLE AND HAS BEEN OMITTED.**

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**ITEM 4**                                SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS

At the Annual Meeting of Stockholders held on May 16, 2006, thefollowing proposals were submitted to stockholders with the following results:

***Proposal1.***  To elect twopersons as Class II Directors, each to a three-year term, and until theirsuccessors are duly elected and qualified:

·                  Donovan D.Huennekens—votes “For” — 18,525,050; votes “Withheld” — 976,218

·                  Richard G.Newman—votes “For” — 18,875,018; votes “Withheld” — 626,220

***Proposal2. ***To approve theCompany’s 2006 Equity Incentive Plan:

·                  Votes “For” —7,610,436

·                  Votes “Against” —3,526,495

·                  Votes “Abstained”— 228,110

**ITEM 5 IS NOT APPLICABLE AND HAS BEEN OMITTED.**

**ITEM 6.**                             EXHIBITS
| Exhibit  Number | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                           | ** ** |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 3.2             |       | Amendment No. 3 to  Amended and Restated Bylaws of Southwest Water Company effective May 16,  2006 (incorporated by reference to Exhibit 3.2 to the Company’s Form 8-K  filed with the Commission on May 19, 2006)                                                                           |       |
| 4.13.1          |       | Southwest Water Company  2006 Equity Incentive Plan (incorporated by reference as Exhibit 4.13.1 to  the Company’s Registration Statement on Form S-8, File No. 33-134575,  filed with the Commission on May 31, 2006)                                                                            |       |
| 4.13.2          |       | Southwest Water Company  2006 Equity Incentive Plan Notice of Restricted Stock Award and Restricted  Stock Agreement (incorporated by reference as Exhibit 4.13.2 to the Company’s  Registration Statement on Form S-8, File No. 33-134575, filed with the  Commission on May 31, 2006)           |       |
| 4.13.3          |       | Southwest Water Company  2006 Equity Incentive Plan Notice of Restricted Stock Unit Award and  Restricted Stock Unit Agreement (incorporated by reference as Exhibit 4.13.3  to the Company’s Registration Statement on Form S-8, File No. 33-134575,  filed with the Commission on May 31, 2006) |       |
| 4.13.4          |       | Southwest Water Company  2006 Equity Incentive Plan Stock Option Agreement (incorporated by reference  as Exhibit 4.13.4 to the Company’s Registration Statement on Form S-8, File  No. 33-134575, filed with the Commission on May 31, 2006)                                                     |       |
| 4.13.5          |       | Southwest Water Company  2006 Equity Incentive Plan SAR Agreement (incorporated by reference as  Exhibit 4.13.5 to the Company’s Registration Statement on Form S-8, File No.  33-134575, filed with the Commission on May 31, 2006)                                                              |       |
| 10.1            |       | Executive Employment  Agreement dated April 28, 2006, between Cheryl L. Clary and Southwest Water  Company (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K  filed with the Commission on May 3, 2006)                                                              |       |
| 10.2            |       | Executive Employment  Agreement dated April 28, 2006, between Michael O. Quinn and Southwest Water  Company (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K  filed with the Commission on May 3, 2006)                                                             |       |

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| Exhibit  Number | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                                          | ** ** |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 10.3            |       | Change of Control  Agreement dated April 28, 2006, between Cheryl L. Clary and Southwest Water  Company (incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K  filed with the Commission on May 3, 2006)                                                                                                |       |
| 10.4            |       | Change of Control  Agreement dated April 28, 2006, between Michael O. Quinn and Southwest Water  Company (incorporated by reference to Exhibit 10.4 to the Company’s Form 8-K  filed with the Commission on May 3, 2006)                                                                                               |       |
| 10.5            |       | Change of Control  Agreement dated as of May 15, 2006, between Southwest Water Company, a  Delaware corporation, and Mark A. Swatek, the Company’s Chairman of the Board  and Chief Executive Officer (incorporated by reference to Exhibit 10.1 to the  Company’s Form 8-K filed with the Commission on May 19, 2006) |       |
| 15*             |       | Letter  regarding unaudited interim financial information from Independent Registered  Public Accounting Firm                                                                                                                                                                                                                         |       |
| 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**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereto dulyauthorized.
|                       | ** ** | **SOUTHWEST WATER  COMPANY (REGISTRANT)** |
|-----------------------|------------|-------------------------------------------|
| Date: August 9,  2006 |       | By:                                       |   | /s/ CHERYL L. CLARY |
|                  |       |                                      |   | Cheryl L. Clary |
|                  |       |                                      |   | Chief Financial  Officer |

 

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