Table of Contents

 

 

 

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**x****                              Quarterlyreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**for the quarterly period ended September 30, 2010**

 

**or**

 

**o****                                 Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**for the transition period from                    to                     **

 

**Commission file number   001-14431**

 

**AmericanStates Water Company**

(Exact Name ofRegistrant as Specified in Its Charter)

 

| **California**                                                 | ** ** | **95-4676679**                    |
|----------------------------------------------------------------|------------|-----------------------------------|
| (State or Other Jurisdiction of Incorporation or Organization) |       | (IRS Employer Identification No.) |
| ** **                                                     | ** ** | ** **                        |
| **630 E. Foothill Blvd, San Dimas, CA**                        | ** ** | **91773-1212**                    |
| (Address of Principal Executive Offices)                       |       | (Zip Code)                        |

 

**(909) 394-3600**

(Registrant’s Telephone Number, Including Area Code)

 

**Not Applicable**

(Former Name, Former Address and Former Fiscal Year, if Changed SinceLast Report)

 

**Commission file number   001-12008**

 

**GoldenState Water Company**

(Exact Name of Registrantas Specified in Its Charter)

 

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

 

**(909) 394-3600**

(Registrant’s Telephone Number, IncludingArea Code)

 

**Not Applicable**

(Former Name, Former Address and FormerFiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

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

 

Indicate by check mark whether Registrant has submitted electronicallyand posted on its corporate Web site, if any, every Interactive Data Filerequired to be submitted and posted pursuant to Rule 405 of Regulation S-T(§ 232.405 of this chapter) during the preceding 12 months (or such shorterperiod that the Registrant was required to submit and post such files).

 

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

 

Indicate by check mark whether theRegistrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definition of “largeaccelerated filer”, “accelerated filer” and smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

**American States Water Company**

 

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

 

**Golden State Water Company**

 

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

 

Indicateby check mark whether the Registrant is a shell company (as defined in Rule 12b-2of the Exchange Act)

 

| American States Water Company |   | Yes o Nox |
|-------------------------------|--------|-----------|
| Golden State Water Company    |   | Yes o Nox |

 

Asof November 8, 2010, the number of Common Shares outstanding, of AmericanStates Water Company was 18,620,355 shares. As of November 8, 2010,all of the 142 outstanding Common Shares of Golden State Water Company wereowned by American States Water Company.

 

GoldenState Water Company meets the conditions set forth in General Instruction(H)(1)(a) and (b) of Form 10-Q and is therefore filing thisForm, in part, with the reduced disclosure format for Golden State WaterCompany.

 

 

 

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**AMERICAN STATES WATER COMPANY**

**and**

**GOLDEN STATE WATER COMPANY**

**FORM 10-Q**

 

**INDEX**

 
| **Part I**  | **Financial Information**                                                                                                          | ** ** |
|------------------|------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **       | ** **                                                                                                                         | ** ** |
| Item 1:          | Financial Statements                                                                                                               | 1          |
|             |                                                                                                                               |       |
|             | Consolidated  Balance Sheets of American States Water Company as of September 30, 2010  and December 31, 2009            | 2          |
|             |                                                                                                                               |       |
|             | Consolidated  Statements of Income of American States Water Company for the Three Months  Ended September 30, 2010 and 2009   | 4          |
|             |                                                                                                                               |       |
|             | Consolidated Statements of Income of American States  Water Company for the Nine Months Ended September 30, 2010 and 2009     | 5          |
|             |                                                                                                                               |       |
|             | Consolidated Statements of Cash Flow of American  States Water Company for the Nine Months Ended September 30, 2010 and  2009 | 6          |
|             |                                                                                                                               |       |
|             | Balance  Sheets of Golden State Water Company as of September 30, 2010 and  December 31, 2009                            | 7          |
|             |                                                                                                                               |       |
|             | Statements  of Income of Golden State Water Company for the Three Months Ended  September 30, 2010 and 2009                   | 9          |
|             |                                                                                                                               |       |
|             | Statements  of Income of Golden State Water Company for the Nine Months Ended  September 30, 2010 and 2009                    | 10         |
|             |                                                                                                                               |       |
|             | Statements  of Cash Flow of Golden State Water Company for the Nine Months Ended  September 30, 2010 and 2009                 | 11         |
|             |                                                                                                                               |       |
|             | Notes to Consolidated Financial Statements                                                                                         | 12         |
|             |                                                                                                                               |       |
| Item 2:          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                        | 33         |
|             |                                                                                                                               |       |
| Item 3:          | Quantitative and  Qualitative Disclosures About Market Risk                                                                        | 72         |
|             |                                                                                                                               |       |
| Item 4:          | Controls and  Procedures                                                                                                           | 72         |
|             |                                                                                                                               |       |
| Item 4T:         | Controls and  Procedures                                                                                                           | 72         |
|             |                                                                                                                               |       |
| **Part II** | **Other Information**                                                                                                              |       |
| ** **       | ** **                                                                                                                         | ** ** |
| Item 1:          | Legal Proceedings                                                                                                                  | 73         |
|             |                                                                                                                               |       |
| Item 1A:         | Risk Factors                                                                                                                       | 73         |
|             |                                                                                                                               |       |
| Item 2:          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                       | 73         |
|             |                                                                                                                               |       |
| Item 3:          | Defaults Upon  Senior Securities                                                                                                   | 73         |
|             |                                                                                                                               |       |
| Item 4:          | [Removed and Reserved]                                                                                                             | 73         |
|             |                                                                                                                               |       |
| Item 5:          | Other Information                                                                                                                  | 73         |
|             |                                                                                                                               |       |
| Item 6:          | Exhibits                                                                                                                           | 74         |
|             |                                                                                                                               |       |
|             | Signatures                                                                                                                         | 75         |

 

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**PART I**

 

**Item 1. Financial Statements**

 

General

 

Thebasic financial statements included herein have been prepared by Registrant,without audit, pursuant to the rules and regulations of the Securities andExchange Commission.

 

Certaininformation and footnote disclosures normally included in financial statements,prepared in accordance with accounting principles generally accepted in theUnited States of America, have been condensed or omitted pursuant to suchrules and regulations. In the opinion of management, all adjustmentsconsisting of normal recurring items and estimates necessary for a fairstatement of results for the interim period have been made.

 

Itis suggested that these financial statements be read in conjunction with thefinancial statements and notes thereto in the latest Annual Report onForm 10-K of American States Water Company and its wholly ownedsubsidiary, Golden State Water Company.

 

FilingFormat

 

AmericanStates Water Company (hereinafter “AWR”) is the parent company of Golden StateWater Company (hereinafter “GSWC”), Chaparral City Water Company (hereinafter “CCWC”)and American States Utility Services, Inc. (hereinafter “ASUS”) and itssubsidiaries.

 

Thisquarterly report on Form 10-Q is a combined report being filed by twoseparate Registrants: AWR and GSWC. For more information, please see Note 1 tothe Notes to Consolidated Financial Statements and the heading entitled Generalin Item 2 - Management’s Discussion and Analysis of Financial Condition andResults of Operations. References in this report to “Registrant” are to AWR andGSWC collectively, unless otherwise specified. GSWC makes no representations asto the information contained in this report relating to AWR and itssubsidiaries, other than GSWC.

 

**Forward-LookingInformation**

 

This Form 10-Q and the documents incorporated by reference hereincontain forward-looking statements intended to qualify for the “safe harbor”from liability established by the Private Securities Litigation Reform Act of1995.  Forward-looking statements includestatements regarding our goals, beliefs, plans or current expectations, takinginto account the information currently available to management.  Forward-looking statements are not statementsof historical facts.   For example, whenwe use words such as “believes,” “anticipates,” “expects,” “plans,” “estimates,”“intends,” “may” and other words that convey uncertainty of future events oroutcome, we are making forward-looking statements. Such statements addressfuture events and conditions concerning such matters as our ability to raisecapital, capital expenditures, earnings, litigation, rates, water sales, waterquality and other regulatory matters, adequacy of water supplies, our abilityto recover electric, natural gas and water supply costs from ratepayers,contract operations, liquidity and capital resources, and accounting matters.

 

Wecaution you that any forward-looking statements made by us are not guaranteesof future performance and that actual results may differ materially from those currently anticipated in suchstatements, by reason of factors such as: changes in utility regulation;recovery of regulatory assets not yet included in rates; future economicconditions which affect changes in customer demand and changes in water andenergy supply costs; changes in pension and post-retirement benefit plan costs;future climatic conditions; delays in customer payments or priceredeterminations and/or equitable adjustments on contracts executed by ASUS andits subsidiaries; potential assessments for failure to meet interim targets forthe purchase of renewable energy; fines, penalties or disallowance of costs bystate regulatory commissions or by the federal government; termination ofcontracts and suspension or debarment for a period of time from contractingwith the federal government due to violations of federal law and regulations inconnection with military utility privatization activities; and legislative,legal proceedings, regulatory and other circumstances affecting anticipatedrevenues and costs.

 

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**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED BALANCE SHEETS**

**ASSETS**

**(Unaudited)**

 
| **(in thousands)**                                                                                       | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Property, Plant and Equipment**                                                                             | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Regulated utility plant, at cost                                                                              |       | $                            | 1,223,760  |                        | $          | 1,171,618 |   |
| Non utility property, at cost                                                                                 |       | 5,601                        |       | 4,532                       |       |
| Total                                                                                                         |       | 1,229,361                    |       | 1,176,150                   |       |
| Less - Accumulated depreciation                                                                               |       | (377,310                     | )          | (354,123                    | )          |
| Net property, plant and equipment                                                                             |       | 852,051                      |       | 822,027                     |       |
|                                                                                                          |       |                         |       |                        |       |
| **Other Property and Investments**                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Goodwill                                                                                                      |       | 1,116                        |       | 1,116                       |       |
| Other property and investments                                                                                |       | 10,920                       |       | 10,989                      |       |
| Total other property and investments                                                                          |       | 12,036                       |       | 12,105                      |       |
|                                                                                                          |       |                         |       |                        |       |
| **Current Assets**                                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                                     |       | 7,692                        |       | 1,557                       |       |
| Accounts receivable — customers (less allowance  for doubtful accounts of $633 in 2010 and $657 in 2009) |       | 20,517                       |       | 16,193                      |       |
| Unbilled revenue                                                                                              |       | 23,582                       |       | 17,835                      |       |
| Receivable from the U.S. government (less  allowance for doubtful accounts of $43 in 2010 and $67 in 2009)    |       | 6,640                        |       | 4,245                       |       |
| Other accounts receivable (less allowance for  doubtful accounts of $280 in 2010 and $434 in 2009)            |       | 6,087                        |       | 8,334                       |       |
| Income tax receivables and prepaids                                                                           |       | 16,019                       |       | 4,159                       |       |
| Materials and supplies, at average cost                                                                       |       | 2,104                        |       | 1,895                       |       |
| Regulatory assets — current                                                                              |       | 20,757                       |       | 12,267                      |       |
| Prepayments and other current assets                                                                          |       | 2,211                        |       | 3,165                       |       |
| Costs and estimated earnings in excess of billings  on uncompleted contracts                                  |       | 34,646                       |       | 19,766                      |       |
| Deferred income taxes — current                                                                          |       | 5,680                        |       | 5,307                       |       |
| Assets of discontinued operations (Note 10)                                                                   |       | 50,782                       |       | 50,177                      |       |
| Total current assets                                                                                          |       | 196,717                      |       | 144,900                     |       |
|                                                                                                          |       |                         |       |                        |       |
| **Regulatory and Other Assets**                                                                               | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Regulatory assets                                                                                             |       | 110,994                      |       | 110,420                     |       |
| Other accounts receivable                                                                                     |       | 6,021                        |       | 5,717                       |       |
| Costs and estimated earnings in excess of billings  on uncompleted contracts                                  |       | 6,499                        |       | 7,933                       |       |
| Deferred income taxes                                                                                         |       | 94                           |       | 220                         |       |
| Other                                                                                                         |       | 7,017                        |       | 9,971                       |       |
| Total regulatory and other assets                                                                             |       | 130,625                      |       | 134,261                     |       |
|                                                                                                          |       |                         |       |                        |       |
| **Total Assets**                                                                                              |       | $                            | 1,191,429  |                        | $          | 1,113,293 |   |

 

*The accompanying notes are an integral part of these consolidatedfinancial statements*

 

2

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**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED BALANCE SHEETS**

**CAPITALIZATION AND LIABILITIES**

**(Unaudited)**

 
| **(in thousands)**                                                      | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Capitalization**                                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Common shares, no par value, no stated value                                 |       | $                            | 226,169    |                        | $          | 223,066 |   |
| Earnings reinvested in the business                                          |       | 145,937                      |       | 136,364                     |       |
| Total common shareholders’ equity                                       |       | 372,106                      |       | 359,430                     |       |
| Long-term debt                                                               |       | 299,902                      |       | 300,221                     |       |
| Total capitalization                                                         |       | 672,008                      |       | 659,651                     |       |
|                                                                         |       |                         |       |                        |       |
| **Current Liabilities**                                                      | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Notes payable to banks                                                       |       | 57,200                       |       | 17,400                      |       |
| Long-term debt — current                                                |       | 372                          |       | 365                         |       |
| Accounts payable                                                             |       | 43,388                       |       | 33,746                      |       |
| Income taxes payable                                                         |       | 333                          |       | 72                          |       |
| Accrued employee expenses                                                    |       | 8,019                        |       | 7,262                       |       |
| Accrued interest                                                             |       | 5,251                        |       | 3,263                       |       |
| Regulatory liabilities - current                                             |       | —                       |       | 113                         |       |
| Unrealized loss on purchased power contracts                                 |       | 11,361                       |       | 7,338                       |       |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       | 14,212                       |       | 6,315                       |       |
| Other                                                                        |       | 21,643                       |       | 23,047                      |       |
| Liabilities of discontinued operations (Note 10)                             |       | 27,612                       |       | 27,006                      |       |
| Total current liabilities                                                    |       | 189,391                      |       | 125,927                     |       |
|                                                                         |       |                         |       |                        |       |
| **Other Credits**                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Advances for construction                                                    |       | 78,502                       |       | 79,443                      |       |
| Contributions in aid of construction — net                              |       | 94,214                       |       | 91,519                      |       |
| Deferred income taxes                                                        |       | 99,220                       |       | 94,341                      |       |
| Unamortized investment tax credits                                           |       | 2,086                        |       | 2,154                       |       |
| Accrued pension and other postretirement benefits                            |       | 36,759                       |       | 40,158                      |       |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       | 10,534                       |       | 11,580                      |       |
| Other                                                                        |       | 8,715                        |       | 8,520                       |       |
| Total other credits                                                          |       | 330,030                      |       | 327,715                     |       |
|                                                                         |       |                         |       |                        |       |
| **Commitments and Contingencies  (Note 9)**                                  |       | —                       |       | —                      |       |
|                                                                         |       |                         |       |                        |       |
| **Total Capitalization and  Liabilities**                                    |       | $                            | 1,191,429  |                        | $          | 1,113,293 |   |

 

*The accompanying notes are an integral part of these consolidatedfinancial statements*

 

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**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED STATEMENTS OF INCOME**

**FOR THE THREE MONTHS**

**ENDED SEPTEMBER 30, 2010 AND2009**

**(Unaudited)**

 
| ** **                                                            | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| **Operating Revenues**                                                | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Water                                                                 |       | $                                                    | 82,634     |   | $ | 76,121 |   |
| Electric                                                              |       | 7,917                                                |       | 6,563 |   |
| Contracted services                                                   |       | 20,749                                               |       | 16,641 |   |
| Total operating revenues                                              |       | 111,300                                              |       | 99,325 |   |
|                                                                  |       |                                                 |       |   |   |
| **Operating Expenses**                                                | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Water purchased                                                       |       | 15,693                                               |       | 13,822 |   |
| Power purchased for pumping                                           |       | 3,459                                                |       | 3,131 |   |
| Groundwater production assessment                                     |       | 3,311                                                |       | 3,247 |   |
| Power purchased for resale                                            |       | 2,950                                                |       | 2,793 |   |
| Supply cost balancing accounts                                        |       | 6,219                                                |       | 4,806 |   |
| Other operation expenses                                              |       | 7,788                                                |       | 7,494 |   |
| Administrative and general expenses                                   |       | 26,282                                               |       | 16,806 |   |
| Depreciation and amortization                                         |       | 8,397                                                |       | 7,890 |   |
| Maintenance                                                           |       | 4,314                                                |       | 3,893 |   |
| Property and other taxes                                              |       | 3,566                                                |       | 3,509 |   |
| ASUS construction expenses                                            |       | 12,424                                               |       | 9,266 |   |
| Total operating expenses                                              |       | 94,403                                               |       | 76,657 |   |
|                                                                  |       |                                                 |       |   |   |
| **Operating Income**                                                  |       | 16,897                                               |       | 22,668 |   |
|                                                                  |       |                                                 |       |   |   |
| **Other Income and Expenses**                                         | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Interest expense                                                      |       | (4,963                                               | )          | (5,760 | ) |
| Interest income                                                       |       | 166                                                  |       | 174 |   |
| Other — net                                                      |       | (553                                                 | )          | 38 |   |
| Total other income and expenses                                       |       | (5,350                                               | )          | (5,548 | ) |
|                                                                  |       |                                                 |       |   |   |
| **Income from continuing  operations before income tax expense**      |       | 11,547                                               |       | 17,120 |   |
| Income tax expense                                                    |       | 5,878                                                |       | 7,229 |   |
| **Income from continuing  operations**                                |       | 5,669                                                |       | 9,891 |   |
|                                                                  |       |                                                 |       |   |   |
| **Income (loss) from discontinued  operations, net of tax**           |       | 983                                                  |       | (193 | ) |
|                                                                  |       |                                                 |       |   |   |
| **Net Income**                                                        |       | $                                                    | 6,652      |   | $ | 9,698 |   |
|                                                                  |       |                                                 |       |   |   |
| **Basic Earnings Per Common Share**                                   |       |                                                 |       |   |   |
| Income from continuing operations                                     |       | $                                                    | 0.31       |   | $ | 0.53 |   |
| Income (loss) from discontinued operations, net of  tax               |       | 0.05                                                 |       | (0.01 | ) |
| Net Income                                                            |       | $                                                    | 0.36       |   | $ | 0.52 |   |
|                                                                  |       |                                                 |       |   |   |
| **Fully Diluted Earnings Per  Share**                                 |       |                                                 |       |   |   |
| Income from continuing operations                                     |       | $                                                    | 0.30       |   | $ | 0.53 |   |
| Income (loss) from discontinued operations, net of  tax               |       | 0.05                                                 |       | (0.01 | ) |
| Net Income                                                            |       | $                                                    | 0.35       |   | $ | 0.52 |   |
|                                                                  |       |                                                 |       |   |   |
| **Weighted Average Number of  Shares Outstanding**                    |       | 18,595                                               |       | 18,502 |   |
| **Weighted Average Number of  Diluted Shares**                        |       | 18,734                                               |       | 18,645 |   |
|                                                                  |       |                                                 |       |   |   |
| **Dividends Declared Per Common  Share**                              |       | $                                                    | 0.26       |   | $ | 0.25 |   |

 

*The accompanying notes are an integral part of these consolidatedfinancial statements*

 

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**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED STATEMENTS OF INCOME**

**FOR THE NINE MONTHS**

**ENDED SEPTEMBER 30, 2010 AND 2009**

**(Unaudited)**

 
| ** **                                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| **Operating Revenues**                                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Water                                                                 |       | $                                                   | 211,507    |   | $ | 203,594 |   |
| Electric                                                              |       | 26,741                                              |       | 21,083 |   |
| Contracted services                                                   |       | 56,994                                              |       | 44,332 |   |
| Total operating revenues                                              |       | 295,242                                             |       | 269,009 |   |
|                                                                  |       |                                                |       |   |   |
| **Operating Expenses**                                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Water purchased                                                       |       | 37,259                                              |       | 33,764 |   |
| Power purchased for pumping                                           |       | 7,062                                               |       | 7,233 |   |
| Groundwater production assessment                                     |       | 8,597                                               |       | 8,621 |   |
| Power purchased for resale                                            |       | 9,495                                               |       | 9,158 |   |
| Supply cost balancing accounts                                        |       | 14,720                                              |       | 11,666 |   |
| Other operation expenses                                              |       | 21,734                                              |       | 21,418 |   |
| Administrative and general expenses                                   |       | 61,478                                              |       | 48,525 |   |
| Depreciation and amortization                                         |       | 25,121                                              |       | 23,643 |   |
| Maintenance                                                           |       | 12,882                                              |       | 11,571 |   |
| Property and other taxes                                              |       | 10,469                                              |       | 9,483 |   |
| ASUS construction expenses                                            |       | 29,225                                              |       | 25,540 |   |
| Net (gain) loss on sale of property                                   |       | 2                                                   |       | (15 | ) |
| Total operating expenses                                              |       | 238,044                                             |       | 210,607 |   |
|                                                                  |       |                                                |       |   |   |
| **Operating Income**                                                  |       | 57,198                                              |       | 58,402 |   |
|                                                                  |       |                                                |       |   |   |
| **Other Income and Expenses**                                         | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Interest expense                                                      |       | (16,491                                             | )          | (16,508 | ) |
| Interest income                                                       |       | 985                                                 |       | 675 |   |
| Other — net                                                      |       | (558                                                | )          | 90 |   |
| Total other income and expenses                                       |       | (16,064                                             | )          | (15,743 | ) |
|                                                                  |       |                                                |       |   |   |
| **Income from continuing  operations before income tax expense**      |       | 41,134                                              |       | 42,659 |   |
| Income tax expense                                                    |       | 18,305                                              |       | 16,325 |   |
| **Income from continuing  operations**                                |       | 22,829                                              |       | 26,334 |   |
|                                                                  |       |                                                |       |   |   |
| **Income (loss) from discontinued  operations, net of tax**           |       | 1,288                                               |       | (205 | ) |
|                                                                  |       |                                                |       |   |   |
| **Net Income**                                                        |       | $                                                   | 24,117     |   | $ | 26,129 |   |
|                                                                  |       |                                                |       |   |   |
| **Basic Earnings Per Common Share**                                   |       |                                                |       |   |   |
| Income from continuing operations                                     |       | $                                                   | 1.22       |   | $ | 1.46 |   |
| Income (loss) from discontinued operations, net of  tax               |       | 0.07                                                |       | (0.01 | ) |
| Net Income                                                            |       | $                                                   | 1.29       |   | $ | 1.45 |   |
|                                                                  |       |                                                |       |   |   |
| **Fully Diluted Earnings Per  Share**                                 |       |                                                |       |   |   |
| Income from continuing operations                                     |       | $                                                   | 1.21       |   | $ | 1.46 |   |
| Income (loss) from discontinued operations, net of  tax               |       | 0.07                                                |       | (0.01 | ) |
| Net Income                                                            |       | $                                                   | 1.28       |   | $ | 1.45 |   |
|                                                                  |       |                                                |       |   |   |
| **Weighted Average Number of  Shares Outstanding**                    |       | 18,573                                              |       | 17,896 |   |
| **Weighted Average Number of  Diluted Shares**                        |       | 18,714                                              |       | 18,029 |   |
|                                                                  |       |                                                |       |   |   |
| **Dividends Declared Per Common  Share**                              |       | $                                                   | 0.78       |   | $ | 0.75 |   |

 

*The accompanying notes are an integral part of these consolidatedfinancial statements*

 

5

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**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED STATEMENTS OF CASHFLOW**

**FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands)**                                                      | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| **Cash Flows From Operating  Activities:**                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income                                                                   |       | $                                                   | 24,117     |   | $ | 26,129 |   |
| Adjustments for non-cash items:                                              |       |                                                |       |   |   |
| Depreciation and amortization                                                |       | 25,901                                              |       | 25,148 |   |
| Provision for doubtful accounts                                              |       | 833                                                 |       | 774 |   |
| Deferred income taxes and investment tax credits                             |       | 6,352                                               |       | 5,134 |   |
| Stock-based compensation expense                                             |       | 1,237                                               |       | 1,042 |   |
| Impairment and other charges                                                 |       | 9,011                                               |       | — |   |
| Loss on settlement for removal of wells                                      |       | —                                              |       | 760 |   |
| Other — net                                                             |       | (607                                                | )          | 1,123 |   |
| Changes in assets and liabilities:                                           |       |                                                |       |   |   |
| Accounts receivable — customers                                         |       | (5,144                                              | )          | (5,270 | ) |
| Unbilled revenue                                                             |       | (5,846                                              | )          | (5,849 | ) |
| Other accounts receivable                                                    |       | 1,842                                               |       | 1,900 |   |
| Receivable from the U.S. government                                          |       | (2,395                                              | )          | (2,187 | ) |
| Materials and supplies                                                       |       | (209                                                | )          | 197 |   |
| Prepayments and other current assets                                         |       | 980                                                 |       | 964 |   |
| Regulatory assets — supply cost balancing accounts                      |       | 14,720                                              |       | 11,666 |   |
| Costs and estimated earnings in excess of billings  on uncompleted contracts |       | (13,446                                             | )          | (5,317 | ) |
| Other assets                                                                 |       | (22,984                                             | )          | (13,033 | ) |
| Accounts payable                                                             |       | 8,581                                               |       | 382 |   |
| Income taxes receivable/payable/prepaids                                     |       | (8,214                                              | )          | (1,225 | ) |
| Billings in excess of costs and estimated earnings  on uncompleted contracts |       | 6,851                                               |       | 4,375 |   |
| Accrued pension and other postretirement benefits                            |       | (3,399                                              | )          | (3,015 | ) |
| Other liabilities                                                            |       | (1,047                                              | )          | 6,716 |   |
| Net cash provided                                                            |       | 37,134                                              |       | 50,414 |   |
|                                                                         |       |                                                |       |   |   |
| **Cash Flows From Investing  Activities:**                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Construction expenditures                                                    |       | (57,703                                             | )          | (55,633 | ) |
| Proceeds from sale of property                                               |       | 118                                                 |       | — |   |
| Net cash used                                                                |       | (57,585                                             | )          | (55,633 | ) |
|                                                                         |       |                                                |       |   |   |
| **Cash Flows From Financing  Activities:**                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from issuance of Common Shares, net of  issuance costs              |       | 1,428                                               |       | 35,354 |   |
| Proceeds from stock option exercises                                         |       | 370                                                 |       | 67 |   |
| Receipt of advances for and contributions in aid  of construction            |       | 4,492                                               |       | 1,065 |   |
| Refunds on advances for construction                                         |       | (3,452                                              | )          | (3,033 | ) |
| Repayments of long-term debt                                                 |       | (312                                                | )          | (226 | ) |
| Proceeds from issuance of long-term debt, net of  issuance costs             |       | —                                              |       | 39,750 |   |
| Net change in notes payable to banks                                         |       | 39,800                                              |       | (54,150 | ) |
| Dividends paid                                                               |       | (14,485                                             | )          | (13,285 | ) |
| Other — net                                                             |       | (144                                                | )          | (249 | ) |
| Net cash provided                                                            |       | 27,697                                              |       | 5,293 |   |
| **Net increase in cash and cash  equivalents**                               |       | 7,246                                               |       | 74 |   |
| **Cash and cash equivalents,  beginning of period**                          |       | 1,685                                               |       | 7,283 |   |
| **Cash and cash equivalents, end  of period**                                |       | 8,931                                               |       | 7,357 |   |
| **Less cash and cash equivalents  of discontinued operations**               |       | 1,239                                               |       | 112 |   |
| **Cash and cash equivalents of  continuing operations**                      |       | $                                                   | 7,692      |   | $ | 7,245 |   |

 

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

 

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**GOLDEN STATE WATER COMPANY**

**BALANCE SHEETS**

**ASSETS**

**(Unaudited)**

 
| **(in thousands)**                                                                                | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Utility Plant**                                                                                      | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Utility plant, at cost                                                                                 |       | $                            | 1,223,760  |                        | $          | 1,171,618 |   |
| Less - Accumulated depreciation                                                                        |       | (375,219                     | )          | (352,574                    | )          |
| Net utility plant                                                                                      |       | 848,541                      |       | 819,044                     |       |
|                                                                                                   |       |                         |       |                        |       |
| **Other Property and Investments**                                                                     |       | 8,833                        |       | 8,738                       |       |
|                                                                                                   |       |                         |       |                        |       |
| **Current Assets**                                                                                     | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                              |       | 4,448                        |       | 1,096                       |       |
| Accounts receivable-customers (less allowance for  doubtful accounts of $662 in 2010 and $657 in 2009) |       | 20,517                       |       | 16,193                      |       |
| Unbilled revenue                                                                                       |       | 23,582                       |       | 17,835                      |       |
| Inter-company receivable                                                                               |       | 629                          |       | 372                         |       |
| Other accounts receivable (less allowance for doubtful  accounts of $278 in 2010 and $431 2009)        |       | 4,577                        |       | 8,044                       |       |
| Income taxes receivable from Parent                                                                    |       | 13,356                       |       | 2,496                       |       |
| Materials and supplies, at average cost                                                                |       | 1,713                        |       | 1,679                       |       |
| Regulatory assets — current                                                                       |       | 20,757                       |       | 12,267                      |       |
| Prepayments and other current assets                                                                   |       | 2,186                        |       | 3,144                       |       |
| Deferred income taxes — current                                                                   |       | 5,534                        |       | 5,146                       |       |
| Total current assets                                                                                   |       | 97,299                       |       | 68,272                      |       |
|                                                                                                   |       |                         |       |                        |       |
| **Regulatory and Other Assets**                                                                        | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Regulatory assets                                                                                      |       | 110,994                      |       | 110,420                     |       |
| Other accounts receivable                                                                              |       | 6,021                        |       | 5,717                       |       |
| Other                                                                                                  |       | 6,711                        |       | 9,654                       |       |
| Total regulatory and other assets                                                                      |       | 123,726                      |       | 125,791                     |       |
|                                                                                                   |       |                         |       |                        |       |
| **Total Assets**                                                                                       |       | $                            | 1,078,399  |                        | $          | 1,021,845 |   |

 

*The accompanying notes are an integral part of these financialstatements*

 

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**GOLDEN STATE WATER COMPANY**

**BALANCE SHEETS**

**CAPITALIZATION AND LIABILITIES**

**(Unaudited)**

 
| **(in thousands)**                           | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Capitalization**                                | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Common shares, no par value, no stated value      |       | $                            | 216,878    |                        | $          | 195,821 |   |
| Earnings reinvested in the business               |       | 136,865                      |       | 135,709                     |       |
| Total common shareholder’s equity            |       | 353,743                      |       | 331,530                     |       |
| Long-term debt                                    |       | 299,902                      |       | 300,221                     |       |
| Total capitalization                              |       | 653,645                      |       | 631,751                     |       |
|                                              |       |                         |       |                        |       |
| **Current Liabilities**                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Long-term debt — current                     |       | 372                          |       | 365                         |       |
| Accounts payable                                  |       | 30,078                       |       | 26,829                      |       |
| Inter-company payable                             |       | 30,397                       |       | 7,551                       |       |
| Accrued employee expenses                         |       | 7,115                        |       | 6,338                       |       |
| Accrued interest                                  |       | 5,251                        |       | 3,256                       |       |
| Regulatory liabilities - current                  |       | —                       |       | 113                         |       |
| Unrealized loss on purchased power contracts      |       | 11,361                       |       | 7,338                       |       |
| Other                                             |       | 20,631                       |       | 22,136                      |       |
| Total current liabilities                         |       | 105,205                      |       | 73,926                      |       |
|                                              |       |                         |       |                        |       |
| **Other Credits**                                 | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Advances for construction                         |       | 78,502                       |       | 79,443                      |       |
| Contributions in aid of construction - net        |       | 94,214                       |       | 91,519                      |       |
| Deferred income taxes                             |       | 99,360                       |       | 94,418                      |       |
| Unamortized investment tax credits                |       | 2,086                        |       | 2,154                       |       |
| Accrued pension and other postretirement benefits |       | 36,759                       |       | 40,158                      |       |
| Other                                             |       | 8,628                        |       | 8,476                       |       |
| Total other credits                               |       | 319,549                      |       | 316,168                     |       |
|                                              |       |                         |       |                        |       |
| **Commitments and Contingencies  (Note 9)**       |       | —                       |       | —                      |       |
|                                              |       |                         |       |                        |       |
| **Total Capitalization and  Liabilities**         |       | $                            | 1,078,399  |                        | $          | 1,021,845 |   |

 

*The accompanying notes are an integral part of these financialstatements*

 

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**GOLDEN STATE WATER COMPANY**

**STATEMENTS OF INCOME**

**FOR THE THREE MONTHS**

**ENDED SEPTEMBER 30, 2010 AND 2009**

**(Unaudited)**

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(in thousands)**                               | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| **Operating Revenues**                                | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Water                                                 |       | $                                                    | 82,634     |   | $ | 76,121 |   |
| Electric                                              |       | 7,917                                                |       | 6,563 |   |
| Total operating revenues                              |       | 90,551                                               |       | 82,684 |   |
|                                                  |       |                                                 |       |   |   |
| **Operating Expenses**                                | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Water purchased                                       |       | 15,693                                               |       | 13,822 |   |
| Power purchased for pumping                           |       | 3,459                                                |       | 3,131 |   |
| Groundwater production assessment                     |       | 3,311                                                |       | 3,247 |   |
| Power purchased for resale                            |       | 2,950                                                |       | 2,793 |   |
| Supply cost balancing accounts                        |       | 6,219                                                |       | 4,806 |   |
| Other operating expenses                              |       | 6,884                                                |       | 6,557 |   |
| Administrative and general expenses                   |       | 23,009                                               |       | 13,711 |   |
| Depreciation and amortization                         |       | 8,181                                                |       | 7,716 |   |
| Maintenance                                           |       | 3,706                                                |       | 3,303 |   |
| Property and other taxes                              |       | 3,154                                                |       | 3,145 |   |
| Total operating expenses                              |       | 76,566                                               |       | 62,231 |   |
|                                                  |       |                                                 |       |   |   |
| **Operating Income**                                  |       | 13,985                                               |       | 20,453 |   |
|                                                  |       |                                                 |       |   |   |
| **Other Income and Expenses**                         |       |                                                 |       |   |   |
| Interest expense                                      |       | (4,864                                               | )          | (5,693 | ) |
| Interest income                                       |       | 163                                                  |       | 170 |   |
| Other - net                                           |       | (395                                                 | )          | 30 |   |
| Total other income and expenses                       |       | (5,096                                               | )          | (5,493 | ) |
|                                                  |       |                                                 |       |   |   |
| **Income from operations before  income tax expense** |       | 8,889                                                |       | 14,960 |   |
|                                                  |       |                                                 |       |   |   |
| Income tax expense                                    |       | 4,736                                                |       | 6,418 |   |
|                                                  |       |                                                 |       |   |   |
| **Net Income**                                        |       | $                                                    | 4,153      |   | $ | 8,542 |   |

 

*The accompanying notes are an integral part of these financialstatements*

 

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**GOLDEN STATE WATER COMPANY**

**STATEMENTS OF INCOME**

**FOR THE NINE MONTHS**

**ENDED SEPTEMBER 30, 2010 AND 2009**

**(Unaudited)**

 
| ** **                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands)**                               | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| **Operating Revenues**                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Water                                                 |       | $                                                   | 211,507    |   | $ | 203,594 |   |
| Electric                                              |       | 26,741                                              |       | 21,083 |   |
| Total operating revenues                              |       | 238,248                                             |       | 224,677 |   |
|                                                  |       |                                                |       |   |   |
| **Operating Expenses**                                | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Water purchased                                       |       | 37,259                                              |       | 33,764 |   |
| Power purchased for pumping                           |       | 7,062                                               |       | 7,233 |   |
| Groundwater production assessment                     |       | 8,597                                               |       | 8,621 |   |
| Power purchased for resale                            |       | 9,495                                               |       | 9,158 |   |
| Supply cost balancing accounts                        |       | 14,720                                              |       | 11,666 |   |
| Other operating expenses                              |       | 19,142                                              |       | 18,841 |   |
| Administrative and general expenses                   |       | 51,382                                              |       | 39,809 |   |
| Depreciation and amortization                         |       | 24,544                                              |       | 23,150 |   |
| Maintenance                                           |       | 11,305                                              |       | 9,340 |   |
| Property and other taxes                              |       | 9,314                                               |       | 8,511 |   |
| Net (gain) loss on sale of property                   |       | 5                                                   |       | (15 | ) |
| Total operating expenses                              |       | 192,825                                             |       | 170,078 |   |
|                                                  |       |                                                |       |   |   |
| **Operating Income**                                  |       | 45,423                                              |       | 54,599 |   |
|                                                  |       |                                                |       |   |   |
| **Other Income and Expenses**                         |       |                                                |       |   |   |
| Interest expense                                      |       | (16,196                                             | )          | (16,112 | ) |
| Interest income                                       |       | 469                                                 |       | 665 |   |
| Other - net                                           |       | (403                                                | )          | 71 |   |
| Total other income and expenses                       |       | (16,130                                             | )          | (15,376 | ) |
|                                                  |       |                                                |       |   |   |
| **Income from operations before income  tax expense** |       | 29,293                                              |       | 39,223 |   |
|                                                  |       |                                                |       |   |   |
| Income tax expense                                    |       | 13,482                                              |       | 16,074 |   |
|                                                  |       |                                                |       |   |   |
| **Net Income**                                        |       | $                                                   | 15,811     |   | $ | 23,149 |   |

 

*The accompanying notes are an integral part of these financialstatements*

 

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**GOLDEN STATE WATER COMPANY**

**STATEMENTS OF CASH FLOW**

**FOR THE NINE MONTHS ENDEDSEPTEMBER 30, 2010 AND 2009**

**(Unaudited)**

 
| ** **                                                           | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(in thousands)**                                              | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| **Cash Flows From Operating  Activities:**                           | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income                                                           |       | $                                                   | 15,811     |   | $ | 23,149 |   |
| Adjustments for non-cash items:                                      |       |                                                |       |   |   |
| Depreciation and amortization                                        |       | 24,544                                              |       | 23,150 |   |
| Provision for doubtful accounts                                      |       | 814                                                 |       | 736 |   |
| Deferred income taxes and investment tax credits                     |       | 6,137                                               |       | 5,678 |   |
| Stock-based compensation expense                                     |       | 937                                                 |       | 783 |   |
| Impairment and other charges                                         |       | 9,011                                               |       | — |   |
| Other — net                                                     |       | (721                                                | )          | 787 |   |
| Changes in assets and liabilities:                                   |       |                                                |       |   |   |
| Accounts receivable — customers                                 |       | (5,013                                              | )          | (5,138 | ) |
| Unbilled revenue                                                     |       | (5,747                                              | )          | (5,784 | ) |
| Other accounts receivable                                            |       | 3,038                                               |       | 265 |   |
| Materials and supplies                                               |       | (34                                                 | )          | (253 | ) |
| Prepayments and other current assets                                 |       | 958                                                 |       | 999 |   |
| Regulatory assets — supply cost balancing accounts              |       | 14,720                                              |       | 11,666 |   |
| Other assets                                                         |       | (22,863                                             | )          | (13,078 | ) |
| Accounts payable                                                     |       | 2,027                                               |       | 2,728 |   |
| Inter-company receivable/payable                                     |       | 175                                                 |       | (50 | ) |
| Income taxes receivable/payable from/to Parent                       |       | (7,936                                              | )          | (1,703 | ) |
| Accrued pension and other postretirement benefits                    |       | (3,399                                              | )          | (3,015 | ) |
| Other liabilities                                                    |       | (1,473                                              | )          | 6,363 |   |
| Net cash provided                                                    |       | 30,986                                              |       | 47,283 |   |
|                                                                 |       |                                                |       |   |   |
| **Cash Flows From Investing  Activities:**                           | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Construction expenditures                                            |       | (56,202                                             | )          | (53,118 | ) |
| Proceeds from sale of property                                       |       | 115                                                 |       | — |   |
| Net cash used                                                        |       | (56,087                                             | )          | (53,118 | ) |
|                                                                 |       |                                                |       |   |   |
| **Cash Flows From Financing  Activities:**                           | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from issuance of Common Shares to Parent                    |       | 20,000                                              |       | — |   |
| Receipt of advances for and contributions in aid  of construction    |       | 4,416                                               |       | 1,015 |   |
| Refunds on advances for construction                                 |       | (3,362                                              | )          | (2,827 | ) |
| Proceeds from the issuance of long-term debt, net  of issuance costs |       | —                                              |       | 39,750 |   |
| Repayments of long-term debt                                         |       | (312                                                | )          | (226 | ) |
| Net change in inter-company borrowings                               |       | 22,400                                              |       | (11,200 | ) |
| Dividends paid                                                       |       | (14,600                                             | )          | (19,400 | ) |
| Other — net                                                     |       | (89                                                 | )          | (224 | ) |
| Net cash provided                                                    |       | 28,453                                              |       | 6,888 |   |
|                                                                 |       |                                                |       |   |   |
| **Net increase in cash and cash  equivalents**                       |       | 3,352                                               |       | 1,053 |   |
| **Cash and cash equivalents,  beginning of period**                  |       | 1,096                                               |       | 3,812 |   |
| **Cash and cash equivalents, end  of period**                        |       | $                                                   | 4,448      |   | $ | 4,865 |   |

 

*The accompanying notes are an integral part of these financialstatements*

 

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**AMERICAN STATES WATER COMPANY**

**AND**

**GOLDEN STATE WATER COMPANY**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

 

General/Natureof Operations: American States Water Company (“AWR”) is theparent company of Golden State Water Company (“GSWC”), Chaparral City WaterCompany (“CCWC”) and American States Utility Services, Inc. (“ASUS”) (andits subsidiaries, Fort Bliss Water Services Company (“FBWS”), Terrapin UtilityServices, Inc. (“TUS”), Old Dominion Utility Services, Inc. (“ODUS”),Palmetto State Utility Services, Inc. (“PSUS”) and Old North UtilityServices, Inc. (“ONUS”)).  AWR andits subsidiaries may be collectively referred to herein as “Registrant” or the “Company”.  The subsidiaries of ASUS may be collectivelyreferred to herein as the “Military Utility Privatization Subsidiaries.”

 

GSWCis a public utility engaged principally in the purchase, production,distribution and sale of water in California serving approximately 256,000water customers. GSWC also distributes electricity in several San BernardinoMountain communities serving approximately 23,000 electric customers. TheCalifornia Public Utilities Commission (“CPUC”) regulates GSWC’s water andelectric business, including properties, rates, services, facilities and othermatters.

 

CCWCis a public utility regulated by the Arizona Corporation Commission (“ACC”) servingover 13,000 customers in the Town of Fountain Hills, Arizona and a portion ofthe City of Scottsdale, Arizona. On June 7, 2010, AWR entered into a stockpurchase agreement with EPCOR Water (USA) Inc. to sell all of the common sharesof CCWC for a total purchase price of $35 million, including the assumption ofapproximately $6 million of long-term debt as more fully described in Note 10.

 

ASUSperforms water and wastewater services and operations on a contract basis. Onits own or through its wholly owned subsidiaries, ASUS operates and maintainsthe water and/or wastewater systems at various military bases pursuant to50-year fixed price contracts, which are subject to periodic priceredeterminations and modifications for changes in circumstances, changes inlaws and regulations and changes in wages and fringe benefits to the extentprovided in each of the contracts. There is no direct regulatory oversight byeither the CPUC or the ACC over AWR or the operation or rates of the servicesprovided by ASUS or any of its wholly owned subsidiaries.  AWR’s assets and operating income areprimarily those of GSWC.

 

Basisof Presentation: The consolidated financial statements and notesthereto are being presented in a combined report being filed by two separateRegistrants: AWR and GSWC. References in this report to “Registrant” are to AWRand GSWC, collectively, unless otherwise specified. Certain prior periodamounts have been reclassified to conform to the 2010 financial statementpresentation related to discontinued operations described in Note 10.

 

The consolidated financialstatements of AWR include the accounts of AWR and its subsidiaries, all ofwhich are wholly owned. These financial statements are prepared in conformitywith accounting principles generally accepted in the United States of America.Inter-company transactions and balances have been eliminated in the AWRconsolidated financial statements. Investmentsin partially-owned affiliates are accounted for by the equity method whenRegistrant’s ownership interest exceeds 20%. The consolidated financialstatements included herein have been prepared by Registrant, without audit,pursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”). Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America for annualfinancial statements have been condensed or omitted pursuant to suchrules and regulations. The preparation of the consolidated financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates. In the opinion of management, alladjustments, consisting of normal, recurring items and estimates necessary fora fair statement of the results for the interim periods, have been made.It is suggested that these consolidated financial statements be read inconjunction with the consolidated financial statements and the notes theretoincluded in the Form 10-K for the year ended December 31, 2009 filedwith the SEC.

 

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GSWC’sRelated Party Transactions: GSWC and othersubsidiaries provide and receive various services to and from their parent,AWR, and among themselves. In addition, AWR has a $100 million syndicatedcredit facility. AWR borrows under this facility and provides funds to itssubsidiaries, including GSWC, in support of their operations. Amounts owed toAWR for borrowings under this facility are included in inter-company payableson GSWC’s balance sheets as of September 30, 2010 and December 31,2009. The interest rate charged to GSWC and other affiliates is sufficient tocover AWR’s interest cost under the credit facility. GSWC also allocatescertain corporate office administrative and general costs to its affiliatesusing allocation factors mandated by the CPUC.

 

OnMay 26, 2010, the Board of Directors approved the issuance of eightadditional GSWC Common Shares to AWR for $20.0 million.  Proceeds from the issuance were used to paydown GSWC’s intercompany borrowings due to AWR.

 

Notes Payable to Banks:  On May 27,2010, AWR entered into the third amendment to the credit agreement in order toextend the expiration date ofthe syndicated credit facility to May 27, 2013 from June 3,2010.  The maximum amount that may be borrowed under this facilitywas reduced from $115,000,000 to $100,000,000.   AWR may, under theterms of the amended credit agreement, elect to increase the aggregate bankcommitments by up to an additional $40,000,000.  The aggregateeffective amount that may be outstanding under letters of credit has beenincreased to $25,000,000 from $20,000,000.  The rates at which AWRmay borrow under this facility have been increased due to market conditions andthe lenders have consented to modifications to certain of the covenants in theamended credit agreement requested by AWR.

 

Sales and Use Taxes:  GSWC bills certain sales and use taxes leviedby state or local governments to its customers. Included in these sales and usetaxes are franchise fees, which GSWC pays to various municipalities (based onordinances adopted by these municipalities) in order to use public right of wayfor utility purposes. GSWC bills these franchise fees to its customers based ona CPUC-authorized rate. These franchise fees, which are required to be paidregardless of GSWC’s ability to collect from the customer, are accounted for ona gross basis. GSWC’s franchise fees billed to customers and recorded asoperating revenue were approximately $866,000 and $782,000 for the three monthsended September 30, 2010 and 2009, respectively, and $2,266,000 and$2,116,000 for the nine months ended September 30, 2010 and 2009,respectively. When GSWC acts as an agent, and the tax is not required to beremitted if it is not collected from the customer, the taxes are accounted foron a net basis.

 

Dependingon the state in which the operations are conducted, ASUS and its subsidiariesare also subject to certain state non-income tax assessments generally computedon a “gross receipts” or “gross revenues” basis.  These non-income tax assessments are requiredto be paid regardless of whether the subsidiary is reimbursed by the U.S.government for these assessments under its 50-year contracts with the U.S.government.  The non-income taxassessments are accounted for on a gross basis and totaled $258,000 and$234,000 during the three months ended September 30, 2010 and 2009,respectively, and $697,000 and $563,000 for the nine months ended September 30,2010 and 2009, respectively.

 

Recently Adopted Accounting Pronouncements:  In June 2009, the Financial AccountingStandards Board (“FASB”) issued revised guidance which enhances informationreported to users of financial statements by providing greater transparencyabout transfers of financial assets and a company’s continuing involvement intransferred assets. Generally accepted accounting principles no longer includethe concept of a qualifying special purpose entity.  The revised guidance also changes therequirements for derecognizing financial assets and requires additionaldisclosures about a transferor’s continuing involvement in transferredfinancial assets. This revised guidance was effective for the Company beginningJanuary 1, 2010 and did not have any impact on Registrant’s consolidatedresults of operations, financial position or cash flows.

 

InJune 2009, the FASB amended the guidance on consolidation for variableinterest entities. The new guidance requires a company to perform a qualitativeanalysis when determining whether it must consolidate a variable interestentity.  This guidance also amends how todetermine whether an entity is a variable interest entity. A company must nowdisclose how its involvement with a variable interest entity affects thecompany’s financial statements and disclose any significant judgments andassumptions made in determining whether it must consolidate a variable interestentity. This guidance was effective for the Company beginning January 1,2010 and did not have any impact on the Registrant’s consolidated results ofoperations, financial position or cash flows.

 

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In October 2009, the FASB issued an update tothe accounting standards and provided amendments to the criteria of AccountingStandards Codification Topic 605, *“RevenueRecognition”*, for separately recognizing consideration inmultiple-deliverable arrangements. The amendments establish a selling pricehierarchy for determining the selling price of a deliverable.  Thisguidance is effective for financial statements issued for fiscal yearsbeginning on or after June 15, 2010.  Registrant does not expect theadoption will have a material impact on its consolidated financial statements.

 

In January 2010, the FASB issued an update tothe accounting standards and amended the disclosure guidance with respect tofair value measurements.  Specifically, the new guidance requiresdisclosure of amounts transferred in and out of Levels 1 and 2 fair valuemeasurements, a reconciliation presented on a gross basis rather than a netbasis of activity in Level 3 fair value measurements, greater disaggregation ofthe assets and liabilities for which fair value measurements are presented andmore robust disclosure of the valuation techniques and inputs used to measureLevel 2 and 3 fair value measurements. This guidance is currently effective,with the exception of the new guidance for Level 3 activity reconciliations. The adoption of the effective portion of the guidance had no impact onRegistrant’s consolidated financial statements.  Certain Level 3 activitiesdisclosure requirements of this guidance will be effective for fiscal yearsbeginning after December 15, 2010.  Registrant is currentlyevaluating the impact of Level 3 disclosure of this guidance, but does notexpect the adoption will have a material impact on its consolidated financialstatements.

 

Otheraccounting standards that have been issued or proposed by the FASB or otherstandards-setting bodies that do not require adoption until a future date arenot expected to have a material impact on Registrant’s consolidated financialstatements upon adoption.

 

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**Note 2— Regulatory Matters:**

 

Inaccordance with accounting principles for rate-regulated enterprises,Registrant records regulatory assets, which represent probable future revenueassociated with certain costs that will be recovered from customers through theratemaking process, and regulatory liabilities, which represent probable futurereductions in revenue associated with amounts that are to be credited tocustomers through the ratemaking process. At September 30, 2010,Registrant had approximately $46.3 million of regulatory assets not accruing carryingcosts. Of this amount, $26.5 million relates to the underfunded positions ofthe pension and other post-retirement obligations, $5.0 million relates todeferred income taxes representing accelerated tax benefits flowed through toratepayers, which will be included in rates concurrently with recognition ofthe associated future tax expense, and $11.4 million relates to a memorandumaccount authorized by the CPUC to track unrealized gains and losses on GSWC’spurchase power contracts over the life of the contract.  The remainder relates to other expenses thatdo not provide for recovery of carrying costs that Registrant expects torecover in rates over a short period. Regulatory assets, less regulatory liabilities, included in theconsolidated balance sheets for continuing operations are as follows:

 
| **(In thousands)**                                                      | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **GSWC**                                                                     |       |                         |       |                        |       |
| Electric supply cost balancing account                                       |       | $                            | 10,458     |                        | $          | 13,111 |   |
| Water supply cost balancing accounts                                         |       | 3,476                        |       | 4,717                       |       |
| Water revenue adjustment mechanism, net of  modified cost balancing accounts |       | 36,181                       |       | 21,168                      |       |
| Aerojet litigation memorandum account                                        |       | 19,040                       |       | 19,676                      |       |
| Pensions and other postretirement obligations                                |       | 26,536                       |       | 27,833                      |       |
| Derivative unrealized loss on purchased power  contracts                     |       | 11,361                       |       | 7,338                       |       |
| Flow-through taxes, net                                                      |       | 5,010                        |       | 6,661                       |       |
| Electric transmission line abandonment costs                                 |       | 2,687                        |       | 2,828                       |       |
| Asset retirement obligations                                                 |       | 4,077                        |       | 3,826                       |       |
| Low income rate assistance balancing accounts                                |       | 5,166                        |       | 4,764                       |       |
| Santa Maria adjudication memorandum accounts                                 |       | 3,742                        |       | 3,895                       |       |
| Deferred rate case costs                                                     |       | 3,254                        |       | 3,642                       |       |
| Refund of water right lease revenues                                         |       | (1,425                       | )          | (1,806                      | )          |
| Other regulatory assets, net                                                 |       | 2,188                        |       | 4,921                       |       |
| Total                                                                        |       | $                            | 131,751    |                        | $          | 122,574 |   |

 

Regulatorymatters are discussed in detail in the consolidated financial statements andthe notes thereto included in the Form 10-K for the year endedDecember 31, 2009 filed with the SEC. The discussion below focuses on significant matters and changes since December 31,2009.

 

***Electric Supply Cost Balancing Accounts******:***

 

Electricpower costs incurred by GSWC’s Bear Valley Electric Service (“BVES”) divisioncontinue to be charged to its electric supply cost balancing account. Theunder-collection in the electric supply cost balancing account is $10.5 millionat September 30, 2010.  For the ninemonths ended September 30, 2010 and 2009, the under-collection decreasedby approximately $2.7 million and $2.8 million, respectively, primarily as aresult of a payment of a surcharge by its customers of 2.2¢ per kilowatt hour,which is currently scheduled to run through August 2011.  In addition, BVES is allowed to include itsactual recorded purchased energy costs up to a weighted annual average cost of$77 per megawatt-hour (“MWh”) through August 2011 in its electric supplycost balancing account.

 

BVESbegan receiving power under a new purchased power contract in January 1,2009.   The main product under the newcontract provides for 13 megawatts (“MW”) of electric energy at a fixed priceof $67.85 per MWh during 2010 as compared to the $77 per MWh included inrates.  The reduction in the actual priceof purchased power helps decrease the under-collection balance in the electricsupply cost balancing account.  To theextent that the actual weighted average annual cost for power purchased exceedsthe $77 per MWh amount, GSWC will not be able to include these amounts in itsbalancing account and such amounts will be expensed.  There were no amounts expensed over the $77per MWh cap during the three months and nine months ended September 30,2010 and 2009.

 

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Asof September 30, 2010, the electric supply cost balancing account consistsof $4.2 million for costs of abandonment of a transmission line upgrade and$6.3 million for changes in purchased energy and power system delivery costs.

 

***Water Supply Cost Balancing Accounts******:***

 

Priorto the implementation of the Modified Cost Balancing Account (“MCBA”) furtherdiscussed below,  Registrant maintainedwater supply cost balancing accounts for GSWC to account for under-collectionsand over-collections of revenues designed to recover such costs.  These supply cost balancing accounts trackeddifferences between the current cost for supply items (water, power and pumptaxes) charged by GSWC’s suppliers and the cost for those items incorporatedinto GSWC’s rates. Under-collections (recorded as regulatory assets) occurredwhen the current cost exceeded the amount in rates for these items and,conversely, over-collections (recorded as regulatory liabilities) occurred whenthe current cost of these items were less than the amount in rates.  Typically, under-collections orover-collections, when they occur, were tracked in the supply cost balancingaccounts for future recovery through a surcharge (in the event of anunder-collection) or refund through a surcredit (in the event of anover-collection) on customers’ bills. Registrant accrues interest on its supply cost balancing accounts at therate prevailing for 90-day commercial paper. Registrant does not maintain a supply cost balancing account for CCWC.

 

Asof September 30, 2010, there is a $3.5 million net under-collectionremaining in the water supply cost balancing accounts.  Of this amount, approximately $1.1 millionrelates to GSWC’s Region III customer service area, $2.2 million relates toGSWC’s Region I customer service areas and $115,000 relates to GSWC’s Region IIcustomer service area.  Currently, thereis a surcharge in place to recover Region I’s under-collections. Whensurcharges expire, any unrecovered balances will be included in future filingsfor recovery.

 

OnAugust 21, 2008, the CPUC issued a final decision approving a settlementagreement between GSWC and the CPUC’s Division of Ratepayer Advocates (“DRA”)regarding conservation rate design.  As aresult of this decision, GSWC established an MCBA that permits GSWC to recoversupply costs related to changes in water supply mix in addition to rate changesby GSWC’s suppliers. GSWC implemented this MCBA in November 2008 forRegions II and III and in September 2009 for Region I.  This account replaces the water supply costbalancing account procedure for costs incurred after the modified supply costbalancing account was implemented.

 

***Water Revenue Adjustment Mechanism (“WRAM”) and Modified Cost BalancingAccount (“MCBA”):***

 

Withthe adoption of the WRAM and the MCBA effective November 25, 2008 forRegions II and III and September 1, 2009 for Region I’s ratemaking areas,GSWC began recording the difference between what is billed to its watercustomers and that which is authorized by the CPUC. Under the WRAM, GSWCrecords the adopted level of volumetric revenues as authorized by the CPUC formetered accounts (adopted volumetric revenues). While the WRAM tracks volumetric-based revenues, the revenuerequirements approved by the CPUC include service charges, flat rate charges,and other items that are not subject to the WRAM. The adopted volumetric revenuesconsider the seasonality of consumption of water based upon historicalaverages. The variance between adopted volumetric revenues and actual billedvolumetric revenues for metered accounts is recorded as a component of revenuewith an offsetting entry to an asset or liability balancing account (trackedindividually for each rate making area). The variance amount may be positive ornegative and represents amounts that will be billed or refunded to customers inthe future.  The WRAM only applies tocustomer classes with conservation rates in place.  Currently, the majority of GSWC’s watercustomers have conservation tiered rate billing structures.

 

Underthe MCBA, GSWC began tracking adopted expense levels for purchased water,purchased power and pump taxes, as established by the CPUC. Variances (whichinclude the effects of changes in both rate and volume) between adopted andactual purchased water, purchased power, and pump tax expenses are recorded asa component of the supply cost balancing account provision, as the amount ofsuch variances will be recovered from or refunded to GSWC’s customers at alater date. This is reflected with an offsetting entry to an asset or liabilitybalancing account (tracked individually for each rate-making area).  Unlike the WRAM, the MCBA applies to allcustomer classes.

 

Thebalances in the WRAM and MCBA assets and liabilities accounts will fluctuate ona monthly basis depending upon the variance between adopted and actual results.The recovery or refund of the WRAM is netted against the MCBA over- orunder-collection for the corresponding rate-making area and is interest bearingat the current 90-day commercial paper rate. Under the current CPUC decision,when the net amount at the end of the

 

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calendaryear for Regions II, III or any of the Region I ratemaking areas achievesa pre-determined level (i.e., at least 2.5 percent over- or under-recovery of theapproved revenue requirement), GSWC will seek approval from the CPUC to refundor collect the balance in the accounts. In September 2010, GSWC, alongwith other California water utilities, filed an application with the CPUC toseek annual approval to refund or collect the balance in the accounts,regardless of percentage of over-or under-recovery.  A decision on this application is expected inDecember 2010.

 

InMarch 2010, GSWC filed an advice letter with the CPUC for recovery of theRegion II and III WRAM, net of the MCBA and supply cost balancing accounts, of$18.3 million.  A surcharge was put inplace in March 2010 which is expected to recover the amounts accumulated,as of December 31, 2009, in Regions II and III’s WRAM, net of MCBA andsupply cost balancing accounts.  In April andMay 2010, surcharges were implemented for recovery of $2.1 million of theRegion I WRAM accounts, net of the MCBA. For the three and nine months ended September 30, 2010,approximately $2.6 million and $4.1 million, respectively, of surcharges werebilled to customers to decrease previously incurred under-collections in theWRAM, net of MCBA balancing accounts. Going forward, GSWC will seek recovery of its WRAM, net of MCBA, on an annualbasis.  As of September 30, 2010, GSWChas a net aggregated regulatory asset of $36.2 million which is comprised of a$49.1 million under-collection in the WRAM accounts and $12.9 millionover-collection in the MCBA accounts.

 

***Aerojet Litigation Memorandum Account******:***

 

OnJuly 21, 2005, the CPUC authorized GSWC to collect approximately $21.3million of the Aerojet litigation memorandum account, through a rate surcharge,which will continue for no longer than 20 years. Beginning in October 2005,new rates went into effect to begin amortizing the memorandum account over a20-year period.  A rate surchargegenerating approximately $278,000 and $277,000 was billed to customers duringthe three months ended September 30, 2010 and 2009, respectively, andapproximately $670,000 and $740,000 was billed to customers for the nine monthsended September 30, 2010 and 2009, respectively.  GSWC will keep the Aerojet memorandum accountopen until the earlier of full amortization of the balance or20 years.  However, no costs will beadded to the memorandum account, other than on-going interest charges approvedby the CPUC decision. Pursuant to the decision, additional interest ofapproximately $12,000 was added to the Aerojet litigation memorandum accountfor the three months ended September 30, 2010 and 2009, and additionalinterest of approximately $33,000 and $45,000 was added to the Aerojetmemorandum account for the nine months ended September 30, 2010 and 2009,respectively. At this time, management believes the full balance of the Aerojetlitigation memorandum account will be collected by 2025.

 

Aerojethas also agreed to reimburse GSWC $17.5 million, plus interest accruingfrom January 1, 2004, for GSWC’s past costs, including legal and expertcosts. The recovery of this amount is contingent upon the issuance of land useapprovals for development in a defined area within Aerojet property in EasternSacramento County and the receipt of certain fees in connection with suchdevelopment.

 

***Derivative Gains and Losses on Purchased Power Contracts MemorandumAccount:***

 

GSWC’sBVES division began receiving power under a new purchased power contract on January 1,2009 at a fixed cost over three and five year terms depending on the amount ofpower and the period during which the power will be purchased under the contract.  This contract is subject to accountingguidance as amended for derivative instruments and hedging activities**and requires mark-to-market derivative accounting.  In May 2009, the CPUC authorized GSWC toestablish a non-interest bearing regulatory memorandum account to track unrealizedgains and losses on this contract. Accordingly, all unrealizedgains and losses generated from this contract will be deferred on a monthlybasis into the memorandum account and, as a result, do not impact GSWC’searnings. As of September 30, 2010, $11.4 million of unrealized losseshave been included in this memorandum account. This unrealized loss increased since December 31,2009 as a result of decreasing quoted market prices forenergy over the duration of the contract.

 

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***Other Regulatory Matters:***

 

*Bear Valley Electric Service*:

 

As part of the CPUC’s final decision in October 2009on the BVES general rate case, GSWC’s BVES division was authorized to establisha Base Revenue Requirement Adjustment Mechanism (“BRRAM”) account effective November 2,2009. With the adoption of the BRRAM account, GSWC began recording the differencebetween the base rate revenue portion of its charges on customers’ bills andthe amount of base rate costs authorized for recovery in rates by theCPUC.  The variance between adoptedelectric base rate revenue and actual billed base rate revenue will be recordedas a component of electric revenue with an offsetting entry to an asset orliability balancing account.  Thevariance amount may be positive or negative and represents amounts that will bebilled or refunded to electric customers in the future.  Amounts in this account bear interest at thecurrent 90-day commercial paper rate. When the amount of the under- or over-collection is equal to or greaterthan five percent of the adopted base rate revenue requirement established forthe previous twelve months, GSWC intends to seek approval from the CPUC torefund or collect the balance in the account. As of September 30, 2010, GSWC has included in other regulatoryassets $1.1 million related to the BRRAM.

 

Included in other regulatory assets as of September 30,2010 is a BVES memorandum account totaling $832,000.  In June 2009, the CPUC authorized BVESto track the difference between the 2007 adopted general office cost allocationto BVES and the 1996 adopted general office cost allocation to BVES, until the2007 costs were incorporated into BVES’ rates. From June 4, 2009 to October 31, 2009, when the 2007 costswere incorporated into BVES’ rates, $958,000 was recorded in the memorandumaccount.  However, the decision issued onOctober 15, 2009 did not address the disposition of this memorandumaccount.   In November 2009, GSWCfiled a petition for modification to seek clarification from the CPUC on thetreatment and recovery of this memorandum account.   In March 2010, the CPUC approved forrecovery this memorandum account through a surcharge over a 24-month periodeffective May 1, 2010.  Accordingly,during the first quarter of 2010, GSWC recorded a regulatory asset and acorresponding increase to earnings for amounts included in this memorandumaccount.  The October 2009 decisionin the general rate case for BVES also allows for an update to BVES’ rates in2010 for the corporate headquarters’ costs based on the CPUC’s adoption of newrates for GSWC’s current Regions II and III general rate case, including therecovery of expenses associated with its corporate headquarters.  For the three and nine months ended September 30,2010, surcharges of approximately $95,000 and $128,000, respectively, werebilled to BVES customers.

 

In January 2010, the City of Big Bear Lake andsurrounding areas of San Bernardino County experienced a series of snow storms,which damaged many BVES power lines, poles, transformers, and other facilitiesand caused temporary interruption of service to many BVES customers.  As a result of these storms, BVES hasincurred additional operating costs to repair equipment and restore electricservice to its customers.  In February 2010,GSWC informed the CPUC that it will track these costs in a Catastrophic EventMemorandum Account (“CEMA”).   Theincremental costs include BVES labor, outside services assistance, equipment,materials, facilities damages and related snow removal services.  GSWC intends to file with the CPUC in 2011for recovery of these costs.  Managementbelieves these incremental costs will be approved by the CPUC for recoverythrough the CEMA.  As of September 30,2010, approximately $327,000 has been incurred as a result of the storms andhas been included in the CEMA account within other regulatory assets.

 

BVEShas been regularly filing compliance reports with the CPUC regarding itspurchases of energy from renewable energy resources. The filings have indicatedthat BVES has not achieved interim target purchase levels of renewable energyresources and thus, on its face, might be subject to a potential penalty.However, BVES expects that the CPUC will waive any potential fines inaccordance with the CPUC’s flexible compliance rules.  Accordingly, no provision for loss has beenrecorded in the financial statements as of September 30, 2010.  At this time, management cannot determine ifinterim targets for the 2010 year will be met. BVES is continuing its efforts to procure renewable resources. In November 2009,GSWC entered into a ten-year contract to purchase renewable energy created fromlandfill gas.  The contract is subject toCPUC approval.  On June 8, 2010,GSWC filed an application with the CPUC seeking approval of this contract.  If approved, the contract will provide up to3 megawatts for ten years at a fixed price of $110.0 per MWh.  In November 2009, GSWC also entered intoa ten-year contract to purchase biogas to power BVES’s gas-fueled 8.4 MWgeneration facility.  This contract isalso subject to CPUC approval.  On July 8,2010, GSWC filed an application with the CPUC seeking approval of thiscontract.

 

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*Chaparral City WaterCompany:*

 

FountainHills Sanitary District (“FHSD”) is a political subdivision of the State ofArizona that provides sanitary sewer service to customers residing within CCWC’swater service area. In connection with its sanitary system, FHSD constructed arecharge system whereby it recharges treated effluent through multipleinjection wells. In order for FHSD to secure an Aquifer Protection Permit forits recharge system, FHSD requested CCWC to permanently cease using one of itswells. As a possible replacement for this well, FHSD constructed a new welladjacent to the community center (“Community Center Well”).  However, this well was not able to produce anequivalent amount of water to CCWC’s well that was taken out ofproduction.  Accordingly, in February 2005,CCWC entered into an agreement with FHSD whereby CCWC agreed to permanentlyremove from service this well and in return CCWC received a settlement fee of$1,520,000 from FHSD.

 

In2005, CCWC recognized a net gain of $760,000 related to this settlementagreement and established a regulatory liability for the remaining $760,000pending ACC review of this matter.  On October 8,2009, the ACC made a final ruling ordering CCWC to treat the entire gain of$1,520,000 from the settlement agreement with FHSD as a reduction to rate base.As a result, CCWC recorded a loss of $760,000 during the third quarter of2009.  This effectively reversed theoriginal gain recorded in 2005.  In November 2009,CCWC filed an application for rehearing on several issues including the sharingof this gain from the settlement proceeds.  The ACC granted CCWC’srequest to hold a rehearing on two of the issues in CCWC’s request.  In January 2010,a procedural conference was held with the judge and the staff of the ACCinvolved in the rate case to address a schedule for the rehearing. Therehearing was held in April 2010 and a final decision by the ACC isexpected later this year.  At this time,management cannot predict the final outcome of this matter.

 

*Other:*

 

*Excess Usage Charges - Refund to Customers:*

 

In July 2009, GSWC began receiving reducedwater allocations from member agencies of the Metropolitan Water District ofSouthern California (“MWD”). As a result, in July 2009, GSWC beganimplementing water rationing, restrictions, and excess usage charges to its customersin several of its service areas. The excess usage charges were being collectedin the event that penalties were required to be paid to MWD for exceeding GSWC’swater allocations.  As of September 30,2010, GSWC has billed its customers excess usage charges totaling $3.3 million,which are included in other regulatory assets/liabilities.  In the event that GSWC is required to paypenalties to MWD for exceeding GSWC’s water allocations in the current wateryear, GSWC will use the $3.3 million previously billed to customers to pay thepenalties.

 

*Interest Rate Balancing Account*

 

Adecision issued in July 2009in the GSWC cost of capital proceeding authorized GSWC an interest ratebalancing account to track interest costs of new debt.  This balancing account tracks any differencebetween the incremental cost of debt included in the cost of capital decisionand the actual cost of debt for any long-term debt issued by GSWC from theeffective date of the final decision.  InAugust 2010, GSWC filed an advice letter with the CPUC for approval of acustomer refund based on the difference between the adopted cost of new debt inits authorized capital structure and the actual cost of new debt since January 1,2009.  In response to this advice letterfiled by GSWC, CPUC issued a resolution in October 2010 and confirmed themethodology of how the difference in the cost of debt should be calculated inthe interest rate balancing account pursuant to the cost of capitaldecision.  As a result of thisresolution, GSWC recorded a downward adjustment of $654,000 to interest expenseduring the third quarter of 2010, which was previously recorded in the interestrate balancing account.  As ofSeptember 30, 2010, GSWC has included in other regulatory liabilitiesa total of $510,000 related to the interest rate balancing account that will berefunded to customers.

 

***Pending Regulatory Matters******:***

 

Thefollowing are two pending regulatory matters related to GSWC that resulted in apretax charge of $9.0 million during the third quarter of 2010 for theimpairment of assets and loss contingencies.  Registrant will accrue themost likely amount when such an amount can be reasonably estimated or, at leastthe minimum of the range of probable loss when a range of probable loss can be estimated.  Thesereserve estimates will be adjusted as additional information becomesknown.

 

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*CPUC Subpoena*:

 

OnFebruary 15, 2007, the CPUC issued a subpoena to GSWC in connection withan investigation of certain work orders and charges paid to a specificcontractor used previously by GSWC for numerous construction projects estimatedto total $24.0 million. The CPUC’s investigation focuses on whether GSWC wasovercharged for these construction projects and whether these overcharges wereapproved in customer rates.  The construction projects completed by thisspecific contractor related primarily to work on water treatment and pumpingplants which have been placed in service and are used and useful.  InJune 2007, GSWC received notification from the CPUC that it wasinstituting an audit. The purpose of the audit was to examine for the period1994 to the present, GSWC’s policies, procedures, and practices throughout itsthree water regions regarding the granting or awarding of constructioncontracts or jobs.  GSWC continues to respond to data requests submittedby the CPUC including data requests which asked for information prior to 1994.

 

Shouldthe CPUC investigation result in a proposed disallowance of certain previouslycapitalized costs, such costs, and potentially any return earned on such costs,may be required to be refunded to the customers upon settlement of the proposeddisallowance, if any, resulting in a charge to operating income.  Inaddition to the disallowance of previously capitalized costs and the returnearned on such costs, the CPUC also has the authority to assess fines andpenalties.  At this time, Registrant cannot predict the final outcome of thismatter.  Although it does notbelieve a disallowance or penalty is justified, and reserving all rights,management believes it prudent to reserve for a probable loss related to thismatter. The reserve estimates for thismatter are subject to change as additional information becomes known and theCPUC approaches the conclusion of its investigation and determines its nextcourse of action, if any.  Registrantcould experience increases in its recorded estimated reserves fordisallowances, refunds, assessments or fines. Any such increases in estimatedreserves for additional disallowances, refunds to customers assessmentsor fines, if imposed, could have a material adverse effect on AWR and GSWC.

 

In January 2009, the ACC staff requestedinformation regarding the CPUC subpoena and on-going audit.  GSWC has been working with the ACC staff andhas provided responsive materials, including but not limited to, materials thatare relevant to CCWC. Although the ACC has issued a decision in the CCWCgeneral rate case, it has held the docket open pending resolution of the staff’sreview of the CPUC subpoena documents. In the first quarter of 2010, the ACC staff issued a report recommendingthat proper controls be established in CCWC’s procurement policies andprocedures, and that status reports of the CPUC’s investigation and resolutionbe filed with the ACC periodically. The staff’s report did not result in anyfinancial impact to CCWC.  The ACC hasnot yet acted on the staff’s recommendations. Management cannot predict the outcome of the ACC’s final decision onthis matter.

 

*General Rate Case - Region II, Region III and GeneralOffice:*

 

GSWCfiled its general rate case for Regions II and III plus the general office onJuly 1, 2008 for rates effective for years 2010, 2011 and 2012.  On January 29, 2010, the CPUC issued aruling revising the scoping memo and reopening the general rate case proceedingto receive supplemental information and testimony on a number of issues includingcost allocation, the definition of firm capacity, pension and benefitcalculations, general office rent expense, salary and wage adjustments, costsregarding the La Serena Plant Improvement Project and other capital projects,and deferred rate case costs.  GSWC hasprovided additional information and testimony regarding these issues to theCPUC.

 

OnOctober 20, 2010, the administrative law judge and the assignedcommissioner issued a proposed decision and an alternate proposed decision,respectively (“Proposed Decisions”). These Proposed Decisions adopt the partial settlement agreement reachedbetween GSWC and the Division of Ratepayer Advocates which include capitalbudgets, projected sale levels, and supply costs.  The Proposed Decisionsalso adopt certain positions regarding the number of issues where supplementalinformation and testimony were provided including costs regarding the La SerenaPlant Improvement Project and other capital projects, and deferred rate casecosts.    The CPUC may approve either theproposed or alternate proposed decision, as written, or modify them based uponcomments received during a twenty day comment period which commenced on October 20,2010.   GSWC is in the process ofproviding comments to the CPUC regarding items in the Proposed Decisions andcannot predict whether any changes will be made and incorporated in the finaldecision prior to adoption, which may require an increase in the recordedestimated pretax charge for the impairment of assets and further negativelyimpact GSWC. The CPUC is scheduled to issue a final decision during the fourthquarter of 2010.

 

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** **

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

 

Inaccordance with the accounting guidance for participating securities andearnings per share (“EPS”), Registrant uses the “two-class” method of computingEPS. The “two-class” method is an earnings allocation formula that determinesEPS for each class of common stock and participating security. AWR hasparticipating securities related to stock options and restricted stock unitsthat earn dividend equivalents on an equal basis with AWR’s Common Shares (the “CommonShares”) that have been issued under AWR’s 2000 and 2008 Employee Plans and the2003 Directors Plan. In applying the “two-class” method, undistributed earningsare allocated to both common shares and participating securities. The followingis a reconciliation of Registrant’s net income and weighted average CommonShares outstanding for calculating basic net income per share:

 
| **Basic**                                                             | ** **                                                    | **For The Three Months********Ended September 30,** | ** ** | **For The Nine Months********Ended September 30,** | ** ** |
|-----------------------------------------------------------------------|---------------------------------------------------------------|------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** **                                                    | **2010**                                                                     | ** ** | **2009**                                                                    | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net income from continuing operations                                 |                                                          | $                                                                            | 5,669      |                                                                        | $          | 9,891 |   | $ | 22,829 |   | $ | 26,334 |   |
| Net income (loss) from discontinued operations                        |                                                          | 983                                                                          |       | (193                                                                        | )          | 1,288 |   | (205 | ) |
| Total net income                                                      |                                                          | 6,652                                                                        |       | 9,698                                                                       |       | 24,117 |   | 26,129 |   |
| Less: (a)                                                             | Distributed earnings to common shareholders                   |                                                                         | 4,835      |                                                                        | 4,625      |   | 14,487 |   | 13,422 |   |
|                                                                  | Distributed earnings to participating securities              |                                                                         | 27         |                                                                        | 22         |   | 75 |   | 62 |   |
| Undistributed earnings                                                |                                                          | 1,790                                                                        |       | 5,051                                                                       |       | 9,555 |   | 12,645 |   |
|                                                                  |                                                          |                                                                         |       |                                                                        |       |   |   |   |   |
| (b)                                                                   | Undistributed earnings allocated to common  shareholders      |                                                                         | 1,780      |                                                                        | 5,026      |   | 9,506 |   | 12,587 |   |
|                                                                  | Undistributed earnings allocated to participating  securities |                                                                         | 10         |                                                                        | 25         |   | 49 |   | 58 |   |
|                                                                  |                                                          |                                                                         |       |                                                                        |       |   |   |   |   |
| Total income available to common shareholders,  basic (a)+(b)         |                                                          | $                                                                            | 6,615      |                                                                        | $          | 9,651 |   | $ | 23,993 |   | $ | 26,009 |   |
|                                                                  |                                                          |                                                                         |       |                                                                        |       |   |   |   |   |
| Weighted average Common Shares outstanding, basic                     |                                                          | 18,595                                                                       |       | 18,502                                                                      |       | 18,573 |   | 17,896 |   |
|                                                                  |                                                          |                                                                         |       |                                                                        |       |   |   |   |   |
| **Basic earnings per Common  Share:**                                 |                                                          |                                                                         |       |                                                                        |       |   |   |   |   |
| Income from continuing operations                                     |                                                          | $                                                                            | 0.31       |                                                                        | $          | 0.53 |   | $ | 1.22 |   | $ | 1.46 |   |
| Income (loss) from discontinued operations                            |                                                          | 0.05                                                                         |       | (0.01                                                                       | )          | 0.07 |   | (0.01 | ) |
| Net Income                                                            |                                                          | $                                                                            | 0.36       |                                                                        | $          | 0.52 |   | $ | 1.29 |   | $ | 1.45 |   |
|                                                                       |                                                               |                                                                              |            |                                                                             |            |  |  |  |  |  |  |  |  |  |  |

 

DilutedEPS is based upon the weighted average number of Common Shares, including bothoutstanding shares and shares potentially issuable in connection with stockoptions granted under Registrant’s 2000 and 2008 Employee Plans, and the 2003Directors Plan, and net income. At September 30, 2010 and 2009, there were741,561 and 679,258 options outstanding, respectively, under these Plans. AtSeptember 30, 2010 and 2009, there were also 105,153 and 86,947 restrictedstock units outstanding, respectively.

 

Thefollowing is a reconciliation of Registrant’s net income and weighted averageCommon Shares outstanding for calculating diluted net income per share:

 
| **Diluted**                                                           | ** ** | **For The Three Months********Ended September 30,** | ** ** | **For The Nine Months********Ended September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2010**                                                                     | ** ** | **2009**                                                                    | ** ** | **2010** | ** ** | **2009** | ** ** |
| Common shareholders earnings, basic                                   |       | $                                                                            | 6,615      |                                                                        | $          | 9,651 |   | $ | 23,993 |   | $ | 26,009 |   |
| Undistributed earnings for dilutive stock options                     |       | 10                                                                           |       | 25                                                                          |       | 49 |   | 58 |   |
| Total common shareholders earnings, diluted                           |       | $                                                                            | 6,625      |                                                                        | $          | 9,676 |   | $ | 24,042 |   | $ | 26,067 |   |
|                                                                  |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Weighted average common shares outstanding, basic                     |       | 18,595                                                                       |       | 18,502                                                                      |       | 18,573 |   | 17,896 |   |
| Stock-based compensation (1)                                          |       | 139                                                                          |       | 143                                                                         |       | 141 |   | 133 |   |
| Weighted average common shares outstanding,  diluted                  |       | 18,734                                                                       |       | 18,645                                                                      |       | 18,714 |   | 18,029 |   |
|                                                                  |       |                                                                         |       |                                                                        |       |   |   |   |   |
| **Diluted earnings per Common  Share:**                               |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Income from continuing operations                                     |       | $                                                                            | 0.30       |                                                                        | $          | 0.53 |   | $ | 1.21 |   | $ | 1.46 |   |
| Income (loss) from discontinued operations                            |       | 0.05                                                                         |       | (0.01                                                                       | )          | 0.07 |   | (0.01 | ) |
| Net Income                                                            |       | $                                                                            | 0.35       |                                                                        | $          | 0.52 |   | $ | 1.28 |   | $ | 1.45 |   |

 

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(1)          In applying the treasury stock method of reflectingthe dilutive effect of outstanding stock-based compensation in the calculationof diluted EPS, 395,337 and 422,553 stock options at September 30, 2010and 2009, respectively, were deemed to be outstanding in accordance withaccounting guidance on earnings per share. All of the 105,153 and 86,947 restricted stock units at September 30,2010 and 2009, respectively, were included in the calculation of diluted EPSfor the nine months ended September 30, 2010 and 2009.

 

Stockoptions of 249,826 and 252,326 were outstanding at September 30, 2010 and2009, respectively, but not included in the computation of diluted EPS becausethe related option exercise price was greater than the average market price ofAWR’s Common Shares for the nine months ended September 30, 2010 and2009.  Stock options of 96,398 and 4,379were outstanding at September 30, 2010 and 2009, respectively, but notincluded in the computation of diluted EPS because they were antidilutive.

 

Duringthe nine months ended September 30, 2010 and 2009, Registrant issued71,691and 57,971 Common Shares, for approximately $1,798,000 and $1,446,000,respectively, under Registrant’s Common Share Purchase and DividendReinvestment Plan, the 401(k) Plan, and the stock incentive plans. Inaddition, Registrant purchased 109,273 and 13,772 Common Shares on the openmarket during the nine months ended September 30, 2010 and 2009,respectively, under Registrant’s 401(k) Plan and the Common Share Purchaseand Dividend Reinvestment Plan. The Common Shares purchased by Registrant wereused to satisfy the requirements of these plans.

 

Duringthe three months ended September 30, 2010 and 2009, AWR paid quarterlydividends of approximately $4.8 million, or $0.26 per share and $4.6 million,or $0.25 per share, respectively.  Duringthe nine months ended September 30, 2010 and 2009, AWR paid quarterlydividends to shareholders of approximately $14.5 million, or $0.78 per shareand $13.3 million, or $0.75 per share.

 

OnMay 26, 2010, the Board of Directors approved the issuance of eightadditional GSWC Common Shares to AWR for $20.0 million.  Proceeds from the issuance were used to paydown GSWC’s intercompany borrowings due to AWR.

 

**Note 4 — Derivative Instruments:**

 

In October 2008, GSWC executeda purchased power contract that permits GSWC to purchase power at a fixed costover three and five year terms depending on the amount of power and periodduring which the power is purchased under the contract.  The contract is subject to the accountingguidance for derivatives and requires mark-to-market derivative accounting.   GSWC began receiving power under thiscontract on January 1, 2009.  In May 2009,the CPUC issued a final decision approving the contract and authorized GSWC toestablish a regulatory asset and liability memorandum account to offset theentries required by the accounting guidance. Accordingly, all unrealized gains and losses generated from the newpurchased power contract will be deferred on a monthly basis into anon-interest bearing regulatory memorandum account that will track the changesin fair value of the derivative throughout the term of the contract.   As of September 30, 2010 there was an$11.4 million cumulative unrealized loss which has been included in thememorandum account.  This memorandumaccount does not impact GSWC’s earnings.

 

Registrant adopted accountingguidance for fair value measurements effective January 1, 2008 forfinancial assets and liabilities measured on a recurring basis.  This guidance applies to all financial assetsand financial liabilities that are being measured and reported on a fair valuebasis. There was no impact in the adoption of this accounting guidance to theconsolidated financial statements. However, the accounting guidance requiresdisclosure that establishes a framework for measuring fair value and expandsdisclosure about fair value measurements. The guidance requires fair valuemeasurements to be classified and disclosed in one of the following threecategories:

 

*Level 1*: Unadjusted quoted prices in active markets thatare accessible at the measurement date for identical, unrestricted assets orliabilities;

* *

*Level 2*: Quoted prices in markets that are not active, orinputs which are observable, either directly or indirectly, for substantiallythe full term of the asset or liability, or

* *

*Level 3*: Prices or valuation techniques that require inputsthat are both significant to the fair value measurement and unobservable (i.e.,supported by little or no market activity).

 

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Registrant’s valuation modelutilizes various inputs that include quoted market prices for energy over theduration of the contract. The market prices used to determine the fair valuefor this derivative instrument were estimated based on independent sources suchas broker quotes and publications that are not observable in or corroborated bythe market.  Registrant receives onebroker quote to determine the fair value of its derivative instrument.  When such inputs have a significant impact onthe measurement of fair value, the instrument is categorized in Level 3.Accordingly, the valuation of the derivative on Registrant’s new purchasedpower contract has been classified as Level 3 for all periods presented.

 

The following table presentschanges in the fair value of the derivative for the three and nine months endedSeptember 30, 2010 and 2009.

 
| ** **                                           | ** ** | **For the Three Months Ended  September 30,** | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **(dollars in thousands)**                 | ** ** | **2010**                                                               | ** ** | **2009**                                                              | ** ** | **2010** | ** ** | **2009** | ** ** |
| Balance, at beginning of the period                  |       | $                                                                      | (9,552     | )                                                                     | $          | (8,547 | ) | $ | (7,338 | ) | $ | — |   |
| Unrealized gain (loss) on purchased power  contracts |       | (1,809                                                                 | )          | 1,521                                                                 |       | (4,023 | ) | (7,026 | ) |
| Balance, at end of the period                        |       | $                                                                      | (11,361    | )                                                                     | $          | (7,026 | ) | $ | (11,361 | ) | $ | (7,026 | ) |

 

Forthe three and nine months ended September 30, 2010 and 2009, theunrealized gains and losses were included in regulatory assets due toregulatory mechanisms in place effective January 1, 2009.

 

**Note 5 — Fair Value of FinancialInstruments:**

 

Forcash and cash equivalents, accounts receivable, accounts payable and short-termdebt, the carrying amount is assumed to approximate fair value due to theshort-term nature of the amounts. The table below estimates the fair value oflong-term debt held by GSWC. Rates available to GSWC atSeptember 30, 2010 and December 31, 2009 for debt with similarterms and remaining maturities were used to estimate fair value for long-termdebt. Changes in the assumptions will produce differing results.

 
| ** **                           | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(dollars in thousands)** | ** ** | **Carrying Amount**         | ** ** | **Fair Value**             | ** ** | **Carrying Amount** | ** ** | **Fair Value** | ** ** |
| Financial liabilities:               |       |                             |       |                            |       |   |   |   |   |
| Long-term debt—GSWC             |       | $                                | 300,274    |                            | $          | 347,644 |   | $ | 300,586 |   | $ | 335,217 |   |
|                                      |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

**Note 6— Military Privatization:**

 

ASUS,through its wholly owned subsidiaries, operates and maintains the water and/orwastewater systems at various military bases pursuant to 50-year fixed pricecontracts, subject to periodic prospective price redeterminations andmodifications for changes in circumstances.

 

Theamounts charged by the Military Utility Privatization Subsidiaries for waterand/or wastewater services at the respective military bases are based upon theterms of the 50-year contracts between ASUS or its subsidiaries and the U.S. government.Under the terms of these agreements, the Military Utility PrivatizationSubsidiaries agreed to operate and maintain the water and/or wastewater systemsat the respective bases for a monthly net fixed price for operation andmaintenance, and for an amount to cover renewals and replacements for the firsttwo years of the contract.  Under theterms of each of these contracts, prices are to be redetermined at the end ofthe initial two year period and every three years thereafter, unless otherwiseagreed to by the parties to a contract. In addition, prices may be equitablyadjusted for changes in law and other circumstances.  These adjustments can be retrospective and/orprospective.  The Military UtilityPrivatization Subsidiaries have experienced delays in obtaining readjustment ofprices and equitable adjustments as required by the terms of these contracts.

 

InMarch 2009, ONUS filed a request for equitable adjustment related to ajoint inventory report which indicated the quantity of the Fort Bragg infrastructureto be greater than what was estimated by the U.S. government as part of itssolicitation for this contract.  On January 22,2010, the U.S. government approved a $6.5 million equitable adjustmentregarding this inventory. As a result of this contract modification, ASUSrecorded $3.1 million of revenues and operating income during the first quarterof 2010 (approximately $2.8 million of which is retroactive from thecommencement of the contract in March 2008 toDecember 31, 2009).  Theremaining $3.4 million, related to renewal and replacement funds, was recordedas billings in excess of costs and estimated earnings 

 

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onuncompleted contracts in the first quarter of 2010.  The deferred revenue will be recognized inconstruction revenues (along with the related construction costs) when the workis performed.

 

InMarch 2008, FBWS filed a request for equitable adjustment as a claim withthe U.S. government seeking an adjustment in the contract after it wasdetermined that the infrastructure at Fort Bliss was substantially more thanoriginally estimated by the U.S. government as part of its solicitation for thiscontract.  In January 2010, FBWS andthe U.S. government entered into a settlement agreement pursuant to which theU.S. government agreed to pay FBWS retroactive operation and maintenancemanagement fees and retroactive renewal and replacement fees from the contractcommencement date, October 1, 2004. In March 2010, the U.S. government issued a $6 million contractmodification funding a majority of the settlement agreement.  As a result, ASUS recorded $2.5 million inrevenues and pretax operating income and $510,000 in interest income during thefirst quarter of 2010.  The remaining$3.0 million, related to renewal and replacement funds, was recorded asbillings in excess of costs and estimated earnings on uncompletedcontracts.  The deferred revenue will berecognized in construction revenues (along with the related construction costs)as the work is performed.  An additionalmodification funding the balance of the settlement amount was received in June 2010.As a result, for the second quarter of 2010, ASUS recorded additionalconstruction revenues of $85,000 and a reduction in administrative and generalexpense of $117,000 for reimbursement of costs incurred to prepare the requestfor equitable adjustment filing.

 

InAugust 2010, the U.S, government issued TUS a contract modificationapproving interim increases in operation and maintenance management fees atAndrews Air Force Base retroactive from the second anniversary of the contract,February 1, 2008, pending resolution of the first price redeterminationfiling.  As a result, ASUS recordedadditional retroactive revenues and pretax operating income of $700,000 duringthe third quarter of 2010.

 

InMay 2009, PSUS filed a request for equitable adjustment related toemergency construction work performed in 2008 related to a sanitary seweroverflow at Fort Jackson.  In September 2010,the U.S. government approved the request for equitable adjustment.  As a result, for the third quarter of 2010,ASUS recorded an additional $689,000 in construction revenues and pretaxoperating income.

 

InJune 2010, the U.S. government informed ASUS that the first priceredeterminations filed for ODUS and TUS were deemed deficient.  ASUS is currently in discussions with thegovernment on resolution of these price redeterminations.

 

OnJuly 22, 2010, ASUS was served with a subpoena issued in connection with aGrand Jury investigation related to ODUS’ water and wastewater privatizationcontracts for the military bases in Virginia.  The investigation is in itsearly stages and ASUS is in the process of producing documents requested in thesubpoena.  At this time, management cannot predict the final outcome ofthe investigation or a range of loss, if any.

 

**Note 7— Income Taxes:**

 

Asa regulated utility, GSWC treats certain temporary differences asflow-through adjustments in computing its income tax provisionconsistent with the income tax approach approved by the CPUC for ratemakingpurposes. Flow-through adjustments increase or decrease tax expensein one period, with an offsetting increase or decrease occurring inanother period. Giving effect to these temporary differences as flow-throughadjustments typically results in a greater variance between theeffective tax rate (“ETR”) and the statutory federal income tax rate in any givenperiod than would otherwise exist if GSWC were not requiredto account for its income taxes as a regulated enterprise.  The GSWC ETR for the three months ended September 30,2010 was 53.3% as compared to 42.9% applicable to the three months ended September 30,2009.  The GSWC ETR for the nine monthsended September 30, 2010 was 46.0% as compared to 41.0% applicable to thenine months ended September 30, 2009. The GSWC ETR can deviate from the federal statutory rate primarily dueto changes between book and taxable income that are treated as flow-throughadjustments in accordance with regulatory requirements (principally plant-,rate-case- and compensation-related items) and other nondeductible permanentitems.  Various items such as meals,entertainment, penalties, and certain charitable, lobbying, and politicalcontributions may not be deductible for tax purposes. The effect that theseflow-through and permanent book-tax differences had on the ETR was furthermagnified by the reduced pretax book income.

 

Registrant’spolicy is to classify interest on income tax over/underpayments in interestincome/expense and penalties in operating expenses.

 

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AWR(parent) receives a tax benefit for expenses incurred at the parent-companylevel.  For the nine months ended September 30, 2009, the taxesrecorded at AWR (parent) also include the effect of changes in California law relatingto state unitary tax principles during the first quarter of 2009. Management intends to elect, commencing with the 2011 tax year, analternative apportionment method made available by tax law changes in2009.  As a result of management’s intention to apply the alternativemethod, AWR adjusted its deferred tax balances in the first quarter of 2009 toreflect the expected amount at which it will realize its California deferredtaxes consistent with the change in tax law, and refined certain related estimates. This resulted in the recording of a benefit of approximately $918,000, or $0.05per share, during the first quarter of 2009. While the effect of the tax lawchanges will continue to affect AWR’s state taxes, the future effects may bebeneficial or detrimental depending on a combination of the profitability ofAWR’s non-California activities as well as the relative proportion of thefactor(s) applied by its apportionment method.  Periodically,management will assess its intention to apply the alternative method and willadjust its deferred tax balances accordingly.

 

GSWCcontinues to compute its state tax provision as if it were autonomous and not amember of AWR’s unitary group.  Thisapproach is consistent with the methodology used for ratemaking purposes.  Given that all of GSWC’s activities areconducted within California, GSWC’s state tax provision does not reflectapportionment of its income; consequently, the change in California law has hadno effect upon GSWC’s state taxes.

 

Registrantcontinues to be under examination by the Internal Revenue Service (“IRS”) forthe tax years 2002 through 2004 and 2007 in connection with having filed refundclaims primarily as a result of the IRS consenting to Registrant’s request forapproval to change a tax accounting method. As a result of progress made during the third quarter of 2010 towardsconcluding the examination, it appears reasonably possible that resolution ofthe examination may not require review by the Joint Committee of Taxation, andthat Registrant’s unrecognized-tax-benefit balance of $4.1 million maysignificantly decrease in the range of zero to $4 million within twelve monthsof September 30, 2010.  Any decreasewould be settlement related, and would involve the receipt of tax refunds andthe adjustment of certain deferred taxes. There continues to be no portion of the unrecognized-tax-benefit balancethat would affect the effective tax rate if recognized.

 

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**Note 8— Employee Benefit Plans:**

 

Thecomponents of net periodic benefit costs, before allocation to the overheadpool, for Registrant’s pension plan, postretirement plan, and Supplemental ExecutiveRetirement Plan (“SERP”) for the three and nine months ended September 30,2010 and 2009 are as follows:

 
| ** **                                     | ** ** | **For The Three Months Ended September 30,** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Pension Benefits**                                                  | ** ** | **Other Postretirement  Benefits** | ** ** | **SERP** | ** ** |
| **(dollars in thousands)**           | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Components of Net Periodic  Benefits Cost:** |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Service cost                                   |       | $                                                                          | 1,199      |   | $ | 1,082 |   | $ | 98 |   | $ | 86 |   | $ | 108 |   | $ | 87 |   |
| Interest cost                                  |       | 1,526                                                                      |       | 1,435 |   | 156 |   | 160 |   | 89 |   | 83 |   |
| Expected return on plan assets                 |       | (1,313                                                                     | )          | (972 | ) | (64 | ) | (52 | ) | — |   | — |   |
| Amortization of transition                     |       | —                                                                     |       | — |   | 105 |   | 105 |   | — |   | — |   |
| Amortization of prior service cost (benefit)   |       | 30                                                                         |       | 30 |   | (50 | ) | (50 | ) | 40 |   | 40 |   |
| Amortization of actuarial loss (gain)          |       | 293                                                                        |       | 572 |   | — |   | — |   |   |   | — |   |
| Net periodic pension cost                      |       | $                                                                          | 1,735      |   | $ | 2,147 |   | $ | 245 |   | $ | 249 |   | $ | 237 |   | $ | 210 |   |

 
| ** **                                     | ** ** | **For The Nine Months Ended September 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **Pension Benefits**                                                 | ** ** | **Other Postretirement  Benefits** | ** ** | **SERP** | ** ** |
| **(dollars in thousands)**           | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Components of Net Periodic  Benefits Cost:** |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Service cost                                   |       | $                                                                         | 3,597      |   | $ | 3,246 |   | $ | 294 |   | $ | 258 |   | $ | 324 |   | $ | 261 |   |
| Interest cost                                  |       | 4,578                                                                     |       | 4,305 |   | 468 |   | 480 |   | 267 |   | 249 |   |
| Expected return on plan assets                 |       | (3,939                                                                    | )          | (2,916 | ) | (192 | ) | (156 | ) | — |   | — |   |
| Amortization of transition                     |       | —                                                                    |       | — |   | 315 |   | 315 |   | — |   | — |   |
| Amortization of prior service cost (benefit)   |       | 90                                                                        |       | 90 |   | (150 | ) | (150 | ) | 120 |   | 120 |   |
| Amortization of actuarial loss (gain)          |       | 879                                                                       |       | 1,716 |   | — |   | — |   | — |   | — |   |
| Net periodic pension cost                      |       | $                                                                         | 5,205      |   | $ | 6,441 |   | $ | 735 |   | $ | 747 |   | $ | 711 |   | $ | 630 |   |

 

Duringthe nine months ended September 30, 2010, Registrant has contributedapproximately $8.6 million to the pension plan and expects to contribute $600,000to the postretirement medical plan later in 2010.  Registrant contributed approximately $7.9million and $8.6 million to the pension plan during the three and nine monthsended September 30, 2010, respectively.  In May 2009, the Board of Directorsapproved the establishment of a Rabbi Trust created for the SERP plan.  During the nine months ended September 30,2010, Registrant deposited $948,000 into the Rabbi Trust.

 

**Note 9 — Contingencies:**

 

***Water Quality-Related Litigation******:***

 

Perchlorateand/or Volatile Organic Compounds (“VOC”) have been detected in five wellsservicing GSWC’s South San Gabriel System. GSWC filed suit in federal court,along with two other affected water purveyors and the San Gabriel Basin WaterQuality Authority (“WQA”), against some of those allegedly responsible for thecontamination of two of these wells. Some of the other potential defendantssettled with GSWC, other water purveyors and the WQA (the “Water Entities”), onVOC related issues prior to the filing of the lawsuit. In response to thefiling of the lawsuit, the Potentially Responsible Party (“PRP”) defendantsfiled motions to dismiss the suit or strike certain portions of the suit. Thejudge issued a ruling on April 1, 2003 granting in part and denying inpart the PRP’s motions. A key ruling of the court was that the water purveyors,including GSWC, by virtue of their ownership of wells contaminated withhazardous chemicals are themselves PRPs under the Comprehensive EnvironmentalResponse, Compensation, and Liability Act (“CERCLA”).

 

GSWChas, pursuant to permission of the court, amended its suit to claim certainaffirmative defenses as an “innocent” party under CERCLA. Registrant ispresently unable to predict the outcome of this ruling on its ability to fullyrecover from the PRPs future costs associated with the treatment of thesewells. In this same suit, the PRPs have filed cross-complaints against theWater Entities, the MWD, the Main San Gabriel Basin Watermaster and

 

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otherson the theory that they arranged for and did transport contaminated water intothe Main San Gabriel Basin for use by GSWC and the other two affected water purveyorsand for other related claims.

 

OnAugust 29, 2003, the US Environmental Protection Agency (“EPA”) issuedUnilateral Administrative Orders (“UAO”) against 41 parties deemed responsiblefor polluting the groundwater in that portion of the San Gabriel Valley fromwhich the two impacted GSWC wells draw water. GSWC was not named as a party tothe UAO. The UAO requires that these parties remediate the contamination. Thejudge in the lawsuit has appointed a special master to oversee mandatorysettlement discussions between the PRPs and the Water Entities. EPA is alsoconducting settlement discussions with several PRPs regarding the UAO. TheWater Entities and EPA are working to coordinate their settlement discussionsunder the special master in order to arrive at a complete resolution of allissues affecting the lawsuit and the UAO. Settlements have been reached betweenWQA and some PRPs. Settlements with a number of other PRPs are being finalized;however, Registrant is presently unable to predict the ultimate outcome ofthese settlement discussions.

 

***Condemnation of Properties******:***

 

Thelaws of the State of California and the State of Arizona provide for theacquisition of public utility property by governmental agencies through theirpower of eminent domain, also known as condemnation, where doing so isnecessary and in the public interest. In addition, the laws of Californiaprovide: (i) that the owner of utility property may contest whether thecondemnation is actually necessary and in the public interest, and(ii) that the owner is entitled to receive the fair market value of itsproperty if the property is ultimately taken.

 

TheTown of Apple Valley (the “Town”) abandoned its activities related to apotential condemnation of GSWC’s water system serving the Town in 2007.However, in April 2009, the Town announced that it will again consider apotential takeover of GSWC’s Apple Valley water systems as well as those ofanother privately-owned utility.  TheTown Council has directed staff to research the costs associated with updatingthe previously prepared financial feasibility study for the acquisition of GSWC’swater system.

 

TheStanton City Council recently decided to solicit proposals to identify theprocess, potential costs and legal issues for acquiring the water system ownedby GSWC.

 

Exceptfor the City of Stanton and the Town of Apple Valley, Registrant is currentlynot involved in activities related to the potential condemnation of any of itswater customer service areas or in its BVES customer service area. No formalcondemnation proceedings have been filed against any of the Registrant’sservice areas during the past three years.

 

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

 

In 1997, the Santa Maria Valley Water ConservationDistrict (“plaintiff”) filed a lawsuit against multiple defendants, includingGSWC, the City of Santa Maria, and several other public water purveyors. Theplaintiff’s lawsuit sought an adjudication of the Santa Maria Groundwater Basin(the “Basin”). A stipulated settlement of the lawsuit has been reached, subjectto CPUC approval.  The settlement, amongother things, if approved by the CPUC, would preserve GSWC’s historical pumpingrights and secure supplemental water rights for use in case of drought or otherreductions in the natural yield of the Basin. GSWC, under the stipulation, hasa right to 10,000 acre-feet of groundwater replenishment provided by theTwitchell Project, a storage and flood control reservoir project operated bythe Santa Maria Valley Conservation District.  A monitoring and annualreporting program has been established to allow the parties to responsiblymanage the Basin and to respond to shortage conditions.  If severe watershortage conditions are found over a period of five years, the management areaengineer will make findings and recommendations to alleviate suchshortages.  In the unlikely case that the Basin experiences severeshortage conditions, the court has the authority to limit GSWC’sgroundwater production to 10,248 acre-feet per year, based on developedwater in the Basin.  Over the lastfive years, GSWC’s average groundwater production has been 10,140 acre-feet peryear.

 

On February 11, 2008, the court issued itsfinal judgment, which approves and incorporates the stipulation.  Thejudgment awards GSWC prescriptive rights to groundwater against thenon-stipulating parties.  In addition, the judgment grants GSWC the rightto use the Basin for temporary storage and to recapture 45 percent of thereturn flows that are generated from its importation of State Water Projectwater.  Pursuant to this judgment, the court retains jurisdiction over allof the parties to make supplemental orders or to amend the judgment asnecessary.  On 

 

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March 20, 2008, the non-stipulating partiesfiled notices of appeal.  Registrant isunable to predict the outcome of the appeal.

 

***Aerojet Note Receivable:***

 

Pursuantto the settlement agreement with Aerojet discussed in Note 2, GSWC has a notereceivable which is scheduled to be paid by Aerojet in installments over fiveyears beginning in December 2009. GenCorp Inc. is the parent of Aerojet. In January 2010, Standard & Poor’s (“S&P”) upgradedGenCorp Inc’s credit rating to B- from CCC+ with a stable outlook.  This is a non-investment grade ratingassigned by S&P to companies whose financial situation varies.  On March 26, 2010, Moody’s InvestorServices (“Moody’s) upgraded its corporate family rating from B3 to B2.  This is a non-investment grade ratingassigned by Moody’s to obligations that are speculative and subject to highcredit risk and of generally poor credit quality.

 

In December 2009, the Company received from Aerojet $2.6million, including interest, as payment of the first annual installmentunder the terms of the 2004 settlement agreement.  As of September 30, 2010, the unpaidportion of the note receivable is $8.5 million, comprised of $6.4 million inprincipal and $2.1 million in accrued interest. At this time, management believes the note receivable from Aerojet isfully collectible and has not provided a reserve for uncollectible amounts asof September 30, 2010.  GSWC willcontinue to assess recoverability of this note receivable.

 

***Environmental Clean-Up and Remediation******:***

 

ChadronPlant: GSWC has been involved in environmental remediation and clean-up at aplant site (“Chadron Plant”) that contained an underground storage tank whichwas used to store gasoline for its vehicles. This tank was removed inJuly 1990 along with the dispenser and ancillary piping. Since then, GSWChas been involved in various remediation activities at this site.  Recent site assessments have been conductedwhich showed thatthere was more gasoline at higher concentrations spread over a larger area thanpreviously measured. Remediation is estimated to take two more years, followed by at least oneyear of monitoring and reporting.  As of September 30, 2010, the total spent to clean-up and remediateGSWC’s plant facility is approximately $2.4 million, of which $1.5 millionhas been paid by the State of California Underground Storage Tank Fund. Amountspaid by GSWC have been included in rate base and approved by the CPUC forrecovery.

 

As of September 30, 2010, GSWC has an accrued liability for theestimated additional cost of $1.3 million to complete the clean-up at the site.The ultimate cost may vary as there are many unknowns in remediation ofunderground gasoline spills and this is an estimate based on currentlyavailable information. Management also believes it is probable that theestimated additional costs will be approved in rate base by the CPUC.

 

BallonaPlant: During the first quarter of 2008, hydrocarbon contaminated soil wasfound at a plant site (“Ballona Plant”) located in GSWC’s Southwest customerservice area where an abandoned water tank was demolished.  An investigation and characterization of thecontaminated area was conducted.  Theinvestigation report indicates that contamination levels are below normalcleanup goals.  GSWC submitted a clean-upaction plan to the local Certified Unified Program Agency (“CUPA”), whichapproved the clean-up plan.  The clean-upwas completed during the first quarter of 2010. All contaminated soil was removed and replaced with clean soil.  The final Removal Action Completion Report (“RACR”)was submitted to the Site Mitigation Unit (“SMU”) on May 10, 2010.  The SMU reviewed the RACR and issued a nofurther action letter.  The letter statesthat the SMU concurs with the contents of the RACR, which states that the sitecontamination has been satisfactorily mitigated for the current use and nofurther action is required at the subject site. Clean-up costs incurred through September 30, 2010 totaledapproximately $337,000.  Historically,the costs for this type of cleanup have been included in rate base forrecovery.

 

Hawaiian Plant:GSWC conducted****a study for arsenicremoval at the Hawaiian Plant located in the city of Hawaiian Gardens in GSWC’sRegion II from October 2009 through March 2010.  Two loads of sludge generated****during this time period thatwere hazardous waste were inadvertently classified and disposed of asnon-hazardous waste.   OnMay 28, 2010, GSWC voluntarily reported disposing of hazardous wastefrom the plant incorrectly to the Department of Toxic Substance Control (“DTSC”).DTSC has guidelines for voluntary disclosure which is intended to reducepenalties and eliminate the potential for criminal prosecution.  At this time, management cannot estimate anamount of penalties, if any, DTSC may assess.

 

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***Other Litigation******:***

 

Registrantis also subject to other ordinary routine litigation incidental to itsbusiness. Management believes that rate recovery, proper insurance coverage andreserves are in place to insure against property, general liability and workers’compensation claims incurred in the ordinary course of business. Registrant isunable to predict an estimate of the loss, if any, resulting from any pendingsuits or administrative proceedings.

 

**Note 10 — DiscontinuedOperations:**

 

On June 7, 2010, Registrantentered into a stock purchase agreement with EPCOR Water (USA) Inc. to sell allof the common shares of CCWC for a total purchase price of $35 million,including the assumption of approximately $6 million of long-term debt.  Approximately $29 million in cash will bepaid to AWR at closing. The purchase price is subject to certain adjustmentsfor changes in retained earnings. The consummation of the transactioncontemplated by the agreement is subject to customary conditions, includingamong other things, regulatory approval by the Arizona Corporation Commission,which is anticipated to be received in 2011. Therefore, no gain on disposal of CCWC has been recorded during thethree and nine months ended September 30, 2010, pending regulatoryapproval.  Had the transaction closed asof September 30, 2010, AWR would have recognized a pretax gain on disposalof approximately $6.0 million, net of transaction costs of $708,000. The assetsand liabilities of CCWC have been classified as current assets and liabilitiesheld for sale as of September 30, 2010.

 

The carrying amounts of the majorclasses of assets and liabilities of CCWC included in discontinued operationsare as follows:

 
| ** **                                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in thousands)**                    | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Assets:                                                 |       |                   |       |                  |       |
| Utility Plant, net                                      |       | $                      | 43,843     |                  | $          | 44,391 |   |
| Goodwill, net                                           |       | 3,321                  |       | 3,321                 |       |
| Other assets                                            |       | 3,618                  |       | 2,465                 |       |
| Total assets of discontinued operations                 |       | $                      | 50,782     |                  | $          | 50,177 |   |
|                                                    |       |                   |       |                  |       |
| Liabilities:                                            |       |                   |       |                  |       |
| Advances and contributions in aid of construction,  net |       | $                      | 17,852     |                  | $          | 18,035 |   |
| Long term debt                                          |       | 5,975                  |       | 5,975                 |       |
| Other liabilities                                       |       | 3,785                  |       | 2,996                 |       |
| Total liabilities of discontinued operations            |       | $                      | 27,612     |                  | $          | 27,006 |   |

 

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A summary of discontinuedoperations presented in the consolidated statements of income for the three andnine months ended September 30, 2010 and 2009 are as follows:

 
| ** **                                         | ** ** | **For The Three Months Ended  September 30,** | ** ** | **For The Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **(dollars in thousands)**               | ** ** | **2010**                                                               | ** ** | **2009**                                                              | ** ** | **2010** | ** ** | **2009** | ** ** |
| Operating revenues                                 |       | $                                                                      | 2,489      |                                                                  | $          | 2,176 |   | $ | 6,578 |   | $ | 5,654 |   |
|                                               |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Supply costs                                       |       | 328                                                                    |       | 533                                                                   |       | 1,092 |   | 1,336 |   |
| Other operating expenses **(1)**                   |       | 389                                                                    |       | 1,856                                                                 |       | 2,368 |   | 4,333 |   |
| Total operating expenses                           |       | 717                                                                    |       | 2,389                                                                 |       | 3,460 |   | 5,669 |   |
|                                               |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Operating income (loss)                            |       | 1,772                                                                  |       | (213                                                                  | )          | 3,118 |   | (15 | ) |
|                                               |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Interest expense, net                              |       | (87                                                                    | )          | (102                                                                  | )          | (268 | ) | (310 | ) |
|                                               |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Income (loss) before income taxes                  |       | 1,685                                                                  |       | (315                                                                  | )          | 2,850 |   | (325 | ) |
|                                               |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Income tax expense/(benefit) **(2)**               |       | 671                                                                    |       | (122                                                                  | )          | 1,136 |   | (120 | ) |
| Net income (loss)                                  |       | 1,014                                                                  |       | (193                                                                  | )          | 1,714 |   | (205 | ) |
|                                               |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Transaction costs, net of taxes **(3)**            |       | 31                                                                     |       | —                                                                |       | 426 |   | — |   |
| Income (loss) from discontinued operations **(4)** |       | $                                                                      | 983        |                                                                  | $          | (193 | ) | $ | 1,288 |   | $ | (205 | ) |

 

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**(1)****        **In accordancewith the accounting guidance relating to assets held for sale, Registrantceased recording depreciation expense for CCWC as of June 2010.

 

**(2)****        **Income taxexpense (benefit) does not include the effects of CCWC’s inclusion in the AWRcombined California unitary return, which are included in, and do notmaterially affect, the income tax expense of continuing operations.

 

**(3)****        **Included indiscontinued operations for the three and nine months ended September 30,2010 are direct transaction costs of $51,000 and $708,000, respectively forlegal and consulting services in connection with the sale of CCWC.

 

**(4)****        **Corporateoverhead costs allocated to CCWC have been excluded from discontinuedoperations.  The majority of these costsare expected to continue primarily at GSWC. Accordingly, these corporate overhead costs have been included in otheroperating expenses and administrative and general expenses as part ofcontinuing operations in the consolidated statements of income.  Such costs allocated to CCWC that have beenreflected as part of continuing operations amounted to $233,000 and $231,000for the three months ended September 30, 2010 and 2009, respectively, and$747,000 and $665,000 for the nine months ended September 30, 2010 and2009, respectively.

 

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**Note 11 — Business Segments**

 

AWRhas three reportable segments, water, electric and contracted services, whereasGSWC has two segments, water and electric. Within the segments, AWR has twocontinuing principal business units: water and electric service utilityoperations conducted through GSWC, and a contracted services unit conductedthrough ASUS and its subsidiaries. All activities of GSWC are geographicallylocated within California.  The operatingactivities of CCWC have been included in discontinued operations as describedin Note 10.  All activities of CCWC are locatedin the state of Arizona. Both GSWC and CCWC are rate-regulated utilities.

 

Activitiesof ASUS and its subsidiaries have been conducted in California, Maryland, NewMexico, North Carolina, South Carolina, Texas and Virginia.  ASUS’s wholly owned subsidiaries areregulated by the state in which the subsidiary primarily conducts water and/orwastewater operations.  Fees charged foroperation and maintenance and renewal and replacement services are based uponthe terms of the contracts with the U.S. government which have been filed withthe commissions in the states in which ASUS’s subsidiaries areincorporated.  On a stand-alone basis,AWR has no material assets other than its investments in its subsidiaries.

 

Thetables below set forth information relating to GSWC’s operating segments, ASUSand its subsidiaries, and other matters. Certain assets, revenues and expenseshave been allocated in the amounts set forth. The identifiable assets are netof respective accumulated provisions for depreciation. Capital additionsreflect capital expenditures paid in cash and exclude property installed bydevelopers and conveyed to GSWC and CCWC.

 
| ** **                                      | ** ** | **As Of And For The Three Months Ended September 30, 2010** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **GSWC**                                                                                                      | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**            | ** ** | **Water**                                                                                                     | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating revenues                              |       | $                                                                                                             | 82,634     |   | $ | 7,917 |   | $ | — |   | $ | 20,749 |   | $ | — |   | $ | 111,300 |   |
| Operating income (loss) **(1)**                 |       | 12,852                                                                                                        |       | 1,133 |   | (233 | ) | 3,159 |   | (14 | ) | 16,897 |   |
| Interest expense, net                           |       | 4,341                                                                                                         |       | 360 |   | — |   | 59 |   | 37 |   | 4,797 |   |
| Identifiable assets                             |       | 811,596                                                                                                       |       | 36,945 |   | — |   | 3,510 |   | — |   | 852,051 |   |
| Depreciation and amortization expense           |       | 7,621                                                                                                         |       | 560 |   | — |   | 216 |   | — |   | 8,397 |   |
| Net income from discontinued operations **(2)** |       | —                                                                                                        |       | — |   | 983 |   | — |   | — |   | 983 |   |
| Capital additions                               |       | 17,878                                                                                                        |       | 873 |   | 192 |   | 415 |   | — |   | 19,358 |   |
|                                            |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |
| ** **                                      | ** ** | **As Of And For The Three Months Ended September 30, 2009** | ** ** |
| ** **                                      | ** ** | **GSWC**                                                                                                      | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**            | ** ** | **Water**                                                                                                     | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating revenues                              |       | $                                                                                                             | 76,121     |   | $ | 6,563 |   | $ | — |   | $ | 16,641 |   | $ | — |   | $ | 99,325 |   |
| Operating income (loss) **(1)**                 |       | 21,122                                                                                                        |       | (669 | ) | (231 | ) | 2,456 |   | (10 | ) | 22,668 |   |
| Interest expense, net                           |       | 4,964                                                                                                         |       | 559 |   | — |   | 86 |   | (23 | ) | 5,586 |   |
| Identifiable assets                             |       | 771,578                                                                                                       |       | 36,842 |   | — |   | 3,072 |   | — |   | 811,492 |   |
| Depreciation and amortization expense           |       | 7,151                                                                                                         |       | 565 |   | — |   | 174 |   | — |   | 7,890 |   |
| Net loss from discontinued operations           |       | —                                                                                                        |       | — |   | (193 | ) | — |   | — |   | (193 | ) |
| Capital additions                               |       | 16,812                                                                                                        |       | 340 |   | 370 |   | 1,171 |   | — |   | 18,693 |   |
|                                            |       |                                                                                                          |       |   |   |   |   |   |   |   |   |   |   |
| ** **                                      | ** ** | **As Of And For The Nine Months Ended September 30, 2010**  | ** ** |
| ** **                                      | ** ** | **GSWC**                                                                                                      | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**            | ** ** | **Water**                                                                                                     | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating revenues                              |       | $                                                                                                             | 211,507    |   | $ | 26,741 |   | $ | — |   | $ | 56,994 |   | $ | — |   | $ | 295,242 |   |
| Operating income (loss) **(1)**                 |       | 41,114                                                                                                        |       | 4,309 |   | (747 | ) | 12,606 |   | (84 | ) | 57,198 |   |
| Interest expense, net                           |       | 14,610                                                                                                        |       | 1,117 |   | — |   | (310 | ) | 89 |   | 15,506 |   |
| Identifiable assets                             |       | 811,596                                                                                                       |       | 36,945 |   | — |   | 3,510 |   | — |   | 852,051 |   |
| Depreciation and amortization expense           |       | 22,864                                                                                                        |       | 1,680 |   | — |   | 577 |   | — |   | 25,121 |   |
| Net income from discontinued operations **(2)** |       | —                                                                                                        |       | — |   | 1,288 |   | — |   | — |   | 1,288 |   |
| Capital additions                               |       | 54,588                                                                                                        |       | 1,614 |   | 406 |   | 1,095 |   | — |   | 57,703 |   |

 

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| ** **                            | ** ** | **As Of And For The Nine Months Ended September 30, 2009** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **GSWC**                                                                                                     | ** ** | **CCWC** | ** ** | **ASUS** | ** ** | **AWR** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**  | ** ** | **Water**                                                                                                    | ** ** | **Electric** | ** ** | **Water** | ** ** | **Contracts** | ** ** | **Parent** | ** ** | **AWR** | ** ** |
| Operating revenues                    |       | $                                                                                                            | 203,594    |   | $ | 21,083 |   | $ | — |   | $ | 44,332 |   | $ | — |   | $ | 269,009 |   |
| Operating income (loss) **(1)**       |       | 55,740                                                                                                       |       | (1,141 | ) | (665 | ) | 4,539 |   | (71 | ) | 58,402 |   |
| Interest expense, net                 |       | 13,834                                                                                                       |       | 1,613 |   | — |   | 275 |   | 111 |   | 15,833 |   |
| Identifiable assets                   |       | 771,578                                                                                                      |       | 36,842 |   | — |   | 3,072 |   | — |   | 811,492 |   |
| Depreciation and amortization expense |       | 21,456                                                                                                       |       | 1,694 |   | — |   | 493 |   | — |   | 23,643 |   |
| Net loss from discontinued operations |       | —                                                                                                       |       | — |   | (205 | ) | — |   | — |   | (205 | ) |
| Capital additions                     |       | 52,189                                                                                                       |       | 929 |   | 1,194 |   | 1,321 |   | — |   | 55,633 |   |
|                                       |            |                                                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**(1)****        **Operatingincome (loss) include CCWC’s allocated corporate overhead costs that areexpected to continue primarily at GSWC.

 

**(2)****        **In accordancewith the accounting guidance relating to assets held for sale, Registrantceased recording depreciation expense for CCWC as of June 2010.

 

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**Item 2. Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

**General**

 

AmericanStates Water Company (“AWR”) is the parent company of Golden State WaterCompany (“GSWC”), Chaparral City Water Company (“CCWC”) and American StatesUtility Services, Inc. (“ASUS”) and its subsidiaries (Fort Bliss WaterServices Company (“FBWS”), Terrapin Utility Services, Inc. (“TUS”), OldDominion Utility Services, Inc. (“ODUS”), Palmetto State Utility Services, Inc.(“PSUS”) and Old North Utility Services, Inc. (“ONUS”)). AWR wasincorporated as a California corporation in 1998 as a holding company.  AWR has three reportable segments: water,electric and contracted services. Within the segments, AWR has three principalbusiness units: water and electric service utility operations conducted throughGSWC, a water service utility operation conducted through CCWC, and contractedservices conducted through ASUS and its subsidiaries. FBWS, TUS, ODUS, PSUS andONUS may be referred to herein collectively as the “Military UtilityPrivatization Subsidiaries.”

 

GSWCis a California public utility company engaged principally in the purchase,production and distribution of water. GSWC also distributes electricity in onecustomer service area. GSWC is regulated by the California Public UtilitiesCommission (“CPUC”) and was incorporated as a California corporation on December 31,1929. GSWC is organized into one electric customer service area and three waterservice regions operating within 75 communities in 10 counties in the State ofCalifornia in 21 customer service areas. Region I consists of 7 customerservice areas in northern and central California; Region II consists of 4customer service areas located in Los Angeles County; and Region III consistsof 10 customer service areas in eastern Los Angeles County, and in Orange, SanBernardino and Imperial counties. GSWC provides electric service to the City ofBig Bear Lake and surrounding areas in San Bernardino County through its BearValley Electric Service (“BVES”) division.

 

GSWCserved 255,724 water customers and 23,176 electric customers at September 30,2010, or a total of 278,900 customers, compared with 255,028 water customersand 23,055 electric customers, or a total of 278,083 customers at September 30,2009. GSWC’s utility operations exhibit seasonal trends. Although GSWC’s waterutility operations have a diversified customer base, residential and commercialcustomers account for the majority of GSWC’s water sales and revenues. Revenuesderived from commercial and residential water customers accounted forapproximately 90% of totalwater revenues for the three and nine months ended September 30,2010 and 2009.

 

GSWChas also been pursuing opportunities to provide retail water services withinthe service area of the Natomas Central Mutual Water Company (“Natomas”). Natomas is a California mutual water company which currently provides waterservice to its shareholders, primarily for agricultural irrigation in portionsof Sacramento and Sutter counties in northern California. GSWC and Natomas haveentered into various agreements for water transfers that may allow GSWC theability to serve portions of Sutter County in the future.

 

CCWCis an Arizona public utility company serving 13,463 customers at September 30,2010, compared with 13,397 customers at September 30, 2009. Located in thetown of Fountain Hills, Arizona and a portion of the City of Scottsdale,Arizona, the majority of CCWC’s customers are residential. The ArizonaCorporation Commission (“ACC”) regulates CCWC. On June 7, 2010, AWR entered into a stock purchase agreement withEPCOR Water (USA) Inc. (“EPCOR”) to sell all the common shares of CCWC for atotal purchase price of $35 million, including the assumption of approximately$6 million of long-term debt. Approximately $29 million in cash will be paid to AWR at closing. Thepurchase price is subject to certain adjustments for changes in retainedearnings. The consummation of the transaction contemplated by the agreement issubject to customary conditions, including among other things, regulatoryapproval by the ACC, which is anticipated to be received in 2011.  Accordingly,the operational results of CCWC are reported in discontinued operations.

 

ASUS,itself or through its wholly owned subsidiaries, has contracted with the U.S.government to provide water and/or wastewater services, including both theoperation and maintenance and, in most cases, the renewal and replacement ofthe water and/or wastewater systems pursuant to 50-year fixed price contracts,which are subject to periodic prospective price redeterminations andmodifications for changes in circumstances. All of the contracts with the U.S. government may be terminated, inwhole or in part, prior to the end of the 50-year term for convenience of theU.S. government or as a result of default or nonperformance by the subsidiaryperforming the contract. In either event, ASUS or the affected subsidiary isentitled to recover the remaining amount of its capital investment pursuant tothe terms of a termination settlement with the U.S. government at the time oftermination as provided in each of the contracts. The contract price for eachof these contracts is subject to redetermination two years after commencementof operations and every three years thereafter under the terms of thesecontracts unless the parties agree otherwise. Prices are subject to equitableadjustment based upon changes in circumstances, changes

 

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inlaws and/or regulations, and changes in wages and fringe benefits to the extentprovided in each of the contracts.  AWRguarantees performance on all of ASUS’ military contracts.  Pursuant to the terms of these contracts, theMilitary Utility Privatization Subsidiaries operate, as of the effective dateof their respective contracts, the following water and wastewater systems:

 

·                  FBWS - water and wastewater systems at Fort Bliss locatednear El Paso, Texas and extending into southeastern New Mexico effective October 1,2004;

 

·                  TUS - water and wastewater systems at Andrews Air ForceBase in Maryland effective February 1, 2006;

 

·                  ODUS - wastewater systems at Fort Lee in Virginia effectiveFebruary 23, 2006 and the water and wastewater systems at Fort Eustis,Fort Monroe and Fort Story in Virginia effective April 3, 2006(collectively, the “TRADOC bases”);

 

·                  PSUS - water and wastewater systems at Fort Jackson inSouth Carolina effective February 16, 2008; and

 

·                  ONUS - water and wastewater systems at Fort Bragg, Pope AirForce Base and Camp MacKall, North Carolina effective March 1, 2008.

 

**Overview**

 

Thefollowing analysis includes a presentation of “adjusted fully diluted earningsfrom continuing operations”, which exclude the one-time pretax charge for theimpairment of assets and loss contingencies recorded during the three and ninemonths ended September 30, 2010. This measure is not presented in accordancewith Generally Accepted Accounting Principles (“GAAP”). Management believesthat the presentation of this adjusted measure is useful to investors becauseit provides a means of evaluating AWR’s operating performance without givingeffect to one-time charges that occurred in the third quarter of 2010, whichhad been triggered principally by pending regulatory matters and do not reflectthe day-to-day operations of the Company. Included in the following analysis isalso a discussion of water and electric margins.  Water and electric margins are computed bytaking total revenues, less total supply costs. Registrant uses these margins and related percentages as an importantmeasure in evaluating its operating results. Registrant believes this measure is a useful internal benchmark inevaluating the utility business performance within its water and electricsegments. Registrant reviews these measurements regularly and compares them tohistorical periods and to our operating budget as approved. However, thismeasure, which is not presented in accordance with GAAP, may not be comparableto similarly titled measures used by other entities and should not beconsidered as an alternative to operating income, which is determined inaccordance with GAAP, as an indicator of operating performance. Areconciliation of water and electric margins to the most directly comparableGAAP measures are included in the table under our discussion of supply costsincluded in operating expenses.

 

Registrant’srevenues, operating income and cash flows are earned primarily throughdelivering potable water to homes and businesses through approximately 2,900miles of water distribution pipelines and the delivery of electricity in theBig Bear area of San Bernardino County. Rates charged to customers of GSWC andCCWC are determined by the CPUC and ACC, respectively. These rates are intendedto allow recovery of operating costs and a reasonable rate of return on capital.  Factors affecting financial performance ofour regulated utilities include the process and timing of setting rates chargedto customers; the ability to recover, and the process for recovering in rates,the costs of distributing water and electricity and our overhead costs; fines,penalties and disallowances by state regulatory agencies arising from failuresto comply with regulatory requirements; weather; the impact of increased waterquality standards and environmental regulations on the cost of operations andcapital expenditures; pressures on water supply caused by population growth,more stringent water quality standards, deterioration in water quality andwater supply from a variety of causes; capital expenditures needed to upgradewater systems and increased costs; and risks associated with litigationrelating to water quality and water supply, including suits initiated byRegistrant to protect its water supply.

 

Operating revenues andincome from contracted services at ASUS and its subsidiaries are earnedprimarily from the operation and maintenance and renewal and replacement of thewater and/or wastewater systems for the U.S. government at various militarybases. All of the current contracts with the U.S. government are 50-year firm,fixed-price contracts with prospective price redeterminations. ASUS also maygenerate revenues from the construction of infrastructure improvements at thesebases pursuant to the terms of these 50-year contracts or pursuant to contractmodifications.  Additional revenuesgenerated by contract operations are primarily dependent on these newconstruction activities.  As a result,ASUS is subject to risks that are different than those of Registrant’sregulated water and electric utilities. ASUS plans to continue seeking contracts for the operation andmaintenance and renewal and replacement of water and/or wastewater services atmilitary bases.  Factors affecting thefinancial performance of our Military Utility Privatization Subsidiariesinclude delays in receiving payments from the U.S. government and theredetermination and equitable adjustment of prices under the contracts with theU.S. government; fines, penalties or disallowance of costs by the federalgovernment; and termination of contracts and suspension or debarment for aperiod of time from contracting with the federal government due to violationsof federal law and regulations in connection with military utilityprivatization activities.

 

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Registrantplans to continue to seek additional rate increases in future years to recoveroperating and supply costs and receive reasonable returns on invested capital.Capital expenditures in future years are expected to remain at much higherlevels than depreciation expense. When necessary, Registrant obtains funds fromexternal sources in capital markets and through bank borrowings. In May 2010,the Company entered into the Third Amendment to the Amended and Restated CreditAgreement in order to extend the expiration date of the syndicated creditfacility from June 3, 2010 to May 27, 2013.  The maximumamount that may be borrowed under the amended facility was reduced from$115,000,000 to $100,000,000.  The Company may, under the terms ofthe Amended and Restated Credit Agreement, elect to increase the aggregate bankcommitments by up to $40,000,000.

 

Forthe three months ended September 30, 2010, income from continuingoperations was $5.7 million compared to $9.9 million in the same period of2009, a decrease of 42.7%. Diluted earnings per share from continuingoperations for the three months ended September 30, 2010 were $0.30compared to $0.53 in the same period of 2009, a decrease of $0.23 per share duelargely to a one-time pretax charge of $9.0 million, or $0.32 per share,recorded at GSWC during the third quarter of 2010 for the impairment of assetsand loss contingencies resulting from pending regulatory matters, which may beadjusted as additional information becomes known.

 

Excludingthe effect of the $0.32 per share one-time pretax charge for the impairment ofassets and loss contingencies discussed above, adjusted fully diluted earningsfrom continuing operations (a non-GAAP financial measure) would be $0.62 pershare for the third quarter ended September 30, 2010, a $0.09 per shareincrease, as compared to the same period of 2009 due to the followingsignificant items, all of which are more fully discussed later: (i) anincrease in the dollar water margin of GSWC’s water operations of $2.6 million,or $0.08 per share; (ii) an increase in the dollar electric margin of $1.5million, or $0.05 per share; (iii) an increase in other operating expenses(other than supply costs) at GSWC of $1.5 million, or $0.05 per share; (iv) anincrease in ASUS’ pretax operating income of $703,000, or $0.02 per share; (v) adecrease in other income of $591,000 or $0.02 per share related to lossesincurred at one of AWR’s investments in a partially-owned affiliate accountedfor by the equity method; (vi) an increase in the effective income taxrate, negatively impacting earnings by $0.02 per share, due primarily tochanges between book and taxable income that are treated as flow-throughadjustments in accordance with regulatory requirements and other non-deductibleitems; and (vii) a decrease in interest expense, net of interest income of$789,000, or $0.03 per share.

 

Forthe nine months ended September 30, 2010, income from continuingoperations decreased to $22.8 million compared to $26.3 million in the sameperiod of 2009.  Reported dilutedearnings from continuing operations for the nine months ended September 30,2010 were $1.21 per share compared to $1.46 per share for the nine months endedSeptember 30, 2009.  Excluding theeffect of the $0.32 per share one-time pretax charge for the impairment ofassets and loss contingencies discussed above, adjusted fully diluted earningsfrom continuing operations (a non-GAAP financial measure) would be $1.53, a$0.07 per share increase, as compared to the same period of 2009 due to thefollowing significant items, all of which are more fully discussed later: (i) anincrease in GSWC’s dollar water and electric margin of $6.9 million, or $0.22per share; (ii) an increase in other operating expenses at GSWC (otherthan supply costs), of $7.1 million, or $0.23 per share; (iii) an increasein operating income of $8.1 million, or $0.26 per share for contracted servicesdue primarily to the receipt of retroactive and prospective equitableadjustments and other improved financial performance at the Military UtilityPrivatization Subsidiaries; (iv) a decrease in other income of $648,000,or $0.02 per share, due to losses incurred at one of AWR’s investments,accounted for by the equity method; (v) a change in enacted state tax lawduring the first quarter of 2009 which resulted in a tax benefit of $918,000,or $0.05 per share which did not recur in 2010; (vi) an overall increasein the effective income tax rate (excluding the tax benefit mentionedpreviously) decreasing earnings by approximately $0.06 per share, due primarilyto changes between book and taxable income that are treated as flow-throughadjustments in accordance with regulatory requirements and other nondeductiblepermanent items; and (vii) a decrease of $0.05 per share due to anincrease in the weighted average number of common shares outstanding resultingfrom the issuance of 1.15 million shares of AWR’s Common Shares in a publicoffering in May 2009.

 

Aspreviously discussed, on June 7, 2010, Registrant entered into a stockpurchase agreement to sell all of the common shares of CCWC for a totalpurchase price of $35 million, including the assumption of approximately $6million of long-term debt. Approximately $29 million in cash will be paid toAWR at closing. The purchase price is subject to certain adjustments forchanges in retained earnings.  Theconsummation of the transaction contemplated by the agreement is subject tocustomary conditions, including among other things, regulatory approval by theACC, which is anticipated to be received in 2011.  Therefore, no gain on disposal of CCWC hasbeen recorded during the three and nine months ended September 30, 2010.Had the transaction closed as of September 30, 2010, AWR would haverecognized a pretax gain on disposal of approximately $6.0 million, net of

 

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transactioncosts of $708,000. The results of operations of CCWC for the three and ninemonths ended September 30, 2010 and 2009 have been presented as adiscontinued operation.  For the threeand nine months ended September 30, 2010, income from discontinuedoperations increased by $1.2 million or $0.06 per share, and $1.5 million or$0.08 per share, respectively, compared to the same periods of 2009 due toimproved financial performance at CCWC.

 

Negativelyimpacting pretax operating income from GSWC’s water operations for the threeand nine months ended September 30, 2010 is the delay from the CPUC inreceiving final approval of GSWC’s Region II, Region III, and general officerate case filed in July 2008.  On October 20,2010, the CPUC issued a proposed decision and an alternate decision (“ProposedDecisions”) for this rate case. TheProposed Decisions adopt the partial settlement agreement reached between GSWCand the Division of Ratepayer Advocates which include capital budgets, sales, andsupply costs.  The CPUC mayapprove either the proposed or alternate decision, as written, or modify thembased upon comments received during a twenty day comment period which commencedon October 20, 2010. GSWC is in the process of providing comments to theCPUC regarding items in the decisions and cannot predict whether any changeswill be made to the decisions prior to adoption. The CPUC is scheduled to issuea final decision in the fourth quarter of 2010.

 

Onceapproved, the final decision will authorize the 2010 rate increases retroactiveto January 1, 2010.  In addition tothe new rates, GSWC will implement a surcharge to recover, over the remainderof this three year rate case cycle, the revenue difference between interimrates implemented on January 1, 2010 and the new rates, once a finaldecision is issued by the CPUC. The final decision would also adopt new revenuerequirements and reflect the most recent rates in supply costs.  Accordingly, once a final decision is issuedby the CPUC, GSWC will re-calculate and adjust, retroactively, amounts recordedfor 2010 in Region II and Region III’s Water Revenue Adjustment Mechanismaccounts and Modified Cost Balancing Accounts based on the new adopted revenuesand supply costs. Depreciation expense will also be re-calculated based on newcomposite depreciation rates.  Thisadjustment will also be recorded retroactively to January 1, 2010.  Based on the Proposed Decisions, GSWC’sdepreciation expense for the nine months ended September 30, 2010 wouldhave increased by approximately $2.8 million had the decision been in place on January 1,2010.  The adjustments noted above, amongothers, will be included in the results of the fourth quarter of 2010 uponissuance of the final decision by the CPUC. Had the new rates from the Proposed Decisions been in place on January 1,2010, pretax operating income for the nine months ended September 30, 2010would have increased by $10.3 million, or $0.33 per share, and have beenreflected in the following quarters (amounts in thousands, except per shareamounts):

 
| ** **                                              | ** ** | **Impact To** | ** ** | ** **         | ** ** |
|---------------------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                              | ** ** | **Pretax**         | ** ** | ** **         | ** ** |
| ** **                                              | ** ** | **Operating**      | ** ** | **Impact To** | ** ** |
| **Pro-Forma Increase by Quarter *** | ** ** | **Income**         | ** ** | **EPS**            | ** ** |
| First Quarter                                           |       | $                  | 2,312      |               | $          | 0.07 |   |
| Second Quarter                                          |       | 4,312              |       | 0.14               |       |
| Third Quarter                                           |       | 3,644              |       | 0.12               |       |
| Nine months ended September 30, 2010               |       | $                  | 10,268     |               | $          | 0.33 |   |

 

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*****The amounts summarized in the above table have notbeen reflected in reported earnings through September 30, 2010 pendingfinal approval by the CPUC of Regions II and II and the General Office generalrate case.  As previously discussed, thefinal decision is expected in the fourth quarter of 2010.  Management cannot predict the ultimateoutcome from the final decision.

 

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**Summary Results by Segment**

 

AWR has three reportable segments:water, electric and contracted services. Within the segments, AWR has twoprincipal business units included in continuing operations: water and electricservice utility operations conducted through GSWC, and a contracted servicesunit through ASUS and its subsidiaries. As discussed previously, in June 2010 AWR entered into a stockpurchase agreement to sell all the common shares of CCWC.  Accordingly, the results of operations ofCCWC for the three and nine months ended September 30, 2010 and 2009 havebeen reported in discontinued operations. The summary results by segment below are presented for AWR’s continuingoperations.

 

*Third Quarter Results*

 

The tables below set forthsummaries of the results by segment of continuing operations (amounts inthousands):

 
| ** **                        | ** ** | **Operating Revenues** | ** ** | **Pretax Operating Income** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **3 Months**           | ** ** | **3 Months**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **Ended**                   | ** ** | **Ended**                             | ** ** | **$** | ** ** | **%** | ** ** | **Ended** | ** ** | **Ended** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                        | ** ** | **9/30/2010**               | ** ** | **9/30/2009**                         | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** | **9/30/2010** | ** ** | **9/30/2009** | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
|                              |       |                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Water                             |       | $                           | 82,634     |                                  | $          | 76,121 |   | $ | 6,513 |   | 8.6 | % | $ | 12,852 |   | $ | 21,122 |   | $ | (8,270 | ) | -39.2 | % |
| Electric                          |       | 7,917                       |       | 6,563                                 |       | 1,354 |   | 20.6 | % | 1,133 |   | (669 | ) | 1,802 |   | -269.4 | % |
| Contracted services               |       | 20,749                      |       | 16,641                                |       | 4,108 |   | 24.7 | % | 3,159 |   | 2,456 |   | 703 |   | 28.6 | % |
| AWR (parent)                      |       | —                      |       | —                                |       | — |   | — |   | (247 | ) | (241 | ) | (6 | ) | 2.5 | % |
| Totals from continuing operations |       | $                           | 111,300    |                                  | $          | 99,325 |   | $ | 11,975 |   | 12.1 | % | $ | 16,897 |   | $ | 22,668 |   | $ | (5,771 | ) | -25.5 | % |

 

***Water -***For the three months ended September 30,2010, pretax operating income for water decreased by $8.3 million, or 39.2%,primarily due to a pretax charge of $9.0 million, or $0.32 per share, forimpairment of assets and loss contingencies resulting from pending regulatorymatters, as discussed further in *Regulatory Matters*.  This was partially offset by a $2.6 millionincrease in the dollar water margin. This increase in water margin was largely due to the implementation ofthe Water Revenue Adjustment Mechanism (“WRAM”) account and the Modified CostBalancing Account (“MCBA”) for Region I, both implemented in September 2009.  Due to the delay in the Region II, Region IIIand general office rate case, GSWC’s revenues and supply costs for Regions IIand III for the third quarter of 2010 have been recorded using 2009 adoptedsales levels pending resolution of this general rate case, which is expected inthe fourth quarter of 2010.  New rates,once approved by the CPUC, are expected to be retroactive to January 1,2010.

 

***Electric —***For the three months ended September 30,2010, pretax operating income from electric operations increased by $1.8million due to an increase in the electric margin of $1.5 million due primarilyto revenues related to rate increases effective November 2009 and January 2010,and a decrease of $342,000 in operating expenses.

 

***Contracted Services -***For the threemonths ended September 30, 2010, pretax operating income for contractedservices increased by $703,000, or 28.6%. This was primarily due to an increase in construction activities.   There was an increase in constructionactivity at Fort Jackson in South Carolina and Fort Bragg in North Carolina ascompared to the third quarter of 2009. There was also an increase in operations and maintenance revenues dueprimarily to a retroactive interim increase at Andrews Air Force Base inMaryland.

 

Thetimely receipt of price redeterminations continues to be critical in order forASUS to recover increasing costs for operating and maintaining the water and/orwastewater systems at the military bases. In addition, higher allocations of corporate headquarters’ expenses toASUS and its wholly owned subsidiaries by the CPUC were not contemplated at thetime the contracts with the U.S. government were negotiated and will need to beaddressed in future price redeterminations.

 

Under theterms of these contracts, the contract price is subject to priceredetermination two years after commencement of operations and every threeyears thereafter, unless otherwise agreed to by the parties to a contract.  In the event that ASUS is managing moreassets at specific military bases than were included in the U.S. government’sRequest for Proposal or if the assets are in substandard condition, ASUS ispermitted to file, and has filed, an REA.

 

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Below isa summary of price redetermination and requests for equitable adjustmentfilings by ASUS subsidiary.

 

·                  FBWS— In connection with the inventory settlement with the U.S. government reachedin January 2010, FBWS and the government agreed to waive the first andsecond price redeterminations for Fort Bliss required under the original50-year contract.

 

·                  TUS—The first price redetermination for Andrews Air Force Base was filed in December 2007.  In June 2010, TUS received notificationfrom the U.S. government that its price redetermination filing wasdeficient.  TUS is currently indiscussions with the government on the resolution of the first priceredetermination.  Pending suchresolution, the government has approved a retroactive adjustment of $1.0million, resulting in the recording in the third quarter of 2010 of $700,000 inadditional revenues and pretax operating income, and $300,000 for payment ofwork performed and previously recognized as construction revenues.  A prospective 18.92% increase in the contractrates is also in effect on an interim basis.

 

·                  ODUS—In June 2010 ODUS received notification from the U.S. government that itsfirst price redetermination filings for the Virginia bases are deficient.  The Company is currently in discussions withthe U.S. government on the resolution of the first price redetermination.Interim increases of 16.93% have been in effect for these bases since 2008.

 

·                  PSUS— PSUS filed an REA in the second quarter of 2009 with the U.S. government inconnection with costs incurred in response to an emergency sanitary sewer overflowat Fort Jackson in South Carolina.  In September 2010,the government approved the REA, resulting in $689,000 in additionalconstruction revenues and pretax operating income recorded in the third quarterof 2010.  PSUS also filed an REA inconnection with the substandard condition of the inventory assumed at FortJackson as compared to what was presented in the government’s Request forProposal.  Resolution of this REA isexpected in late 2010 or early 2011. Finally, the first price redetermination for Fort Jackson is expected tobe filed by the end of 2010.  An interimincrease of 3.4% is currently in effect.

 

·                  ONUS- In April 2009, ONUS filed a request for contract modification with thegovernment in connection with costs associated with initial system deficiencywork.  Resolution of this request isexpected in 2010.  The first priceredetermination for ONUS is expected to be filed by the end of 2010.  An interim increase of 3.6% is currently ineffect.

 

Priceredeterminations and equitable adjustments, which include adjustments toreflect changes in operating conditions and infrastructure levels from thatassumed at the time of the execution of the contracts, as well as inflation incosts, are expected to provide added revenues to help offset increased costsand provide Registrant the opportunity to continue to generate positiveoperating income at its Military Utility Privatization Subsidiaries.  As of September 30, 2010, ASUS has $1.1million of goodwill, which may be at risk for potential impairment if requestedprice redeterminations and equitable adjustments that have not yet beenapproved, are not received.

 

On July 22, 2010, ASUS was served with asubpoena issued in connection with a Grand Jury investigation related to ODUS’water and wastewater privatization contract at the TRADOC bases, and thewastewater utility privatization contract at Fort Lee.  The investigationis in its early stages and ASUS is in the process of producing documentsrequested in the subpoena.  At this time, management cannot predict thefinal outcome of the investigation or a range of loss, if any.

 

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*Year-to-Date Results*

 

The tables below set forthsummaries of the results by segment of continuing operations (amounts inthousands):

 
| ** **                        | ** ** | **Operating Revenues** | ** ** | **Pretax Operating Income** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **9 Months**           | ** ** | **9 Months**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **Ended**                   | ** ** | **Ended**                             | ** ** | **$** | ** ** | **%** | ** ** | **Ended** | ** ** | **Ended** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                        | ** ** | **9/30/2010**               | ** ** | **9/30/2009**                         | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** | **9/30/2010** | ** ** | **9/30/2009** | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
|                              |       |                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Water                             |       | $                           | 211,507    |                                  | $          | 203,594 |   | $ | 7,913 |   | 3.9 | % | $ | 41,114 |   | $ | 55,740 |   | $ | (14,626 | ) | -26.2 | % |
| Electric                          |       | 26,741                      |       | 21,083                                |       | 5,658 |   | 26.8 | % | 4,309 |   | (1,141 | ) | 5,450 |   | -477.7 | % |
| Contracted services               |       | 56,994                      |       | 44,332                                |       | 12,662 |   | 28.6 | % | 12,606 |   | 4,539 |   | 8,067 |   | 177.7 | % |
| AWR (parent)                      |       | —                      |       | —                                |       | — |   | — |   | (831 | ) | (736 | ) | (95 | ) | 12.9 | % |
| Totals from continuing operations |       | $                           | 295,242    |                                  | $          | 269,009 |   | $ | 26,233 |   | 9.8 | % | $ | 57,198 |   | $ | 58,402 |   | $ | (1,204 | ) | -2.1 | % |

 

***Water -***Pretax operating income forwater decreased by $14.6 million, or 26.2%, primarily due to a pretax charge of$9.0 million, or $0.32 per share, for the impairment of assets and losscontingencies resulting from pending regulatory matters, as discussed further in*Regulatory Matters*.  There were also increases in other operatingexpenses, with no corresponding rate recovery due to the delay in the CPUC’sdecision on GSWC’s Regions II, III and general office rate case discussedfurther in *Regulatory Matters*. These increases werepartially offset by a $1.5 million increase in the dollar water margin dueprimarily to the implementation of Region I’s WRAM and MCBA in September 2009,as previously discussed. GSWC’s revenues and supply costs for Regions II andIII for the first nine months of 2010 have been recorded using 2009 adoptedlevels pending resolution of the general rate case, which is expected in thefourth quarter of 2010.  New rates, onceapproved by the CPUC, are expected to be retroactive to January 1, 2010.

 

***Electric —***For the nine months ended September 30,2010, pretax operating income from electric operations increased by $5.5million due to increases in rates which went into effect in November 2009and January 2010.  In addition, as aresult of the Base Revenue Requirement Adjustment Mechanism (“BRRAM”), whichalso went into effect in November 2009, BVES recorded $1.0 million inadditional revenues due to lower customer usage as compared to adopted levelsauthorized by the CPUC.  Also, in March 2010,the CPUC approved for recovery a memorandum account which tracked thedifference between the 2007 adopted general office cost allocation to BVES andthe 1996 adopted general office cost allocation, effective and retroactive fromJune 4, 2009 to October 31, 2009.  As a result, during the first quarter of2010, BVES recorded a regulatory asset of $958,000 and a corresponding increaseto revenues for amounts included in this memorandum account.

 

***Contracted Services -***For the ninemonths ended September 30, 2010, pretax operating income for contractedservices increased by $8.1 million, or $0.27 per share, primarily due tocontract modifications approved by the U.S. government during the first ninemonths of 2010 in connection with requests for equitable adjustment previouslyfiled for inventory price adjustments at Fort Bliss in Texas and Fort Bragg inNorth Carolina.  In addition, there was acontract modification for an interim rate increase pending resolution of thefirst price redetermination which included approximately $700,000 inretroactive management fee revenues at Andrews Air Force Base in Maryland.  These contract modifications increasedrevenues and pretax operating income by a combined $6.3 million.  In addition, there was an overall increase inconstruction activities as compared to the same period in 2009 primarily atFort Bragg, partially offset by decreased construction activity at Fort Bliss,Andrews Air Force Base, and the military bases in Virginia.  Earnings and cash flows from modifications tothe original 50-year contracts with the U.S. government for additionalconstruction activity may or may not continue in future periods.

 

Thefollowing discussion and analysis provides information on AWR’s consolidatedoperations and assets and where necessary, includes specific references to AWR’sindividual segments and/or other continuing subsidiaries, GSWC and ASUS and itssubsidiaries, and the discontinued operations of CCWC.

 

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***Consolidated Results of Operations — Three Months Ended September 30,2010 and 2009 (amounts in thousands):***

 
| ** **                                                   | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                                   | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| OPERATING REVENUES                                           |       |              |       |              |       |       |       |       |       |
| Water                                                        |       | $                 | 82,634     |              | $          | 76,121     |       | $          | 6,513      |   | 8.6 | % |
| Electric                                                     |       | 7,917             |       | 6,563             |       | 1,354      |       | 20.6       | %          |
| Contracted services                                          |       | 20,749            |       | 16,641            |       | 4,108      |       | 24.7       | %          |
| Total operating revenues                                     |       | 111,300           |       | 99,325            |       | 11,975     |       | 12.1       | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| OPERATING EXPENSES                                           |       |              |       |              |       |       |       |       |       |
| Water purchased                                              |       | 15,693            |       | 13,822            |       | 1,871      |       | 13.5       | %          |
| Power purchased for pumping                                  |       | 3,459             |       | 3,131             |       | 328        |       | 10.5       | %          |
| Groundwater production assessment                            |       | 3,311             |       | 3,247             |       | 64         |       | 2.0        | %          |
| Power purchased for resale                                   |       | 2,950             |       | 2,793             |       | 157        |       | 5.6        | %          |
| Supply cost balancing accounts                               |       | 6,219             |       | 4,806             |       | 1,413      |       | 29.4       | %          |
| Other operation expenses                                     |       | 7,788             |       | 7,494             |       | 294        |       | 3.9        | %          |
| Administrative and general expenses                          |       | 26,282            |       | 16,806            |       | 9,476      |       | 56.4       | %          |
| Depreciation and amortization                                |       | 8,397             |       | 7,890             |       | 507        |       | 6.4        | %          |
| Maintenance                                                  |       | 4,314             |       | 3,893             |       | 421        |       | 10.8       | %          |
| Property and other taxes                                     |       | 3,566             |       | 3,509             |       | 57         |       | 1.6        | %          |
| ASUS construction expenses                                   |       | 12,424            |       | 9,266             |       | 3,158      |       | 34.1       | %          |
| Total operating expenses                                     |       | 94,403            |       | 76,657            |       | 17,746     |       | 23.1       | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| OPERATING INCOME                                             |       | 16,897            |       | 22,668            |       | (5,771     | )          | -25.5      | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| OTHER INCOME AND EXPENSES                                    |       |              |       |              |       |       |       |       |       |
| Interest expense                                             |       | (4,963            | )          | (5,760            | )          | 797        |       | -13.8      | %          |
| Interest income                                              |       | 166               |       | 174               |       | (8         | )          | -4.6       | %          |
| Other                                                        |       | (553              | )          | 38                |       | (591       | )          | -1555.3    | %          |
|                                                         |       | (5,350            | )          | (5,548            | )          | 198        |       | -3.6       | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| INCOME FROM CONTINUING OPERATIONS BEFORE INCOME  TAX EXPENSE |       | 11,547            |       | 17,120            |       | (5,573     | )          | -32.6      | %          |
| Income tax expense                                           |       | 5,878             |       | 7,229             |       | (1,351     | )          | -18.7      | %          |
| INCOME FROM CONTINUING OPERATIONS                            |       | 5,669             |       | 9,891             |       | (4,222     | )          | -42.7      | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF  TAX      |       | 983               |       | (193              | )          | 1,176      |       | -609.3     | %          |
| NET INCOME                                                   |       | $                 | 6,652      |              | $          | 9,698      |       | $          | (3,046     | ) | -31.4 | % |

 

Netincome from continuing operations for the three months ended September 30,2010 was $5.7 million, equivalent to $0.31 and $0.30 per common share on abasic and fully diluted basis, respectively, compared to $9.9 million or $0.53per common share on a basic and fully diluted basis, for the three months endedSeptember 30, 2009, a decrease of $0.23 per diluted common share.

 

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Impactingthe comparability of the results from continuing operations between the twoperiods on a diluted per share basis are primarily the following significantitems:

 

·                  An increase in the water margin of GSWC of$2.6 million, or $0.08 per share, during the three months ended September 30,2010 as compared to the same period in 2009 due primarily to the WRAM accounts,net of the MCBA, implemented in September 2009 in Region I’s rate makingareas, offset by consumption decreases.

 

·                  An increase in the electric margin of $1.5million, or $0.05 per share, during the three months ended September 30,2010 as compared to the same period in 2009 due primarily to: (i) higherrates approved by the CPUC effective November 2, 2009 and January 1,2010, and; (ii) the margin impact of recording $324,000 of additionalrevenues in the BRRAM account, implemented in November 2009.

 

·                  A one-time pretax charge of $9.0 million, or$0.32 per share, at GSWC for the impairment of assets and loss contingenciesresulting from pending regulatory matters, which may be adjusted as additionalinformation becomes known.

 

·                   Excluding theone-time pretax charge from pending regulatory matters mentioned above, therewas an increase of $1.5 million, or $0.05 per share, in other operatingexpenses at GSWC during the third quarter of 2010 due primarily to: (i) anincrease in operation and administrative and general expenses of $613,000 due to higher labor costs and otheremployee benefits, and conservation related expenses; (ii) an increase of$403,000 in maintenance expenses; and (iii) an increase of $465,000 indepreciation expense.  These increases inoperating expenses were incurred with no corresponding rate recovery due to thedelay in the CPUC’s decision on GSWC’s Regions II, III and the generaloffice rate case, which is expected in the fourth quarter of 2010 and will beretroactive to January 1, 2010.  Hadthe new rates been in place on January 1, 2010, pretax operating incomefor the three months ended September 30, 2010 would have increased by $3.6million, or $0.12 per share, based on the proposed decisions.

 

·                  An increase inpretax operating income for contracted services of $703,000, or $0.02 pershare, during the three months ended September 30, 2010 due primarily toincreased construction activity at Fort Bragg in North Carolina as compared tothe same period in 2009.

 

·                    A decrease ininterest expense, net of interest income of $789,000, or $0.03 per share, dueprimarily to a downward adjustment in interest expense recorded in the interestrate balancing account, partially offset by slightly higher interest rates onshort-term borrowings as compared to the same period of 2009.

 

·                    An increase inthe effective tax rate negatively impacted earnings by $0.02 per shareprimarily resulting from changes between book and taxable income that aretreated as flow-through adjustments in accordance with regulatory requirementsand other nondeductible permanent items. The effect that these flow-through andpermanent book-tax differences had on the ETR was further magnified by thereduced pretax book income.

 

·                   A decrease inother income of $591,000, or $0.02 per share, due primarily to losses incurredat one of AWR’s investments, accounted for by the equity method.

 

Aspreviously discussed, on June 7, 2010, AWR entered into a stock purchaseagreement with EPCOR Water (USA) Inc. to sell all of the common shares of CCWC.Income from discontinued operations for the three months ended September 30,2010 was $983,000, equivalent to $0.05 per common share on a basic and fullydiluted basis, compared to a loss of $193,000 or negative $0.01 per commonshare on a basic and fully diluted basis, for the three months ended September 30,2009, an increase of $0.06 per common share. This was due to a loss of $760,000 recorded in the third quarter of 2009resulting from a decision issued by the ACC in October 2009 related to asettlement for removal of a well.  Therewas no corresponding loss recorded in 2010. In addition, there was a decrease of $696,000 in depreciation expense.  In accordance with generally acceptedaccounting principles for assets classified as held for sale, the Companyceased depreciating utility plant related to CCWC effective June 2010.

 

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***Operating Revenues***

 

*Water*

 

Dueto the****delay in GSWC’s Regions II and III andgeneral office rate case, GSWC’s revenues and supply costs for Regions II andIII for the third quarter of 2010 have been recorded using 2009 adopted levelspending resolution of this general rate case, which is expected in the fourthquarter of 2010. For the three months ended September 30, 2010, revenuesfrom continuing water operations increased to $82.6 million, compared to $76.1million for the three months ended September 30, 2009.  For the three months ended September 30,2010, GSWC recorded $2.1 million in additional revenues in Region I’s WRAMwhich was implemented in September 2009 to adjust consumption levels tothose adopted by the CPUC, partially offset by a decrease in Region I’s actualconsumption when compared to the third quarter of 2009.  Consumption by GSWC’s customers decreased by4.9% for three months ended September 30, 2010 as compared to the sameperiod in 2009. There was also an increase in water revenues of $3.4 milliondue to surcharges approved by the CPUC in effect to recover under-collectionsin supply costs.

 

*Electric*

 

Forthe three months ended September 30, 2010, revenues from electricoperations increased by 20.6% to $7.9 million compared to $6.6 million for thethree months ended September 30, 2009 due primarily to rate increaseseffective November 2, 2009 and January 1, 2010 approved in October 2009by the CPUC.  This generated an increaseof approximately $1.3 million in electric revenues.  In addition, the Company recorded $324,000 inadditional revenues related to the BRRAM account, also effective November 2,2009, to adjust BVES’ 2010 third quarter revenues to base rate revenuesapproved by the CPUC.  These increaseswere partially offset by a decrease in electric usage of 1.8% for the threemonths ended September 30, 2010 as compared to the same period in 2009.

 

*Contracted Services*

 

Revenues from contracted services are primarilycomprised of construction revenues (including renewals and replacements) andmanagement fees for operating and maintaining the water and/or wastewatersystems at military bases.  For the threemonths ended September 30, 2010, revenues from contracted servicesincreased by $4.1 million, or 24.7%, to $20.7 million compared to $16.6 millionfor the three months ended September 30, 2009. The increase is primarilydue to higher construction revenues.

 

Construction revenues totaled $16.3 million,increasing by $3.0 million compared to the third quarter of 2009.  This was primarily due to an increase of $7.8million in construction revenue at Fort Bragg in North Carolina and at FortJackson in South Carolina including $689,000 of additional constructionrevenues and pretax operating income for the third quarter of 2010 resultingfrom receipt of a contract modification at PSUS to cover previously incurredcosts associated with a sanitary sewer overflow.  These increases were partially offset bylower construction revenues at the military bases in Virginia.  In addition, construction revenues for thethird quarter of 2009 included $1.1 million related to an approved REA forconstruction costs at Fort Jackson mostly incurred in 2008. Earnings and cashflows from modifications to the original 50-year contracts with the U.S.government for new construction activity may or may not continue in futureperiods.

 

For the three months ended September 30, 2010,management fees totaled $4.4 million as compared to $3.4 million for the threemonths ended September 30, 2009. This increase is due to a retroactive price increase effective February 2008,the second anniversary date of commencement of operations, at TUS for AndrewsAir Force Base, pending resolution of a price redetermination filed in2008.  In addition, an REA approved in January 2010resulted in an increase in management fees at Fort Bragg (ONUS) to reflectincreased inventory levels covered under the original contract, which providedfor interim increases totaling $145,000 per month since March 2010.  This resulted in an increase in managementfees of $435,000 for the three months ended September 30, 2010 as comparedto the same period in 2009.  Finally,there was an increase in management fees totaling $207,000 earned in 2010 andrelated to a contract with a municipality to provide billing and meter readingservices. Effective January 1, 2010, GSWC assigned this service contractwith the municipality to ASUS.

 

Registrantrelies upon rate approvals by state regulatory agencies in California andArizona to provide for a return on invested and borrowed capital used to fundutility plant, and price redeterminations and equitable adjustments by the U.S.government in order to recover operating expenses and profit margin. Ifadequate rate relief and/or price redeterminations and adjustments are notgranted in a timely manner, operating revenues and earnings can be negativelyimpacted.

 

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***Operating Expenses:***

 

***Supply Costs***

 

Supplycosts for the water segment consist of purchased water, purchased power forpumping, groundwater production assessments and water supply cost balancingaccounts. Supply costs for the electric segment consist of purchased power forresale (including the cost of natural gas used by BVES in operating itselectric generator) and the electric supply cost balancing account*.* Water and electric margins are computed by taking totalrevenues and deducting total supply costs. Registrant uses these margins andrelated percentages as an important measure in evaluating its operatingresults. Registrant believes this measure is a useful internal benchmark inevaluating the utility business performance within its water and electricsegments. Registrant reviews these measurements regularly and compares them tohistorical periods and to our operating budget as approved. However, thismeasure, which is not presented in accordance with Generally AcceptedAccounting Principles (“GAAP”), may not be comparable to similarly titledmeasures used by other entities and should not be considered as an alternativeto operating income, which is determined in accordance with GAAP, as anindicator of operating performance.

 

Totalsupply costs comprise the largest segment of total operating expenses. Supplycosts accounted for approximately 34% and 36% of total operating expenses forthe three months ended September 30, 2010 and 2009, respectively.

 

Thetable below provides the amount of increases (decreases), percent changes insupply costs, and margins during the three months ended September 30, 2010and 2009 (amounts in thousands):

 
| ** **                                      | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                      | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| WATER OPERATING REVENUES **(1)**                |       | $                 | 82,634     |              | $          | 76,121     |       | $          | 6,513      |   | 8.6 | % |
| WATER SUPPLY COSTS:                             |       |              |       |              |       |       |       |       |       |
| Water purchased **(1)**                         |       | $                 | 15,693     |              | $          | 13,822     |       | $          | 1,871      |   | 13.5 | % |
| Power purchased for pumping **(1)**             |       | 3,459             |       | 3,131             |       | 328        |       | 10.5       | %          |
| Groundwater production assessment **(1)**       |       | 3,311             |       | 3,247             |       | 64         |       | 2.0        | %          |
| Water supply cost balancing accounts **(1)**    |       | 5,645             |       | 3,970             |       | 1,675      |       | 42.2       | %          |
| TOTAL WATER SUPPLY COSTS                        |       | $                 | 28,108     |              | $          | 24,170     |       | $          | 3,938      |   | 16.3 | % |
| WATER MARGIN **(2)**                            |       | $                 | 54,526     |              | $          | 51,951     |       | $          | 2,575      |   | 5.0 | % |
| PERCENT MARGIN - WATER                          |       | 66.0              | %          | 68.2              | %          |       |       |       |       |
|                                            |       |              |       |              |       |       |       |       |       |
| ELECTRIC OPERATING REVENUES **1**          |       | $                 | 7,917      |              | $          | 6,563      |       | $          | 1,354      |   | 20.6 | % |
| ELECTRIC SUPPLY COSTS:                          |       |              |       |              |       |       |       |       |       |
| Power purchased for resale **(1)**              |       | $                 | 2,950      |              | $          | 2,793      |       | $          | 157        |   | 5.6 | % |
| Electric supply cost balancing accounts **(1)** |       | 574               |       | 836               |       | (262       | )          | -31.3      | %          |
| TOTAL ELECTRIC SUPPLY COSTS                     |       | $                 | 3,524      |              | $          | 3,629      |       | $          | (105       | ) | -2.9 | % |
| ELECTRIC MARGIN **(2)**                         |       | $                 | 4,393      |              | $          | 2,934      |       | $          | 1,459      |   | 49.7 | % |
| PERCENT MARGIN - ELECTRIC                       |       | 55.5              | %          | 44.7              | %          |       |       |       |       |

 

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(1)                                  As reported on AWR’sConsolidated Statements of Income, except for supply cost balancing accounts.The sum of water and electric supply cost balancing accounts in the table aboveare shown on AWR’s Consolidated Statements of Income and totaled $6,219,000 and$4,806,000 for the three months ended September 30, 2010 and 2009,respectively.

 

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(2)                                  Water and electric marginsdo not include any depreciation and amortization, maintenance expense, or otheroperating expenses.

 

Twoof the principal factors affecting water supply costs and gross margin are theamount of water produced and the source of the water. Generally, the variablecost of producing water from wells is less than the cost of water purchasedfrom wholesale suppliers. In addition, GSWC is authorized to establish waterand electric supply cost balancing accounts for increases and/or decreases incosts due to changes in rates charged by its suppliers which provide purchasedwater and purchased power, and by agencies assessing groundwater related pumptaxes for water service areas in California. Higher or lower actual costs as compared to costs authorized by the CPUCwill either be recovered from or refunded to customers in the future.

 

OnAugust 21, 2008, the CPUC issued a final decision for Regions II andIII which approved the establishment of a modified cost balancing account thatallows recovery of supply costs for changes in water supply mix.  GSWC implemented the MCBA in late November 2008for Regions II and III and in September 2009 for Region I’s rate-makingareas prospectively in connection with the new conservation rate design and theimplementation of a WRAM.  Under theMCBA, GSWC began tracking adopted expense levels for purchased water, purchasedpower and pump taxes, as established by the CPUC. Variances  between adopted and actual purchased water,purchased power, and pump tax expenses (which include the effects of changes inboth rate and volume) are recorded as a component of the supply cost balancingaccount provision.  The amount of suchvariances will be recovered from or refunded to GSWC’s customers at a laterdate. This is reflected with an offsetting entry to a regulatory asset orliability balancing account (tracked individually for each rate-making area).

 

Aspreviously discussed, GSWC’s supply costs for Regions II and III for the thirdquarter of 2010 have been recorded using 2009 adopted levels pending resolutionof the Region II, Region III and the general office rate case, which isexpected in the fourth quarter of 2010. For the three months ended September 30, 2010, 37.9% of GSWC’swater supply mix was purchased as compared to 38.5% purchased for the threemonths ended September 30, 2009. However, as noted above, the implementation of the MCBA for GSWC’s waterregions eliminates the effects on earnings of changes in the water supply mixprospectively. The adopted percentage of purchased water for the three monthsended September 30, 2010 at Regions I, II and III was 22.5%,64.3% and 49.4%, respectively, as compared to actual purchased water of 19.8%,42.2% and 45.5%, respectively, for the third quarter of 2010. The overallimprovement in actual mix compared to the mix approved by the CPUC resulted inan over-collection in the MCBA account. However, this was partially offset byunder-collections as a result of higher rates charged by suppliers than thoseincluded in the adopted supply costs. The overall water margin percent was 66.0% in the third quarter of 2010as compared to 68.2% in the same period of 2009.

 

Purchasedwater costs for the three months ended September 30, 2010 increased by13.5% to $15.7 million as compared to $13.8 million for the same period of2009.  The increase in purchased watercosts was due to higher water rates charged from wholesale suppliers, partiallyoffset by lower customer usage.

 

Forthe three months ended September 30, 2010, power purchased for pumpingincreased to $3.5 million as compared to $3.1 million in the same period of2009 due to an increase in supplier rates, partially offset by a decrease intotal demand as a result of conservation efforts.  Groundwater productionassessments increased slightly as a result of increases in assessment rates(pump tax rates) levied against groundwater production, effective July 2010,partially offset by lower customer demand.  Average pump tax ratesincreased in Region II by approximately 13% between the two periods. TheMCBA tracks the increases in pump tax rates for future recovery in water rates.

 

Anincrease of $1.7 million in the water supply cost balancing account provisionduring the three months ended September 30, 2010 as compared to the sameperiod in 2009 was primarily caused by a net decrease of $341,000 ofunder-collections for the three months ended September 30, 2010 (related toRegion I) compared to the same period in 2009, and a $3.4 million increase inthe amortization of the water supply cost balancing accounts for surchargescurrently in effect. This was partially offset by a decrease in theover-collection in the MCBA accounts of $2.0 million for the three months endedSeptember 30, 2010 due to an increase in water supply rates as compared tothe same period in 2009.

 

Forthe three months ended September 30, 2010, the cost of power purchased forresale to customers in GSWC’s BVES division increased slightly to $3.0 millioncompared to $2.8 million for the three months ended September 30, 2009reflecting higher energycosts.  On January 1, 2009, GSWC beganreceiving power under a

 

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purchasedpower contract.  The main product underthe contract provides for 13 MWs of electric energy at a fixed price of $67.85per MWh during 2010 as compared to $63.75 per MWh during 2009.  This difference between the price ofpurchased power and $77 per MWh as authorized by the CPUC is reflected in theelectric supply cost balancing account.  This increase in costs was partially offsetby 1.8% lower customer demand as compared to the three months ended September 30,2009.

 

***Other Operation Expenses***

 

Theprimary components of other operation expenses include payroll, materials andsupplies, chemicals and water treatment, and outside service costs of operatingthe regulated systems of Registrant’s continuing water business, including thecosts associated with water transmission and distribution, pumping, waterquality, meter reading, billing, and operations of district offices.  Registrant’s electric and contracted servicesoperations incur many of the same types of costs as well.  For the three months ended September 30,2010 and 2009, other operation expenses by segment consisted of the following(amounts in thousands):

 
| ** **                     | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                     | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                 |       | $                 | 6,371      |              | $          | 6,037      |       | $          | 334        |   | 5.5 | % |
| Electric Services              |       | 536               |       | 549               |       | (13        | )          | -2.4       | %          |
| Contracted Services            |       | 881               |       | 908               |       | (27        | )          | -3.0       | %          |
| Total other operation expenses |       | $                 | 7,788      |              | $          | 7,494      |       | $          | 294        |   | 3.9 | % |

 

Forthe three months ended September 30, 2010, other operation expenses forGSWC’s water services increased by $334,000 due primarily to an increase incosts related to water conservation educational materials and supplies of$563,000. These increases were partially offset by a decrease in outsideservices of $229,000.

 

Therewas a decrease of $27,000 in other operating expenses for contracted servicesdue to a decrease of $300,000 in outsides services and a decrease of $18,000 inmiscellaneous other operating expenses, partially offset by higher wages andrelated benefits of $291,000 as a result of increases in salaries for employeesunder the annual performance-based salary review program and the addition ofstaff at various locations.

 

***Administrative and General Expenses***

 

Administrativeand general expenses include payroll related to administrative and generalfunctions, all employee benefits charged to expense accounts, insuranceexpenses, outside legal and consulting fees, regulatory utility commissionexpenses, expenses associated with being a public company, and generalcorporate expenses. For the three months ended September 30, 2010 and2009, administrative and general expenses by segment, including AWR (parent),consisted of the following (amounts in thousands):

 
| ** **                                | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                            |       | $                 | 21,180     |              | $          | 11,650     |       | $          | 9,530      |   | 81.8 | % |
| Electric Services                         |       | 1,829             |       | 2,061             |       | (232       | )          | -11.3      | %          |
| Contracted Services                       |       | 3,046             |       | 2,883             |       | 163        |       | 5.7        | %          |
| AWR (parent)                              |       | 227               |       | 212               |       | 15         |       | 7.1        | %          |
| Total administrative and general expenses |       | $                 | 26,282     |              | $          | 16,806     |       | $          | 9,476      |   | 56.4 | % |

 

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For the three months ended September 30, 2010, administrative and general expenses increased by$9.5 million from GSWC’s water services compared to the three months ended September 30, 2009 largely due to a one-time pretax charge of$9.0 million for the impairment of assets and loss contingencies resulting frompending regulatory matters.  There wasalso an increase in labor costsand other employee benefits of $991,000 duelargely to higher wages related to Registrant’s annual performance-based salaryreview program and an increase of approximately $38,000 in other miscellaneousadministrative and general expenses.  These increases were partially offset by: (i) adecrease in pension costs of $186,000; (ii) a decrease in datatransmission line costs of $184,000 and, (iii) a decrease of $129,000 inoutside services including legal and consulting costs.

 

Forthe three months ended September 30, 2010, administrative and generalexpenses decreased by $232,000 from electric services as compared to the sameperiod in 2009 due to a decrease of $338,000 in outside services and othercosts incurred related to the general rate case, which was finalized in October 2009. This was partially offset by an increase of $30,000 in labor and employeerelated benefits and $76,000 in miscellaneous other administrative and generalexpenses.

 

For the three months ended September 30, 2010, administrative and general expenses increased by$163,000 for contracted services compared to the three months ended September 30,2009 due primarily to an increase of $149,000 in outside services costs(largely legal costs related to various filings with the U.S. government) andan increase in other miscellaneous administrative and general costs of $14,000.

 

***Depreciation andAmortization***

 

Forthe three months ended September 30, 2010 and 2009, depreciation andamortization by segment consisted of the following (amounts in thousands):

 
| ** **                          | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                          | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                          | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                      |       | $                 | 7,621      |              | $          | 7,151      |       | $          | 470        |   | 6.6 | % |
| Electric Services                   |       | 560               |       | 565               |       | (5         | )          | -0.9       | %          |
| Contracted Services                 |       | 216               |       | 174               |       | 42         |       | 24.1       | %          |
| Total depreciation and amortization |       | $                 | 8,397      |              | $          | 7,890      |       | $          | 507        |   | 6.4 | % |

 

Forthe three months ended September 30, 2010, depreciation and amortizationexpense for water and electric services increased by $465,000 to $8.2 millioncompared to $7.7 million for the three months ended September 30, 2009reflecting, among other things, approximately $82.8 million of additions toutility plant during 2009, depreciation on which began inJanuary 2010.  Registrantanticipates that depreciation expense will continue to increase due to ongoingconstruction at its continuing regulated subsidiaries and increases in thecomposite depreciation rates.  Aspreviously mentioned, once the Region II and Region III general rate case isapproved, depreciation expense will be re-calculated based on new compositedepreciation rates.  This adjustment todepreciation expense will also be recorded retroactively to January 1,2010. Based on the proposed decision that was issued in November 2009 andlater withdrawn, GSWC’s depreciation expense for the three months ended September 30,2010 would have increased by approximately $933,000 had the decision been inplace on January 1, 2010.  Registrantbelieves that depreciation expense related to property additions and updatedcomposite depreciation rates approved by the appropriate regulatory agency willbe recovered through water and electric rates.

 

There were also increases ofapproximately $42,000 for the contracted services segment due to the addition of fixed assets.

 

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***Maintenance***

 

Forthe three months ended September 30, 2010 and 2009, maintenance expense bysegment consisted of the following (amounts in thousands):

 
| ** **          | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **          | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **          | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services      |       | $                 | 3,566      |              | $          | 3,055      |       | $          | 511        |   | 16.7 | % |
| Electric Services   |       | 140               |       | 249               |       | (109       | )          | -43.8      | %          |
| Contracted Services |       | 608               |       | 589               |       | 19         |       | 3.2        | %          |
| Total maintenance   |       | $                 | 4,314      |              | $          | 3,893      |       | $          | 421        |   | 10.8 | % |

 

For the three months ended September 30,2010, maintenance expense for water and electric services increased to $3.7million compared to $3.3 million for the three months ended September 30,2009 due principally to an increase in planned maintenance on GSWC’s wells,water supply and distribution facilities, particularly in Regions II and III.Registrant anticipates that maintenance expense will continue to increase dueto the aging infrastructure.  Registrant believes that increases inmaintenance expense approved by the CPUC will be recovered through water rates.

 

***Property******and OtherTaxes***

 

Forthe three months ended September 30, 2010 and 2009, property and othertaxes by segment consisted of the following (amounts in thousands):

 
| ** **                     | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                     | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                 |       | $                 | 2,959      |              | $          | 2,965      |       | $          | (6         | ) | -0.2 | % |
| Electric Services              |       | 195               |       | 179               |       | 16         |       | 8.9        | %          |
| Contracted Services            |       | 412               |       | 365               |       | 47         |       | 12.9       | %          |
| Total property and other taxes |       | $                 | 3,566      |              | $          | 3,509      |       | $          | 57         |   | 1.6 | % |

 

Propertyand other taxes for the three months ended September 30, 2010 increasedslightly as compared to the same period in 2009 primarily as a result ofincreased gross receipts taxes in contracted services reflecting higherrevenues.

 

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*** ***

***ASUS Construction Expenses***

 

Forthe three months ended September 30, 2010, construction expenses were$12.4 million, increasing $3.2 million compared to the same period in 2009 dueprimarily to new construction projects at Fort Bragg in North Carolina and FortJackson in South Carolina, which increased $6.3 million and $0.7 million,respectively, over the same period in 2009. These increases were partially offset by a decrease of $3.8 million inconstruction expenses at the other Military Utility Privatization Subsidiaries.

 

***Interest Expense***

 

Forthe three months ended September 30, 2010 and 2009, interest expense bysegment, including AWR (parent) consisted of the following (amounts inthousands):

 
| ** **                  | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                  | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                  | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and Electric Services |       | $                 | 4,864      |              | $          | 5,693      |       | $          | (829       | ) | -14.6 | % |
| Contracted Services         |       | 59                |       | 90                |       | (31        | )          | -34.4      | %          |
| AWR (parent)                |       | 40                |       | (23               | )          | 63         |       | -273.9     | %          |
| Total interest expense      |       | $                 | 4,963      |              | $          | 5,760      |       | $          | (797       | ) | -13.8 | % |

 

Interestexpense for the three months ended September 30, 2010 decreased ascompared to the same period in 2009 due primarily to a decrease in the amountrecorded to the interest rate balancing account.  A decision issued in July 2009 in the GSWC cost of capital proceedingauthorized an interest rate balancing account to track interest costs of newdebt.  This balancing account tracks anydifference between the incremental cost of debt included in the cost of capitaldecision and the actual cost of debt for any long-term debt issued by GSWC fromthe effective date of the final decision. In August 2010, GSWC filed an advice letter with the CPUC forapproval of a customer refund based on the difference between the adopted costof new debt in its authorized capital structure and the actual cost of newdebt.  This advice letter was approved inOctober 2010, resulting in a downward adjustment of $654,000 to interestexpense for the third quarter of 2010 which was previously recorded in theinterest rate balancing account.

 

Theaverage interest rate on short-term borrowings for the three months ended September 30, 2010 was 1.5% as compared to an average of 0.9% duringthe same period of 2009. Average bank loan balances outstanding under the AWRcredit facility for the three months ended September 30, 2010 and 2009 were approximately $45.2 million and$12.9 million, respectively.

 

***Interest Income***

 

Forthe three months ended September 30, 2010 and 2009, interest income bysegment, including AWR (parent) consisted of the following (amounts inthousands):

 
| ** **                  | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                  | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                  | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and Electric Services |       | $                 | 163        |              | $          | 170        |       | $          | (7         | ) | -4.1 | % |
| Contracted Services         |       | —            |       | 4                 |       | (4         | )          | -100.0     | %          |
| AWR (parent)                |       | 3                 |       | —            |       | 3          |       | 100        | %          |
| Total interest income       |       | $                 | 166        |              | $          | 174        |       | $          | (8         | ) | -4.6 | % |

 

Interestincome decreased slightly for the three months ended September 30, 2010 ascompared to the same period in 2009 due to lower interest rates.

 

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***Other***

 

For the three months ended September 30, 2010, Registrant recorded other expenses of $553,000 primarilyas a result of losses incurred at one of AWR’s investments,accounted for by the equity method.

 

***Income Tax Expense***

 

Forthe three months September 30, 2010 and 2009, income tax expense bysegment, including AWR (parent), consisted of the following (amounts inthousands):

 
| ** **                  | ** ** | **3 Months** | ** ** | **3 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                  | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                  | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and Electric Services |       | $                 | 4,736      |              | $          | 6,418      |       | $          | (1,682     | ) | -26.2 | % |
| Contracted Services         |       | 1,193             |       | 881               |       | 312        |       | 35.4       | %          |
| AWR (parent)                |       | (51               | )          | (70               | )          | 19         |       | -27.1      | %          |
| Total income tax expense    |       | $                 | 5,878      |              | $          | 7,229      |       | $          | (1,351     | ) | -18.7 | % |

 

Forthe three months ended September 30, 2010, income tax expense for waterand electric services decreased by 26.2% to $4.7 million compared to $6.4million for the three months ended September 30, 2009 due primarily to adecrease in pretax income of $6.1 million, partially offset by an increase inthe effective tax rate (“ETR”) for GSWC which was 53.3% as compared to 42.9%for the same period in 2009.  The ETRdeviates from the combined federal and state statutory rate primarily due tochanges between book and taxable income that are treated as flow-throughadjustments in accordance with regulatory requirements (principally plant-,rate-case- and compensation-related items) and other nondeductible permanentitems.  Flow-through adjustments increaseor decrease tax expense in one period, with an offsetting increase or decreaseoccurring in another period.  Variousitems such as meals, entertainment, penalties, and certain charitable,lobbying, and political contributions may not be deductible for taxpurposes.  The effect that theseflow-through and permanent book-tax differences had on the ETR was furthermagnified by the reduced pretax book income.

 

Incometax expense for contracted services increased to $1.2 million for the threemonths ended September 30, 2010 compared to $881,000 for the three monthsended September 30, 2009 due primarily to an increase in pretaxincome.  The ETR for contracted servicesfor the three months ended September 30, 2010 was 38.5% as compared to a37.2% ETR applicable to the three months ended September 30, 2009.

 

***Income From Discontinued Operations***

 

OnJune 7, 2010, AWR entered into a stock purchase agreement with EPCOR Water(USA) Inc. to sell all the common shares of CCWC for a total purchase price of$35 million, including the assumption of approximately $6 million of long-termdebt.  Approximately $29 million in cashwill be paid to AWR at closing. The purchase price is subject to certain adjustmentsfor changes in retained earnings. The consummation of the transactioncontemplated by the agreement is subject to customary conditions, includingamong other things, regulatory approval by the ACC, which is anticipated to bereceived in 2011.  Accordingly, the results of CCWC have beenreported in discontinued operations.

 

Forthe three months ended September 30, 2010, income from discontinuedoperations of $983,000 includes $31,000 (net of tax) of legal and consultingcosts related to the CCWC sale transaction. CCWC’s results improved by $1.2 million as compared to the third quarterof 2009 due primarily to higher water rates implemented in October 2009 asa result of the approval by the ACC of CCWC’s general rate case, and a decreasein operating expenses as compared to the same period in 2009.  Included in operating expenses for the thirdquarter of 2009 was a loss of $760,000 resulting from a decision issued by theACC in October 2009 related to a settlement for removal of a well fromservice, which had previously been recorded as income.  There was no corresponding loss recorded inthe third quarter of 2010.  In addition,there was a decrease of $696,000 in depreciation expense as compared to thethird quarter of 2009.  In accordancewith generally accepted accounting principles for assets classified as held forsale, the Company ceased depreciating long-lived assets related to CCWCeffective June 2010.

 

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***Consolidated Results of Operations — Nine months ended September 30,2010 and 2009 (amounts in thousands):***

 
| ** **                                                   | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                                   | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                                   | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| OPERATING REVENUES                                           |       |              |       |              |       |       |       |       |       |
| Water                                                        |       | $                 | 211,507    |              | $          | 203,594    |       | $          | 7,913      |   | 3.9 | % |
| Electric                                                     |       | 26,741            |       | 21,083            |       | 5,658      |       | 26.8       | %          |
| Contracted services                                          |       | 56,994            |       | 44,332            |       | 12,662     |       | 28.6       | %          |
| Total operating revenues                                     |       | 295,242           |       | 269,009           |       | 26,233     |       | 9.8        | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| OPERATING EXPENSES                                           |       |              |       |              |       |       |       |       |       |
| Water purchased                                              |       | 37,259            |       | 33,764            |       | 3,495      |       | 10.4       | %          |
| Power purchased for pumping                                  |       | 7,062             |       | 7,233             |       | (171       | )          | -2.4       | %          |
| Groundwater production assessment                            |       | 8,597             |       | 8,621             |       | (24        | )          | -0.3       | %          |
| Power purchased for resale                                   |       | 9,495             |       | 9,158             |       | 337        |       | 3.7        | %          |
| Supply cost balancing accounts                               |       | 14,720            |       | 11,666            |       | 3,054      |       | 26.2       | %          |
| Other operation expenses                                     |       | 21,734            |       | 21,418            |       | 316        |       | 1.5        | %          |
| Administrative and general expenses                          |       | 61,478            |       | 48,525            |       | 12,953     |       | 26.7       | %          |
| Depreciation and amortization                                |       | 25,121            |       | 23,643            |       | 1,478      |       | 6.3        | %          |
| Maintenance                                                  |       | 12,882            |       | 11,571            |       | 1,311      |       | 11.3       | %          |
| Property and other taxes                                     |       | 10,469            |       | 9,483             |       | 986        |       | 10.4       | %          |
| ASUS construction expenses                                   |       | 29,225            |       | 25,540            |       | 3,685      |       | 14.4       | %          |
| Net (gain) loss on sale of property                          |       | 2                 |       | (15               | )          | 17         |       | -113.3     | %          |
| Total operating expenses                                     |       | 238,044           |       | 210,607           |       | 27,437     |       | 13.0       | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| OPERATING INCOME                                             |       | 57,198            |       | 58,402            |       | (1,204     | )          | -2.1       | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| OTHER INCOME AND EXPENSES                                    |       |              |       |              |       |       |       |       |       |
| Interest expense                                             |       | (16,491           | )          | (16,508           | )          | 17         |       | -0.1       | %          |
| Interest income                                              |       | 985               |       | 675               |       | 310        |       | 45.9       | %          |
| Other                                                        |       | (558              | )          | 90                |       | (648       | )          | -720.0     | %          |
|                                                         |       | (16,064           | )          | (15,743           | )          | (321       | )          | 2.0        | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| INCOME FROM CONTINUING OPERATIONS BEFORE INCOME  TAX EXPENSE |       | 41,134            |       | 42,659            |       | (1,525     | )          | -3.6       | %          |
| Income tax expense                                           |       | 18,305            |       | 16,325            |       | 1,980      |       | 12.1       | %          |
| INCOME FROM CONTINUING OPERATIONS                            |       | 22,829            |       | 26,334            |       | (3,505     | )          | -13.3      | %          |
|                                                         |       |              |       |              |       |       |       |       |       |
| INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF  TAX      |       | 1,288             |       | (205              | )          | 1,493      |       | -728.3     | %          |
| NET INCOME                                                   |       | $                 | 24,117     |              | $          | 26,129     |       | $          | (2,012     | ) | -7.7 | % |

 

Netincome from continuing operations for the nine months ended September 30,2010 was $22.8 million, equivalent to $1.22 and $1.21 per common share on abasic and fully diluted basis, respectively, compared to $26.3 million or $1.46on a basic and fully diluted basis, for the nine months ended September 30,2009, a decrease in net income of 13.3%.

 

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Impactingthe comparability in the results from continuing operations of the two periodson a diluted per share basis are primarily the following significant items:

 

·                  An increase in the dollar water margin forthe Company’s continuing water business of $1.5 million, or $0.05 per share,during the nine months ended September 30, 2010, due to the margin impactof recording the WRAM, net of MCBA, implemented for Region I’s rate makingareas in September 2009. Due to the****delay in GSWC’sRegions II and III and the general office rate case discussed further in *Regulatory Matters*, GSWC’s revenues and supply costs forRegions II and III for the first nine months of 2010 have been recorded using2009 adopted levels pending resolution of this general rate case, which isexpected in the fourth quarter of 2010. New rates, once approved, are expected to be retroactive to January 1,2010.

 

·                  An increase in the electric margin of $5.4million, or $0.17 per share, during the nine months ended September 30,2010 compared to the same period of 2009 due primarily to:  (i) increases in rates in November 2009and January 2010 related to BVES’ general rate case approved by the CPUC; (ii) theCPUC approval in March 2010 for recovery of $958,000 in a memorandumaccount which tracked the difference between the 2007 adopted general officecost allocation to BVES and the 1996 adopted general office cost allocation toBVES; and (iii) the recording of $1.0 million in the BRRAM accountimplemented in November 2009 to adjust BVES’ 2010 revenues to the baserate revenues approved by the CPUC.

 

·                  A one-time pretax charge of $9.0 million, or$0.32 per share, at GSWC for the impairment of assets and loss contingenciesresulting from pending regulatory matters, which may be adjusted as additionalinformation becomes known.

 

·                  A settlement agreement reached with MirantTrading resulting in the recording of $1.0 million, or $0.03 per share, inproceeds as a reduction to legal costs in 2009. There was no similar reductionin costs for the same period of 2010.

 

·                  Excluding the one-time pretax charge frompending regulatory matters mentioned above and the Mirant settlement, there wasan increase of  $6.1 million, or $0.20per share, in other operating expenses other than supply costs at GSWC duringthe first nine months of 2010. This was primarily due to: (i)  an increasein labor and other related benefits, and conservation related expenses; and (ii) anincrease in outside services costs as compared to the same period in 2009.  These increases in operating expenses wereincurred with no corresponding rate recovery due to the delay in the CPUC’sdecision on GSWC’s Regions II, III and the general office rate case, whichis expected in the fourth quarter of 2010 and will be retroactive to January 1,2010.  Had the new rates been in place onJanuary 1, 2010, pretax operating income for the nine  months ended September 30, 2010 wouldhave increased by $10.3 million, or $0.33 per share, based on the proposeddecisions.

 

·                  An increase inpretax operating income for contracted services of $8.1 million, or $0.26 pershare, during the nine months ended September 30, 2010 due primarily tocontract modifications received from the U.S government resolving requests forequitable adjustment and for retroactive interim increases in management fees,which increased revenues and pretax operating income by a total ofapproximately $7.0 million as compared to the same period in 2009.  In addition, there was an increase in newconstruction projects at ONUS as compared to the same period in 2009.

 

·                  A decrease inother income of $648,000, or $0.02 per share, due primarily to losses incurredat one of AWR’s investments, accounted for by the equity method.

 

·                  An increase inincome tax expense during the nine months ended September 30, 2010 ascompared to the same period in 2009, due primarily to: (i) a tax benefitof $918,000 or $0.05 per share recorded during the first quarter of 2009resulting from changes in California apportionment laws, which did not recur in2010; and (ii) an increase in the effective income tax rate (excluding theeffects of the tax benefit discussed previously), which negatively impactedearnings by approximately $0.06 per share during the first nine months of 2010primarily resulting from changes between book and taxable income that aretreated as flow-through adjustments in accordance with regulatory requirements.

 

·                  A decrease of$0.05 per share due to an increase in the weighted average number of commonshares outstanding resulting from the issuance of 1.15 million shares of AWR’sCommon Shares in a public offering completed in May 2009.

 

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Netincome from discontinued operations for the nine months ended September 30,2010 was $1.3 million, equivalent to $0.07 per common share on a basic andfully diluted basis, compared to a loss of $205,000 or negative $0.01 percommon share on a basic and fully diluted basis, for the nine months ended September 30,2009, an increase of $0.08 per common share. The improved performance at CCWC was primarily due to: (i) rateincreases approved by the ACC in October 2009; (ii) a decrease inoperating expenses, including depreciation expense, as compared to the firstnine months of 2009; and (iii) a loss of $760,000 recorded in the thirdquarter of 2009 resulting from a decision issued by the ACC in October 2009related to a settlement for removal of a well from service, which hadpreviously been recorded as income. Income from discontinued operationsincludes $426,000, net of tax, in direct legal and consulting costs related tothe stock purchase agreement entered into with EPCOR Water (USA) Inc.

 

***Operating Revenues***

 

*Water*

 

GSWC’srevenues and supply costs for Regions II and III for the first nine months of2010 have been recorded using 2009 adopted levels pending resolution of thegeneral rate case for these Regions, which is expected in the fourth quarter of2010. For the nine months ended September 30, 2010, revenues fromcontinuing water operations increased by $7.9 million to $211.5 million,compared to $203.6 million for the nine months ended September 30,2009.  For the nine months ended September 30,2010, GSWC recorded $5.3 million in additional revenues in Region I’s WRAMwhich was implemented in September 2009 to adjust consumption levelsadopted by the CPUC, partially offset by a decrease in Region I’s actualconsumption when compared to 2009. Overall consumption by customers decreased 8.7% for the nine monthsended September 30, 2010 as compared to the same period in 2009. There wasalso an increase in water revenues of $4.9 million due to surcharges approvedby the CPUC in effect to recover under-collections in supply costs.  These increases in water revenues werepartially offset by the recording of $3.1 million during the nine months ended September 30,2009 included in the WCMA at each of GSWC’s water regions to track theextraordinary expenses and revenue shortfall associated with conservationmeasures in conjunction with the declared drought in California.  The WCMA was effective August 18, 2008until the WRAM was implemented on November 25, 2008 for Regions II and IIIand through August 31, 2009 for Region I. In addition, there was a decrease in management fees at GSWC totaling$363,000 earned in 2009 related to a contract with a municipality to providebilling and meter reading services. Effective January 1, 2010, GSWCassigned this service contract with the municipality to ASUS.  These management fees are now earned by ASUS.

 

*Electric*

 

Forthe nine months ended September 30, 2010, revenues from electricoperations increased by 26.8% to $26.7 million compared to $21.1 million forthe nine months ended September 30, 2009 due primarily to electric rateincreases effective November 2, 2009 and January 1, 2010.  In addition, as a result of the BRRAM whichalso went into effect in November 2009, BVES recorded $1.0 million inadditional electric revenues primarily due to lower customer usage.  Electric usage decreased by 2.3% as comparedto the same period in 2009. Finally, in March 2010, the CPUC approved forrecovery a memorandum account which tracked the difference between the 2007adopted general office cost allocation to BVES and the 1996 adopted generaloffice cost allocation, effective and retroactive from June 4, 2009 to October 31,2009.  As a result, BVES recorded aregulatory asset of $958,000 and a corresponding increase to revenues foramounts included in this memorandum account.

 

*Contracted Services*

 

Revenues from contracted services are primarilycomprised of construction revenues (including renewals and replacements) andmanagement fees for operating and maintaining the water and/or wastewatersystems at military bases.  For the ninemonths ended September 30, 2010, revenues from contracted servicesincreased by $12.7 million, or 28.6%, to $57.0 million compared to $44.3million for the nine months ended September 30, 2009 due to increasedconstruction activity and the receipt of contract modifications in connectionwith: (i) requests for equitable adjustment previously filed for inventoryprice adjustments at Fort Bliss in Texas and Fort Bragg in North Carolina; (ii) anREA for construction costs incurred in connection with a sanitary seweroverflow at Fort Jackson in South Carolina, and (iii) a contractmodification for a retroactive interim increase in management fees at AndrewsAir Force Base in Maryland.  Thesecontract modifications increased revenues and pretax operating income by acombined $7.0 million.

 

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Forthe nine months ended September 30, 2010, management fees increased by$7.5 million to $17.6 million as compared to $10.1 million for the nine monthsended September 30, 2009.  Thecontract modifications discussed above added $6.3 million of additionalmanagement fees.  The contractmodification received for Andrews Air Force Base provided for a retroactiveincrease in management fees effective from February 2008, the secondanniversary date of commencement of operations, pending resolution of a priceredetermination filed in 2008.  Inaddition, there was an increase in management fees totaling $622,000 earned in2010 and related to a contract with a municipality to provide billing and meterreading services.  EffectiveJanuary 1, 2010, GSWC assigned this service contract with the municipalityto ASUS.

 

Therewas also an increase in construction revenues of $5.2 million, primarilyrelated to construction activities at Fort Bragg in North Carolina and FortJackson in South Carolina, partially offset by decreases in constructionrevenues at the other military bases.  Inaddition, construction revenues for the first nine months of 2009 included $1.1million related to an approved REA for construction costs at Fort Jacksonmostly incurred in 2008.  The REAreceived for Fort Jackson increased construction revenues by $689,000.  Earnings and cash flows from amendments andmodifications to the original 50-year contracts with the U.S. government may ormay not continue in future periods.

 

***Operating Expenses:***

 

***Supply Costs***

 

Supplycosts for the water segment consist of purchased water, purchased power forpumping, groundwater production assessments and water supply cost balancingaccounts. Supply costs for the electric segment consist of purchased power forresale (including the cost of natural gas) and the electric supply costbalancing account*.* Water and electric margins arecomputed by taking total revenues, less total supply costs. Registrant usesthese margins and related percentages as an important measure in evaluating itsoperating results. Registrant believes this measure is a useful internalbenchmark in evaluating the utility business performance within its water andelectric segments. Registrant reviews these measurements regularly and comparesthem to historical periods and to its operating budget as approved. However,this measure, which is not presented in accordance with GAAP, may not becomparable to similarly titled measures used by other entities and should notbe considered as an alternative to operating income, which is determined inaccordance with GAAP, as an indicator of operating performance.

 

Totalsupply costs comprise the largest segment of total operating expenses. Supplycosts accounted for approximately 32% and 33% of total operating expenses forthe nine months ended September 30, 2010 and 2009, respectively.

 

Thetable below provides the amount of increases (decreases), percent changes insupply costs, and margins during the nine months ended September 30, 2010and  2009 (amounts in thousands):

 

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| ** **                                      | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                      | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                      | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| WATER OPERATING REVENUES **(1)**                |       | $                 | 211,507    |              | $          | 203,594    |       | $          | 7,913      |   | 3.9 | % |
| WATER SUPPLY COSTS:                             |       |              |       |              |       |       |       |       |       |
| Water purchased **(1)**                         |       | $                 | 37,259     |              | $          | 33,764     |       | $          | 3,495      |   | 10.4 | % |
| Power purchased for pumping **(1)**             |       | 7,062             |       | 7,233             |       | (171       | )          | -2.4       | %          |
| Groundwater production assessment **(1)**       |       | 8,597             |       | 8,621             |       | (24        | )          | -0.3       | %          |
| Water supply cost balancing accounts**(1)**     |       | 11,926            |       | 8,768             |       | 3,158      |       | 36.0       | %          |
| TOTAL WATER SUPPLY COSTS                        |       | $                 | 64,844     |              | $          | 58,386     |       | $          | 6,458      |   | 11.1 | % |
| WATER MARGIN **(2)**                            |       | $                 | 146,663    |              | $          | 145,208    |       | $          | 1,455      |   | 1.0 | % |
| PERCENT MARGIN - WATER                          |       | 69.3              | %          | 71.3              | %          |       |       |       |       |
|                                            |       |              |       |              |       |       |       |       |       |
| ELECTRIC OPERATING REVENUES **(1)**             |       | $                 | 26,741     |              | $          | 21,083     |       | $          | 5,658      |   | 26.8 | % |
| ELECTRIC SUPPLY COSTS:                          |       |              |       |              |       |       |       |       |       |
| Power purchased for resale **(1)**              |       | $                 | 9,495      |              | $          | 9,158      |       | $          | 337        |   | 3.7 | % |
| Electric supply cost balancing accounts **(1)** |       | 2,794             |       | 2,898             |       | (104       | )          | -3.6       | %          |
| TOTAL ELECTRIC SUPPLY COSTS                     |       | $                 | 12,289     |              | $          | 12,056     |       | $          | 233        |   | 1.9 | % |
| ELECTRIC MARGIN **(2)**                         |       | $                 | 14,452     |              | $          | 9,027      |       | $          | 5,425      |   | 60.1 | % |
| PERCENT MARGIN - ELECTRIC                       |       | 54.0              | %          | 42.8              | %          |       |       |       |       |

 

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(1)                                 As reported on AWR’sConsolidated Statements of Income, except for supply cost balancing accounts.The sum of water and electric supply cost balancing accounts in the table aboveare shown on AWR’s Consolidated Statements of Income and totaled $14,720,000and $11,666,000 for the nine months ended September 30, 2010 and 2009,respectively.

 

(2)                                 Water and electric marginsdo not include any depreciation and amortization, maintenance expense, or otheroperating expenses.

 

GSWC’ssupply costs for Regions II and III for the first nine months of 2010 have beenrecorded using 2009 adopted levels pending resolution of the Region II, IIIand the general office rate case, which is expected in the fourth quarter of2010.  For the nine months ended September 30,2010, 36.7% of GSWC’s water supply mix was purchased as compared to 37.3%purchased for the nine months ended September 30, 2009.  However, GSWC implemented the MCBA for allits water regions which eliminates the effects on earnings of changes in thewater supply mix prospectively.  Theadopted percentage of purchased water for the nine months ended September 30, 2010at Regions I, II and III was 23.1%, 62.2% and 44.5%, respectively, ascompared to actual purchased water of 20.3%, 40.4% and 42.8%, respectively, forthe first nine months of 2010.  Theincrease in pumped water in all three Regions’ actual mix compared to the mixapproved by the CPUC resulted in an over-collection in the MCBA account.

 

Purchasedwater costs for the nine months ended September 30, 2010 increased by10.4% to $37.3 million as compared to $33.8 million in the same period of2009.  The increase in purchased watercosts was due to higher water rates charged from wholesale suppliers, partiallyoffset by lower customer usage.

 

Forthe nine months ended September 30, 2010, power purchased for pumpingdecreased to $7.1 million, compared to $7.2 million for the same period of2009, due to a decrease in overall customer demand of 8.7%.  Groundwater production assessments were slightlylower due to lower customer demand, partially offset by 

 

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increasesin assessment rates (pump tax rates) levied against groundwater production,effective July 2010.  In particular,Region II’s average pump tax rates increased by approximately 13%.  The MCBA tracks the increases in pump taxrates for future recovery in water rates.

 

Anincrease of $3.2 million in the water supply cost balancing account provisionduring the nine months ended September 30, 2010 as compared to the sameperiod in 2009 was primarily due to a $4.9 million increase in the amortizationof the water supply cost balancing accounts for surcharges currently ineffect.  This was partially offset by a net decrease of $1.7 million ofover-collections for the nine months ended September 30, 2010 compared tothe same period in 2009 due to an increase in water rates charged fromwholesale suppliers.

 

Forthe nine months ended September 30, 2010, the cost of power purchased forresale to customers in GSWC’s BVES division increased by 3.7% to $9.5 millioncompared to $9.2 million for the nine months ended September 30, 2009 reflecting a higher fixed energy cost under the currentpurchased power contract.  This waspartially offset by lower customer usage of 2.3% over the same period in2009.  GSWC began receiving powerunder this purchased power contract on January 1, 2009.   The main product under the new contractprovides for 13 MWs of electric energy at a fixed price of $67.85 per MWhduring 2010 as compared to $63.75 during 2009. The increase in the price of purchased power is reflected in theelectric supply cost balancing account resulting in no change to the dollar margin for electric services.

 

***Other Operation Expenses***

 

Theprimary components of other operation expenses include payroll, materials andsupplies, chemicals and water treatment, and outside service costs of operatingthe continuing regulated water systems, including the costs associated withwater transmission and distribution, pumping, water quality, meter reading,billing, and operations of district offices. Registrant’s electric and contracted services operations incur many ofthe same types of costs as well.  For thenine months ended September 30, 2010 and 2009, other operation expenses bysegment consisted of the following (amounts in thousands):

 
| ** **                     | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                     | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                 |       | $                 | 17,549     |              | $          | 17,172     |       | $          | 377        |   | 2.2 | % |
| Electric Services              |       | 1,659             |       | 1,740             |       | (81        | )          | -4.7       | %          |
| Contracted Services            |       | 2,526             |       | 2,506             |       | 20         |       | 0.8        | %          |
| Total other operation expenses |       | $                 | 21,734     |              | $          | 21,418     |       | $          | 316        |   | 1.5 | % |

 

Forthe nine months ended September 30, 2010, other operation expenses forwater services increased by $377,000 primarily due to: (i) an increase incosts of $924,000 related to water conservation educational materials andsupplies; (ii) an increase of $117,000 related to bad debt expense; and (iii) anincrease of $124,000 in miscellaneous other operation expenses. These increaseswere partially offset by a decrease in outside services costs of $454,000related to water treatment and a $334,000 decrease in labor and relatedbenefits costs.

 

Therewas a decrease in other operating expenses for electric services primarily dueto a $40,000 decrease in bad debt expense and $41,000 in miscellaneous otheroperating expenses.

 

Contracted services experiencedincreases in other operating expenses of $20,000 primarily due to increases of$546,000 in labor costs due to annual performance-based increases and additionof staff at various locations.  Thisincrease was largely offset by decreases of $490,000 in outsides services and$36,000 in miscellaneous other operating expenses.

 

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***Administrative and General Expenses***

 

Administrativeand general expenses include payroll related to administrative and generalfunctions, all employee benefits charged to expense accounts, insuranceexpenses, outside legal and consulting fees, regulatory utility commissionexpenses, expenses associated with being a public company, and general corporateexpenses. For the nine months ended September 30, 2010 and 2009,administrative and general expenses by segment, including AWR (parent),consisted of the following (amounts in thousands):

 
| ** **                                | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                            |       | $                 | 45,736     |              | $          | 34,236     |       | $          | 11,500     |   | 33.6 | % |
| Electric Services                         |       | 5,646             |       | 5,573             |       | 73         |       | 1.3        | %          |
| Contracted Services                       |       | 9,331             |       | 8,052             |       | 1,279      |       | 15.9       | %          |
| AWR (parent)                              |       | 765               |       | 664               |       | 101        |       | 15.2       | %          |
| Total administrative and general expenses |       | $                 | 61,478     |              | $          | 48,525     |       | $          | 12,953     |   | 26.7 | % |

 

For the nine months ended September 30,2010, administrative and general expenses increased by $11.5 million in waterservices compared to the nine months ended September 30, 2009 largely dueto a one-time pretax charge of $9.0 million for the impairment of assetsand loss contingencies resulting from pending regulatory matters.  In addition, there were increases in labor costs and other employee benefitsof $3.2 million due tohigher wages largely related to Registrant’s annual performance-based salaryreview program and an increase of $705,000 in outside services costs includinglegal costs incurred in preparation for trial and the finalization of asettlement agreement reached in February 2010 between GSWC and two formerofficers.  These increases were partially offset by: (i) adecrease in pension expense of $734,000 due to improved pension planperformance during 2009; (ii) a decrease in data transmission expenses of$212,000; and (iii) a decrease of $458,000 in miscellaneous otheradministrative and general expenses.

 

For the nine months ended September 30,2010, administrative and general expenses increased by $73,000 in electricservices compared to the nine months ended September 30, 2009 dueprimarily to a $213,000 increase in labor costs and employee related benefitsas discussed above in water services. This increase was partially offset by a decrease in pension costs of$110,000 as discussed above and a decrease of $30,000 in miscellaneous otheradministrative and general expenses.

 

Therewas an increase of $1.3 million in contracted services administrative andgeneral expenses due primarily to: (i) an increase of $251,000 in laborcosts and related employee benefits due to higher wages pursuant to the company’sannual performance-basedsalary review program and an increase in the number of employees; (ii) a $582,000 increase in allocation of costs from thecorporate headquarters to ASUS; (iii) a $227,000 increase in outsideservices; and (iv) a $240,000 increase in miscellaneous otheradministrative and general expenses.

 

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***Depreciation andAmortization***

 

Forthe nine months ended September 30, 2010 and 2009, depreciation andamortization by segment consisted of the following (amounts in thousands):

 
| ** **                          | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                          | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                          | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                      |       | $                 | 22,864     |              | $          | 21,456     |       | $          | 1,408      |   | 6.6 | % |
| Electric Services                   |       | 1,680             |       | 1,694             |       | (14        | )          | -0.8       | %          |
| Contracted Services                 |       | 577               |       | 493               |       | 84         |       | 17.0       | %          |
| Total depreciation and amortization |       | $                 | 25,121     |              | $          | 23,643     |       | $          | 1,478      |   | 6.3 | % |

 

Forthe nine months ended September 30, 2010, depreciation and amortizationexpense for water and electric services increased by $1.4 million to $24.5million compared to $23.1 million for the nine months ended September 30, 2009reflecting, among other things, the approximately $82.8 million of additions toutility plant during 2009, depreciation on which began inJanuary 2010.  Registrantanticipates that depreciation expense will continue to increase due to ongoingconstruction at its continuing regulated subsidiaries and increases in thecomposite depreciation rates.  As previouslymentioned, once the Region II and Region III general rate case is approved,depreciation expense will be re-calculated based on new composite depreciationrates.  This adjustment will also berecorded retroactively to January 1, 2010. Based on the proposed CPUCdecision issued in 2009 which was later withdrawn, GSWC’s depreciation expensefor the nine months ended September 30, 2010 would have increased byapproximately $2.8 million had the decision been in place on January 1,2010.  Registrant believes thatdepreciation expense related to property additions and changes in compositerates approved by the appropriate regulatory agency will be recovered throughwater and electric rates.

 

Therewas also an increase in depreciation and amortization expense for contractedservices due primarily to theaddition of fixed assets.

 

***Maintenance***

 

Forthe nine months ended September 30, 2010 and 2009, maintenance expense bysegment consisted of the following (amounts in thousands):

 
| ** **          | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **          | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **          | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services      |       | $                 | 10,770     |              | $          | 8,727      |       | $          | 2,043      |   | 23.4 | % |
| Electric Services   |       | 535               |       | 613               |       | (78        | )          | -12.7      | %          |
| Contracted Services |       | 1,577             |       | 2,231             |       | (654       | )          | -29.3      | %          |
| Total maintenance   |       | $                 | 12,882     |              | $          | 11,571     |       | $          | 1,311      |   | 11.3 | % |

 

For the nine months ended September 30,2010, maintenance expense for water services increased by 23.4% to $10.8 millioncompared to $8.7 million for the nine months ended September 30, 2009 dueprincipally to an increase in planned maintenance on wells, water supply anddistribution facilities at all of GSWC’s water regions.

 

There was a decrease of$78,000 in maintenance expenses for electric services related to the 8.4 MWnatural gas-fueled generation plant.

 

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Forthe nine months ended September 30, 2010, maintenance expense forcontracted services decreased by $654,000 due to lower labor and outsideservices costs.  Internal labor activity for 2010 was focused more onoperations related work and less on maintenance activity, while in 2009 therewas a higher level of maintenance related activity that was required.

 

***Property and Other Taxes***

 

Forthe nine months ended September 30, 2010 and 2009, property and othertaxes by segment consisted of the following (amounts in thousands):

 
| ** **                     | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                     | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water Services                 |       | $                 | 8,691      |              | $          | 7,964      |       | $          | 727        |   | 9.1 | % |
| Electric Services              |       | 623               |       | 548               |       | 75         |       | 13.7       | %          |
| Contracted Services            |       | 1,155             |       | 971               |       | 184        |       | 18.9       | %          |
| Total property and other taxes |       | $                 | 10,469     |              | $          | 9,483      |       | $          | 986        |   | 10.4 | % |

 

Forthe nine months ended September 30, 2010, property and other taxes forwater and electric services increased by $802,000 due in part to a tax refundof $488,000 recorded in the second quarter of 2009 resulting from lowerreassessed property values from an examination. There was also an increase in payroll taxes due to increased laborcosts.

 

Propertyand other taxes were higher in contracted services due primarily to an increase in gross receipts taxes at ONUS.  This increase was due primarily to the $3.1million in management fees approved in the request for equitable adjustmentrecorded in the first quarter of 2010.

 

***ASUS Construction Expenses***

 

Forthe nine months ended September 30, 2010 construction expenses were $29.2million, increasing $3.7 million compared to the same period in 2009, dueprimarily to new construction projects at Fort Bragg and Fort Jackson totaling$14.9 million.  These increases werepartially offset by a decrease of $11.2 million in construction expense at theother military bases.

 

***Interest Expense***

 

Forthe nine months ended September 30, 2010 and 2009, interest expense bysegment, including AWR (parent) consisted of the following (amounts inthousands):

 
| ** **                  | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                  | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                  | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and Electric Services |       | $                 | 16,196     |              | $          | 16,112     |       | $          | 84         |   | 0.5 | % |
| Contracted Services         |       | 201               |       | 281               |       | (80        | )          | -28.5      | %          |
| AWR (parent)                |       | 94                |       | 115               |       | (21        | )          | -18.3      | %          |
| Total interest expense      |       | $                 | 16,491     |              | $          | 16,508     |       | $          | (17        | ) | -0.1 | % |

 

Overall,interest expense for the nine months ended September 30, 2010 wascomparable to the same period in 2009. In August 2010, GSWC filed an advice letter with the CPUC forapproval of a customer refund in connection with the interest rate balancingaccount based on the difference between the adopted cost of new debt in

 

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GSWC’s authorized capitalstructure and the actual cost of new debt. In response to this advice letter filed by GSWC, the CPUC issued aresolution in October 2010 and confirmed the methodology of how thedifference in the cost of debt should be calculated in the interest ratebalancing account pursuant to the cost of capital decision. As a result of theresolution, GSWC recorded a downward adjustment of $654,000 to interest expenseduring the third quarter of 2010, which was previously recorded in the interestrate balancing account.  This reductionin interest expense was largely offset by an increase in interest expense as aresult of $40 million in debt issued in March 2009.

 

Theaverage interest rate on short-term borrowings for the nine months ended September 30, 2010 was 1.4% as compared to an average of 1.2% duringthe same period of 2009. Average bank loan balances outstanding under the AWR creditfacility for the nine months ended September 30, 2010 were approximately$31.6 million, as compared to an average of $38.8 million during the sameperiod of 2009.

 

***Interest Income***

 

Forthe nine months ended September 30, 2010 and 2009, interest income bysegment, including AWR (parent) consisted of the following (amounts inthousands):

 
| ** **                  | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                  | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                  | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and Electric Services |       | $                 |  469  |              | $          |  665  |       | $          |  (196 | ) | -29.5 | % |
| Contracted Services         |       | 511               |       | 6                 |       | 505        |       | 8416.7     | %          |
| AWR (parent)                |       | 5                 |       | 4                 |       |  1    |       | 25.0       | %          |
| Total interest income       |       | $                 |  985  |              | $          |  675  |       | $          |  310  |   | 45.9 | % |

 

Interestincome increased by $310,000 for the nine months ended September 30, 2010due primarily to the recording of $510,000 in interest income in connectionwith the Fort Bliss inventory price adjustment contract modification issued bythe U.S. government in March 2010. This was partially offset by interest income recorded in 2009 related toa property tax refund resulting from lower reassessed property values.

 

***Other***

 

For the nine months ended September 30, 2010, other expenses increased $648,000 as a result of losses incurredat one of AWR’s investments, accounted for by the equity method.

 

***Income Tax Expense***

 

Forthe nine months ended September 30, 2010 and 2009, income tax expense bysegment, including AWR (parent), consisted of the following (amounts inthousands):

 
| ** **                  | ** ** | **9 Months** | ** ** | **9 Months** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                  | ** ** | **Ended**         | ** ** | **Ended**         | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                  | ** ** | **9/30/2010**     | ** ** | **9/30/2009**     | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| Water and Electric Services |       | $                 | 13,482     |              | $          | 16,074     |       | $          | (2,592     | ) | -16.1 | % |
| Contracted Services         |       | 4,975             |       | 1,568             |       | 3,407      |       | 217.3      | %          |
| AWR (parent)                |       | (152              | )          | (1,317            | )          | 1,165      |       | -88.5      | %          |
| Total income tax expense    |       | $                 | 18,305     |              | $          | 16,325     |       | $          | 1,980      |   | 12.1 | % |

 

Forthe nine months ended September 30, 2010, income tax expense for water andelectric services decreased by 16.1% to $13.5 million compared to $16.1 millionfor the nine months ended September 30, 2009 due primarily to a decreasein pretax income of $9.9 million, partially offset by an increase in theeffective tax rate.  The 

 

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effectivetax rate (“ETR”) for water and electric services for the nine months ended September 30,2010 was 46.0% as compared to a 41.0% ETR applicable to the nine months ended September 30,2009.  The ETR deviates from the federalstatutory rate primarily due to state taxes and changes between book andtaxable income that are treated as flow-through adjustments in accordance withregulatory requirements (principally plant-, rate-case- andcompensation-related items) and other nondeductible permanent items.  Flow-through adjustments increase or decreasetax expense in one period, with an offsetting increase or decrease occurring inanother period.  Various items such asmeals, entertainment, penalties, and certain charitable, lobbying, andpolitical contributions may not be deductible for tax purposes.  The effect that these flow-through andpermanent book-tax differences had on the ETR was further magnified by thereduced pretax book income.

 

Incometax expense for contracted services increased to $5.0 million compared to $1.6million for the nine months ended September 30, 2009 due primarily to anincrease in pretax income.  The ETR forcontracted services for the nine months ended September 30, 2010 was 38.5%as compared to a 36.8% ETR applicable to the nine months ended September 30,2009.

 

AWR(parent) receives a tax benefit for expenses incurred at the parent-companylevel.  For the nine months ended September 30,2009, the taxes recorded at AWR (parent) also include the effect of changes inCalifornia law relating to state unitary tax principles during the firstquarter of 2009.  Management intends toelect, commencing with the 2011 tax year, an alternative apportionmentmethod made available by tax law changes in 2009.  As a result of management’s intention toapply the alternative method, AWR adjusted its deferred tax balances in thefirst quarter of 2009 to reflect the expected amount at which it will realizeits California deferred taxes consistent with the change in tax law, andrefined certain related estimates.  This resulted in the recording of abenefit of approximately $918,000, or $0.05 per share, during the first quarterof 2009. While the effect of the tax law changes will continue to affect AWR’sstate taxes, the future effects may be beneficial or detrimental depending on acombination of the profitability of AWR’s non-California activities as well asthe relative proportion of the factor(s) applied by its apportionmentmethod.  Periodically, management will assess its intention to apply thealternative method and will adjust its deferred tax balances accordingly.  The consolidated ETR for the nine monthsended September 30, 2009 was approximately 38.3%.  Absent this tax benefit, the consolidated ETRfor the nine months ended September 30, 2009 would have been 40.4%.

 

***Income (Loss) from DiscontinuedOperations***

 

Asdiscussed in the quarterly results, on June 7, 2010, AWR entered into astock purchase agreement with EPCOR Water (USA) Inc. to sell all the commonshares of CCWC for a total purchase price of $35 million, including theassumption of approximately $6 million of long-term debt.  Accordingly, the results of CCWC have beenreported in discontinued operations.

 

Forthe nine months ended September 30, 2010, income from discontinuedoperations of $1.3 million includes $426,000 (net of tax) of legal andconsulting costs related to the CCWC sale transaction.  Excluding these transaction costs, CCWC’sresults improved by $1.5 million as compared to 2009 due primarily to higherwater rates implemented in October 2009 as a result of the approval by theACC of CCWC’s general rate case, and a decrease in operating expenses ascompared to the same period in 2009 primarily due to: (i) lowerdepreciation expense as a result of reporting CCWC as a discontinued operation,resulting in no further depreciation being recorded in accordance withgenerally accepted accounting principles; and (ii) a pretax loss of$760,000 recorded in the third quarter of 2009 resulting from a decision issuedby the ACC in October 2009 related to a settlement for removal of a wellfrom service, which had previously been recorded as income.

 

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**CriticalAccounting Policies and Estimates**

 

Criticalaccounting policies and estimates are those that are important to the portrayalof AWR’s financial condition, results of operations and cash flows, and requirethe most difficult, subjective or complex judgments of AWR’s management. Theneed to make estimates about the effect of items that are uncertain is whatmakes these judgments difficult, subjective and/or complex. Management makessubjective judgments about the accounting and regulatory treatment of manyitems. These judgments are based on AWR’s historical experience, terms ofexisting contracts, AWR’s observance of trends in the industry, informationprovided by customers and information available from other outside sources, asappropriate. Actual results may differ from these estimates under differentassumptions or conditions.

 

The critical accounting policiesused in the preparation of the Registrant’s financial statements that itbelieves affect the more significant judgments and estimates used in thepreparation of its consolidated financial statements presented in this reportare described in *“Management’s Discussion and Analysis ofFinancial Condition and Results of Operation”* included in Registrant’sAnnual Report on Form 10-K for the year ended December 31, 2009. There havebeen no material changes to the critical accounting policies.

 

**Liquidityand Capital Resources**

 

***AWR***

 

Registrant’sregulated business (primarily that of GSWC), is capital intensive and requiresconsiderable capital resources. A portion of these capital resources areprovided by internally generated cash flows from operations. When necessary,Registrant obtains funds from external sources in the capital markets andthrough bank borrowings. Access to external financing on reasonable termsdepends on Registrant’s credit ratings and current business conditions,including that of the water utility industry in general as well as conditions inthe debt or equity capital markets. If these business and market conditionsdeteriorate to the extent that AWR no longer has access to the capital marketsat reasonable terms, Registrant has access to a revolving credit facility thatis currently utilized to support operations. On May 27, 2010, the Company entered into the Third Amendment to theAmended and Restated Credit Agreement in order to extend the syndicated creditfacility to May 27, 2013 from June 3, 2010. The maximum amount that may be borrowed under this facility was amendedfrom $115 million to $100 million.  Registrantmay, under the terms of the Amended and Restated Credit Agreement, elect toincrease the aggregate bank commitments by up to $40 million.  The aggregate effective amount that may beoutstanding under letters of credit has been increased to $25 million from $20million.  The rates (spreads to LIBOR) atwhich the Company may borrow under this facility have been increased due tomarket conditions and the lenders have consented to modifications to certain ofthe covenants in the Amended and Restated Credit Agreement requested by theCompany.  As of September 30, 2010, anaggregate of $57.2 million in cash borrowings were included in currentliabilities and $11.1 million of letters of credit were outstanding under thisfacility.  As of September 30, 2010, AWRhad $31.7 million available to borrow under the credit facility.  The averageamount borrowed under this facility for the period and the maximum amountborrowed during the period were $31.6 million and $61.2 million, respectively.Registrant has no other short-term borrowing arrangements. Registrant has noobligation to post collateral under this facility unless it issues letters ofcredit that extend beyond the maturity of the facility or AWR or any of itssubsidiaries issues other secured debt. The average interest rate on amountsborrowed under this facility was 1.4% for the nine months ended September 30,2010.

 

Inaddition, AWR filed a Registration Statement on August 10, 2009 with theSecurities and Exchange Commission (“SEC”) for the sale from time to time ofdebt and equity securities. As of September 30, 2010, $115.0 million wasavailable for issuance under this Registration Statement.

 

OnJune 7, 2010, AWR entered into a stock purchase agreement with EPCOR (USA) Inc.to sell all the common shares of CCWC for a total purchase price of $35million, including the assumption of approximately $6 million of long-termdebt.  Approximately $29 million in cashwill be paid to AWR at closing.  Proceedsfrom the sale of CCWC may allow AWR to defer issuing equity to fund operationsand capital expenditures.

 

InJuly 2010, Standard & Poor’s Ratings Services (“S&P”) upgraded itscorporate credit rating on AWR and GSWC from ‘A’ positive to ‘A+’ stable.  S&P debt ratings range from AAA (highestrating possible) to D (obligation is in default).  Securities ratings are not recommendations tobuy, sell, or hold a security and are subject to change or withdrawal at anytime by the rating agency.

 

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Weexpect to fund capital expenditures during 2010 primarily through internallygenerated cash, short-term borrowings, and advances and contributions fromdevelopers.  Registrant’s capitalexpenditures for 2010 are estimated at approximately $80 - $83 million.

 

AWRhas paid common dividends for over 75 consecutive years.  On October 25, 2010, AWR declared a regular quarterly dividend of $0.26 per Common Share. Thedividend, totaling approximately $4.8 million,will be paid on December 1, 2010 to common shareholders of recordat the close of business on November 8, 2010. AWR’s ability to pay cashdividends on its Common Shares outstanding depends primarily upon cash flowsfrom GSWC.  AWR presently intends tocontinue paying quarterly cash dividends in the future, on or about March 1, June1, September 1 and December 1, subject to earnings and financial condition,regulatory requirements and such other factors as the Board of Directors maydeem relevant.

 

InSeptember 2010, President Obama signed the Small Business Jobs Act of 2010,which extended the 50% bonus depreciation provision for an additional year toinclude property purchased and placed into service by December 31, 2010.  Registrant expects that certain capitalexpenditures incurred during 2010 will qualify for the accelerated bonusdepreciation, which would provide additional cash flow benefits in 2010 and2011, estimated to be approximately $11 million.

 

*CashFlows from Operating Activities*:

 

Registrant’sfuture cash flows from operating activities will be affected by utilityregulation; infrastructure investment; maintenance expenses; inflation;compliance with environmental, health and safety standards; production costs;customer growth; per customer usage of water and electricity; weather andseasonality; and required cash contributions to pension and post-retirementplans.  In addition, future cash flowsfrom non-regulated subsidiaries will depend on new business activities,including military base operations and the construction of new and/orreplacement infrastructure, timely redetermination of prices and requests forequitable adjustments of prices and timely collection of payments from the U.S.government.

 

Cashflows from operating activities have generally been sufficient to meetoperating requirements and a portion of capital expenditure requirements. Aspreviously discussed, AWR has access to a $100 million revolving creditfacility that is currently utilized to support operations.  Registrant may continue to seek access todebt and equity capital markets to meet future operating and capital expenditurerequirements.  There can be no assurancethat Registrant will be able to successfully access such markets on favorableterms or at all. Operating cash flows can be negatively affected by changes inthe regulatory environments, regulatory disallowances, the assessment of finesand penalties for failure to meet regulatory requirements and changes ineconomic conditions.

 

Registrantalso obtains cash from non-operating sources such as customer advances for andcontributions in aid of construction, discussed below in financing activities.

 

Netcash provided by operating activities was $37.1 million for the nine monthsended September 30, 2010 as compared to $50.4 million for the nine months endedSeptember 30, 2009.  The overall decreaseof $13.3 million was primarily attributable to an 8.7% decrease in waterconsumption at Registrant’s continuing water operations as compared to thefirst nine months of 2009.  The reductionin water usage reduces cash flow from operating activities and increases theneed for short-term bank borrowings.  Theincrease in other regulatory assets includes the WRAM which represents therevenue difference between what is billed to GSWC’s water customers and thatwhich is authorized by the CPUC. Surcharges have been implemented in 2010 andare expected to be in place through 2011 to recover the revenue shortfalltracked in the WRAM.  This was partiallyoffset by improved performance for the Military Utility PrivatizationSubsidiaries for the first nine months of 2010, resulting in a $4.2 millionincrease in ASUS’ cash flows from operating activities.  The timing of cash receipts and disbursementsrelated to other working capital items also affected the changes in net cashprovided by operating activities.

 

*Cash Flows from Investing Activities*:

 

Netcash used in investing activities, which consists primarily of capitalexpenditures at GSWC, were $57.6 million for the nine months ended September 30,2010 as compared to $55.6 million for the same period in 2009.

 

Registrantintends to invest capital prudently to provide essential services to itsregulated customer base, while working with its regulators to have theopportunity to earn a fair rate of return on investment. Registrant’sinfrastructure investment plan consists of both infrastructure renewalprograms, where infrastructure is replaced, as needed, and major capitalinvestment projects, where new water treatment and delivery facilities will beconstructed.

 

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Capitalexpenditures are expected to be approximately $80 - $83 million during2010.  Projected capital expenditures andother investments are subject to periodic review and revision to reflectchanges in economic conditions and other factors.

 

*Cash Flows from Financing Activities*:

 

Registrant’sfinancing activities include primarily: (i) the issuance of Common Shares,long-term debt and short term notes payable; (ii) the repayments of long-termdebt and notes payable to banks, primarily funded through the operations of itswholly owned subsidiary, GSWC; (iii) proceeds from stock option exercises; and (iv)the payment of dividends on Common Shares. In order to finance new infrastructure, Registrant also receivescustomer advances for and contributions in aid of construction (net of refunds).  Short-term borrowings under Registrant’srevolving credit line are used to fund capital expenditures until long-termfinancing is arranged.

 

Netcash provided by financing activities was $27.7 million for the nine monthsended September 30, 2010 as compared to $5.3 million for the same period in2009.  During the nine months ended September30, 2010, Registrant increased short-term borrowings by $39.8 million on itsrevolving credit facility and paid $14.5 million in dividends on CommonShares.  During the nine months ended September30, 2009, Registrant received net proceeds of $35.4 million from the issuanceof Common Shares and $39.8 million from the issuance of long-term debt.  During the nine months ended September 30,2009, Registrant also paid down short term borrowings under Registrant’srevolving credit line by $54.2 million and paid $13.3 million in dividends onCommon Shares.

 

***GSWC***

 

GSWCfunds the majority of its operating expenses, payments on its debt, anddividends on its outstanding Common Shares and a portion of its constructionexpenditures through internal sources. Internal sources of cash flow areprovided primarily by retention of a portion of earnings from operating activities.Internal cash generation is influenced by factors such as weather patterns,environmental regulation, litigation, changes in supply costs and regulatorydecisions affecting GSWC’s ability to recover these supply costs, timing ofrate relief, increases in maintenance expenses and capital expenditures andregulatory allowances and disallowances. As of September 30, 2010, GSWC had $100 million available for issuanceof debt or equity securities under a Registration Statement filed with the SEC.

 

GSWC relies on external sources,including equity investments and short-term borrowings from AWR, and long-termdebt to help fund a portion of its construction expenditures.  On May 26, 2010, the Board of Directorsapproved the issuance of eight additional GSWC Common Shares to AWR for $20.0million.  Proceeds from the issuance wereused to pay down GSWC’s intercompany borrowings due to AWR.  In addition, GSWC receives advances andcontributions from customers, home builders and real estate developers to fundconstruction necessary to extend service to new areas. Advances forconstruction are refundable generally at rates ranging from 10% to 22% of therevenues received from the installation for which funds were advanced or inequal annual installments, and are generally paid over 40 years.  Amounts which are no longer refundable arereclassified to contributions in aid of construction. Utility plant funded byadvances and contributions is excluded from rate base. Generally, GSWCdepreciates contributed property and amortizes contributions in aid ofconstruction at the composite rate of the related property.

 

*Cash Flows from Operating Activities*:

 

Netcash provided by operating activities was $31.0 million for the nine monthsended September 30, 2010 as compared to $47.3 million for the same period in2009.  This decrease is due primarily tolower water consumption of approximately 8.7% as compared to 2009’sconsumption.  The reduction in waterusage reduces cash flow from operating activities and increases the need forshort-term bank borrowings.  The increasein other regulatory assets includes the WRAM which represents the revenuedifference between what is billed to GSWC’s water customers and that which isauthorized by the CPUC.  Surcharges havebeen implemented in 2010 and are expected to be in place through 2011 torecover the revenue shortfall tracked in the WRAM.  The timing of cash receipts and disbursementsrelated to other working capital items also affected the changes in net cashprovided by operating activities.

 

*Cash Flows from Investing Activities*:

 

Netcash used in investing activities was $56.1 million for the nine months ended September30, 2010 as compared to $53.1 million for the same period in 2009. This isconsistent with Registrant’s capital investment plan

 

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ofapproximately $75 - $80 million primarily for upgrades to its water supply anddistribution facilities as well as costs for computer software andimplementation.

 

*Cash Flows from Financing Activities*:

 

Netcash provided by financing activities was $28.5 million for the nine monthsended September 30, 2010 as compared to $6.9 million for the same period in2009.  The increase in net cash providedby financing activities was primarily due to the issuance of eight additionalshares of GSWC Common Shares to AWR for $20.0 million.  There was also a $22.4 million increase inintercompany borrowings during the nine months ended September 30, 2010. Duringthe nine months ended September 30, 2010, GSWC also paid dividends of $14.6million to AWR.  During the same periodin 2009, GSWC received net proceeds of $39.8 million from the issuance oflong-term debt.  A portion of theproceeds were used to pay down intercompany borrowings.  GSWC also paid dividends of $19.4 millionduring the nine months ended September 30, 2009.

 

***CCWC and ASUS***

 

CCWC funds the majority of itsoperating expenses, payments on its debt and dividends, if any, throughinternal operating sources or short-term borrowings from AWR. CCWC also relieson external sources, including long-term debt,contributions-in-aid-of-construction, advances for construction andinstall-and-convey advances, to fund the majority of its constructionexpenditures. ASUS funds its operating expenses primarily throughinternal operating sources and investments by or loans from AWR.  ASUS, in turn, provides funding to itssubsidiaries.

 

**Contractual Obligations and Other Commitments**

 

Registranthas various contractual obligations which are recorded as liabilities in theconsolidated financial statements. Other items, such as certain purchasecommitments and operating leases are not recognized as liabilities in theconsolidated financial statements, but are required to be disclosed. Inaddition to contractual maturities, Registrant has certain debt instrumentsthat contain annual sinking fund or other principal payments. Registrantbelieves that it will be able to refinance debt instruments at their maturitythrough public issuance, or private placement, of debt or equity. Annualprincipal and interest payments are generally made from cash flow fromoperations.

 

There have been no other materialchanges to AWR’s contractual obligations and other commitments since December 31,2009. See *“Management’s Discussion and Analysis of FinancialCondition and Results of Operation—Contractual Obligations, Commitments and OffBalance Sheet Arrangements”*section of the Registrant’s Form 10-Kfor the year-ended December 31, 2009 for a detailed discussion of contractualobligations and other commitments.

 

**Regulatory Matters**

 

***Recent Changes in Rates***

 

*Rate increases in 2010:*

 

In December 2009, the CPUCapproved escalation rate increases for GSWC’s Region I water ratemaking areaeffective January 1, 2010.  Theauthorized rate increases are expected to provide GSWC with additional annualrevenues of approximately $76,000 for Region I after adjusting for customergrowth based upon normalized sales levels approved by the CPUC.

 

In October 2009, the CPUCissued a final decision regarding the BVES general rate case.  This decision provided for an incrementalannual increase of $1.2 million for 2010, effective on January 1, 2010 at BVESbased on normalized sales levels approved by the CPUC.  In addition, in June 2009, the CPUCauthorized BVES to track the difference between the 2007 adopted general officecost allocation to BVES and the 1996 adopted general office cost allocation toBVES, effective and retroactive from June 4, 2009 to October 31, 2009.  The amount in this memorandum account totaledapproximately $958,000 as of October 31, 2009 (the date when the 2007 costswere incorporated into BVES’ rates). In March 2010, the CPUC approved forrecovery this memorandum account through a surcharge over a 24-month periodeffective May 1, 2010.  Accordingly,during the first quarter of 2010, GSWC recorded a regulatory asset and acorresponding increase to revenues for amounts included in this memorandumaccount.  The balance in this memorandumaccount included in regulatory assets totaled $832,000 as of September 30,2010.  BVES will be entitled to anotherrate increase in 2010 when the CPUC issues its final

 

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decision in the Region II,Region III and general office rate case to the extent that the general officeallocation to BVES increases (see further discussion under *Pending RateRequests*).

 

*Rate increases in 2009:*

 

*GSWC*

 

In January 2009, the CPUCapproved escalation/attrition year rate increases for all three GSWC waterratemaking areas effective January 1, 2009. The authorized rate increases provided GSWC with estimated additionalannual revenues of approximately $256,000 for Region I, approximately $5.1million for Region II, representing the third year of a three-year rate caseincrease approved by the CPUC in 2007, and approximately $4.0 million forRegion III in 2009. These estimates of additional revenues are based uponnormalized sales levels approved by the CPUC, effective January 1, 2009.

 

TheCPUC also issued its final decision in the cost of capital proceeding in June 2009.  In that decision, the CPUC authorized a 10.2%return on equity and a corresponding return on rate base of 8.9% to beimplemented into rates for all GSWC water ratemaking areas.  Implementation of the cost of capitaldecision resulted in an estimated net annual increase in revenues of approximately$670,000.  In the final cost of capitaldecision, the CPUC also authorized aninterest rate balancing account to track interest costs of new debt.  This balancing account tracks differencesbetween the incremental cost of debt included in the cost of capital decisionand the actual cost of debt for long-term debt issued by GSWC from theeffective date of the final decision.

 

During the third quarter of2008, BVES filed an amended application to request CPUC approval of a newpurchased power contract and regulatory accounting treatment for all unrealizedgains and losses on the new contract due to derivative accounting.  A final decision on this application wasissued in May 2009 approving the contract and authorizing the memorandumaccount to track derivative gains and losses.

 

In June 2008, GSWC’s BVESdivision filed its general rate case with the CPUC’s electric division. On October15, 2009, the CPUC issued a final decision regarding the BVES general ratecase.  The decision authorized a returnon equity of 10.5% with a corresponding return on rate base of 9.15%.  The incremental annual revenue increasesapproved in the decision based on normalized sales level were estimated to be$4.8 million for 2009, $1.2 million for 2010, $0.2 million for 2011 and $0.2million in 2012.  All increases areprospective.  BVES was also allowed toestablish a Base Revenue Requirement Adjustment Mechanism to decouple revenuefrom usage.

 

The decision also allows foran update to BVES’ rates in 2010 for the corporate headquarters’ costs based onthe CPUC’s adoption of new rates for GSWC’s current general rate case includingthe recovery of expenses associated with its corporate headquarters. However,as discussed in the pending rate requests below, the general rate case forRegions II and III and the general office has been delayed.

 

*CCWC*

 

CCWC filed a rate case withthe ACC in August 2004 for its water system in Fountain Hills, Arizona.  In September 2005, the ACC approved a rateincrease for CCWC. After appealing the ACC’s decision on various grounds, in July2008, the ACC rendered another decision increasing CCWC’s annual revenues byonly $12,000.  Once again, CCWC appealedthe decision. In June 2010, the Court of Appeals rendered a decision which wasadverse to CCWC’s claim.  CCWC has nointention of appealing this latest decision.

 

CCWC filed a rate caseduring the fourth quarter of 2007, requesting rate increases of approximately$2.9 million.  On October 8, 2009, theACC issued a final decision approving a rate increase for CCWC, which waseffective on October 15, 2009 and is expected to generate additional annualrevenues of approximately $1.7 million, a 23% increase over current revenuesbased on normalized sales.  In addition,despite previous rulings in prior proceedings on similar matters, the ACC alsoordered CCWC to treat the entire gain of $1,520,000 from a settlement agreementwith the Fountain Hills Sanitary District (“FHSD”) as a reduction to rate base.  As a result, CCWC recognized a loss of$760,000, or $0.02 per share, during the third quarter of 2009, whicheffectively reversed the original gain recorded in 2005.  In November 2009, CCWC filed an applicationfor rehearing on several issues including the sharing of this gain from thesettlement proceeds.  The ACC grantedCCWC’s request to hold a rehearing on this issue and one other issue.  On January 27, 2010, a procedural conferencewas held with the judge and the staff of the ACC involved in the rate case toaddress a schedule for the rehearing. The rehearing was held in April 2010 anda final decision by the ACC is expected later this year.  At this time, management is unable to predictthe outcome of this matter.

 

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As of September 30, 2010,CCWC has $3.3 million of goodwill which may be at risk for potential impairmentif the ACC does not approve the sale with EPCOR Water (USA) Inc. and futurerequested rate increases are not granted or further delayed by the ACC.

 

***PendingRate Requests***

 

*GSWC*

 

GSWCfiled its general rate case for Region I on January 4, 2010.  The new rates are to be effective for 2011and 2012.  GSWC’s stipulated position callsfor revenue increases of $5.4 million and $1.2 million for 2011 and 2012, respectively,whereas the Division of Ratepayer Advocate’s position calls for revenueincreases of $2.1 million and $329,000 for 2011 and 2012, respectively. Anyrevenue increase for 2012 approved in the final decision will be subject tocommission-approved escalation factors and pro forma earnings tests.  GSWC has filed for a memorandum account forinterim rate increases effective January 1, 2011 in the event a finaldecision is not issued by the CPUC by the end of 2010.  This establishes an effective date for newrates once they are approved by the CPUC.

 

GSWCfiled its general rate case for Regions II and III plus the general office on July1, 2008 for rates effective for years 2010, 2011 and 2012.  In January 2010, the CPUC approved interimrates for GSWC’s Region II and Region III water ratemaking areas effective January1, 2010, pending a final decision on the general rate case.  While the increase for interim rates was zeropercent, it is important to establish the effective date so that new rates,once approved by the CPUC, will be retroactive to January 1, 2010.  On January 29, 2010, the CPUC issued a rulingrevising the scoping memo and reopening the general rate case proceeding toreceive supplemental information and testimony on a number of issues includingcost allocation, the definition of firm capacity, pension and benefitcalculations, general office rent expense, salary and wage adjustments, costsregarding certain capital projects, and deferred rate case costs.  GSWC has provided additional information andtestimony regarding these issues to the CPUC.

 

OnOctober 20, 2010, the administrative law judge and the assigned commissionerissued a proposed decision and an alternate proposed decision,respectively.  These proposed decisionsadopt the partial settlement agreement reached between GSWC and the Division ofRatepayer Advocates which include capital budgets, sales, and supply costs.  The CPUC may approve either the proposed oralternate proposed decision, as written, or modify them based upon commentsreceived during a twenty day comment period which commenced on October 20, 2010.  GSWC is in the process of providing commentsto the CPUC regarding items in the proposed decisions and cannot predictwhether any changes will be made to the final decision prior to adoption.  The CPUC is scheduled to issue a finaldecision during the fourth quarter of 2010.

 

Therevenue requirements for both proposed decisions are similar.  The increase in revenues amounts toapproximately $31 million, which includes an increase of $14 million for supplycosts.  The $31 million increase is inaddition to the step increases of $9.1 million for Regions II and IIIimplemented in 2009.  As previouslymentioned, once approved by the CPUC, the new rates will be retroactive to January1, 2010.  Had the new rates in thedecisions been in place on January 1, 2010, pretax operating income for thethree and nine months ended September 30, 2010 would have increased by $3.6million, or $0.12 per share and $10.3 million, or $0.33 per share,respectively.  The revenue increases for2011 and 2012 are approximately $3.0 million and $6.0 million, respectively forRegion II and Region III combined. The Region II and Region III revenueincreases for 2011 and 2012 are subject to commission-approved escalationfactors and pro forma earnings tests.

 

***PendingRegulatory Matters***

 

Thefollowing are two pending regulatory matters related to GSWC that resulted in apretax charge of $9.0 million, or $0.32 per share, during the third quarter of2010 for the impairment of assets and loss contingencies.  Registrant will accrue the most likely amountwhen such an amount can be reasonably estimated or, at least the minimum of therange of probable loss when a range of probable loss can be estimated.  Thesereserve estimates will be adjusted as additional information becomesknown.

 

*CPUC Subpoena*:

 

OnFebruary 15, 2007, the CPUC issued a subpoena to GSWC in connection with aninvestigation of certain work orders and charges paid to a specific contractorused previously by GSWC for numerous construction projects estimated to total$24.0 million. The CPUC’s investigation focuses on whether GSWC was overchargedfor these construction projects and whether these overcharges were approved incustomer rates.  The constructionprojects completed by this specific contractor related primarily to work onwater treatment and pumping plants which have been placed in service and areused and useful.  In June 2007, GSWCreceived notification from the CPUC that it was instituting an audit. Thepurpose of the audit was to examine for the period 1994 to the present,

 

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GSWC’spolicies, procedures, and practices throughout its three water regionsregarding the granting or awarding of construction contracts or jobs.  GSWC continues to respond to data requestssubmitted by the CPUC including data requests which asked for information priorto 1994.

 

Shouldthe CPUC investigation result in a proposed disallowance of certain previouslycapitalized costs, such costs, and potentially any return earned on such costs,may be required to be refunded to the customers upon settlement of the proposeddisallowance, if any, resulting in a charge to operating income.  In addition to the disallowance of previouslycapitalized costs and the return earned on such costs, the CPUC also has theauthority to assess fines and penalties. At this time, Registrant cannotpredict the final outcome of this matter. Although it does not believe a disallowance or penalty isjustified, and reserving all rights, management believes it prudent to reservefor a probable loss related to this matter. The reserve estimates for this matter are subject to change as additionalinformation becomes known and the CPUC approaches the conclusion of itsinvestigation and determines its next course of action, if any.  Registrant could experience increases in itsrecorded estimated reserves for disallowances, refunds, assessments or fines.Any such increases in estimated reserves for additional disallowances,refunds to customers assessments or fines, if imposed, could have a materialadverse effect on AWR and GSWC.

 

In January 2009, the ACC staff requestedinformation regarding the CPUC subpoena and on-going audit.  GSWC has been working with the ACC staff andhas provided responsive materials, including but not limited to, materials thatare relevant to CCWC. Although the ACC has issued a decision in the CCWCgeneral rate case, it has held the docket open pending resolution of the staff’sreview of the CPUC subpoena documents. In the first quarter of 2010, the ACC staff issued a report recommendingthat proper controls be established in CCWC’s procurement policies and procedures,and that status reports of the CPUC’s investigation and resolution be filedwith the ACC periodically. The staff’s report did not result in any financialimpact to CCWC.  The ACC has not yetacted on the staff’s recommendations. Management cannot predict the outcome of the ACC’s final decision onthis matter.

 

*General Rate Case - Region II, Region III and GeneralOffice:*

 

Asdiscussed previously above, on October 20, 2010, the administrative law judgeand the assigned commissioner issued a proposed decision and an alternateproposed decision, respectively, in the general rate case for Regions II andIII, plus the general office.  Amongother things, the proposed decisions also adopted certain positions regardingthe number of issues where supplemental information and testimony were providedincluding costs regarding the La Serena Plant Improvement Project and othercapital projects, and deferred rate case costs. The CPUC may approve either the proposed or alternate proposed decision,as written, or modify them based upon comments received during a twenty daycomment period which commenced on October 20, 2010.  GSWC is in the process of providing commentsto the CPUC regarding items in the proposed decisions and cannot predictwhether any changes will be made and incorporated in the final decision priorto adoption, which may require an increase in the recorded estimated pretaxcharge for the impairment of assets and further negatively impact GSWC. TheCPUC is scheduled to issue a final decision during the fourth quarter of 2010.

 

***Other Regulatory Matters***

 

See *“Management’sDiscussion and Analysis of Financial Condition and Results ofOperation—Regulatory Matters”*section of the Registrant’s Form 10-Kfor the year-ended December 31, 2009 for a detailed discussion of otherregulatory matters. The discussion below focuses on significant matters andchanges since December 31, 2009.

 

**ConservationRate Design and Revenue Adjustment Mechanisms**

 

Inaccordance with the CPUC’s administrative processing rules, GSWC implementedtiered increasing block rates and began recording in the WRAM accounts thedifference between what is billed to its regulated customers and that which isauthorized by the CPUC. GSWC provided customers with conservation rate noticesas a bill insert and explained to them the impact of conservation rates oncustomers’ bills.  Conservation ratechanges became effective in Regions II and III in November 2008 and in Region Iin September 2009.

 

InMarch 2010, GSWC filed a tier one advice letter with the CPUC for recovery ofthe Regions II and III WRAM, net of the MCBA and supply cost balancingaccounts, of $18.3 million.  A surchargewas put in place in March 2010 which is expected to recover the amountsaccumulated in Regions II and III’s WRAM, net of MCBA and supply cost balancingaccounts, as of December 31, 2009.  In Apriland May of 2010, surcharges were put in place in Region I’s rate making areasto recover $2.1 million of the $2.8 million net regulatory asset balance as of

 

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December31, 2009.  Going forward, GSWC will seekrecovery of its WRAM, net of MCBA, on an annual basis.  As of September 30, 2010, GSWC has a netaggregated regulatory asset of $36.2 million which is comprised of a $49.1million under-collection in the WRAM accounts and $12.9 million over-collectionin the MCBA accounts.

 

As part of the CPUC’s final decision in October 2009on the BVES general rate case, GSWC was also authorized to establish a BaseRevenue Requirement Adjustment Mechanism (“BRRAM”) account effective November 2,2009. With the adoption of the BRRAM account, GSWC began recording thedifference between the base rate revenue portion of its charges on customers’bills and the amount of base rate costs authorized for recovery in rates by theCPUC.  The variance between adoptedelectric base rate revenue and actual billed base rate revenue will be recordedas a component of electric revenue with an offsetting entry to an asset orliability balancing account.  Thevariance amount may be positive or negative and represents amounts that will bebilled or refunded to electric customers in the future.  Amounts in this account bear interest at thecurrent 90-day commercial paper rate. When the amount of the under- or over-collection is equal to or greaterthan five percent of the adopted base rate revenue requirement established forthe previous twelve months, GSWC intends to seek approval from the CPUC torefund or collect the balance in the account. As of September 30, 2010, GSWC has included in other regulatory assets$1.1 million related to the BRRAM.

 

**Bear Valley ElectricService**

 

GSWC’sBVES division has been regularly filing compliance reports with the CPUCregarding its purchases of energy from renewable energy resources. The filingshave indicated that BVES has not achieved interim target purchase levels ofrenewable energy resources and thus, on its face, might be subject to apotential penalty. At this time, management does not believe interim targetsfor the 2010 year will be met.  However,BVES expects that the CPUC will waive any potential fines in accordance withthe CPUC’s flexible compliance rules. Accordingly, no provision for loss has been recorded in the financialstatements as of September 30, 2010. BVES is continuing its efforts to procure renewable resources.  In November 2009, GSWC entered into aten-year contract to purchase renewable energy created from landfill gas.  The contract is subject to CPUCapproval.  If approved, the contract willprovide up to three megawatts for ten years at a fixed price of $110.0 per MWh.  In November 2009, GSWC also entered into aten-year contract to purchase biogas to power BVES’s gas-fueled 8.4 MWgeneration facility.  This contract isalso subject to CPUC approval.

 

**Catastrophic Event Memorandum Account**

 

In January 2010, the City of Big Bear Lake andsurrounding areas of San Bernardino County experienced a series of snow storms,which damaged many BVES power lines, poles, transformers, and other facilitiesand caused temporary interruption of service to many BVES customers.  As a result of these storms, BVES hasincurred additional operating costs to repair equipment and restore electricservice to its customers.  In February 2010,GSWC informed the CPUC it will track these costs in a Catastrophic EventMemorandum Account (“CEMA”).  GSWCintends to file with the CPUC in 2011for recovery of these costs.  As of September 30, 2010, approximately$327,000 has been incurred as a result of the storms and has been included inthe CEMA account as a regulatory asset. This amount includes BVES labor, outside services assistance, equipment,materials, facilities damages and related snow removal services.  Management believes this amount is probableof future recovery.

 

**Excess Usage Charges - Refund to Customers**

 

In July 2009, GSWC began receiving reduced waterallocations from member agencies of the Metropolitan Water District of SouthernCalifornia (“MWD”). As a result, in July 2009, GSWC began implementing waterrationing, restrictions, and excess usage charges to its customers in severalof its service areas. The excess usage charges were being collected in theevent that penalties were required to be paid to MWD for exceeding GSWC’s waterallocations.  As of September 30, 2010,GSWC has billed its customers excess usage charges totaling $3.3 million, whichare included in other regulatory assets/liabilities.  In the event that GSWC is required to paypenalties to MWD for exceeding GSWC’s water allocations in the current wateryear, GSWC will use the $3.3 million previously billed to customers to pay thepenalties.

 

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**Interest Rate Balancing Account**

 

Adecision issued in July 2009in the GSWC cost of capital proceeding authorized GSWC an interest ratebalancing account to track interest costs of new debt.  This balancing account tracks any differencebetween the incremental cost of debt included in the cost of capital decisionand the actual cost of debt for any long-term debt issued by GSWC from the effectivedate of the final decision.  In August 2010,GSWC filed an advice letter with the CPUC for approval of a customer refundbased on the difference between the adopted cost of new debt in its authorizedcapital structure and the actual cost of new debt since January 1, 2009.  In response to this advice letter filed byGSWC, CPUC issued a resolution in October 2010 and confirmed the methodology ofhow the difference in the cost of debt should be calculated in the interestrate balancing account pursuant to the cost of capital decision.  As a result of this resolution, GSWC recordeda downward adjustment of $654,000 to interest expense during the third quarterof 2010, which was previously recorded in the interest rate balancingaccount.  As of September 30, 2010, GSWChas included in other regulatory liabilities a total of $510,000 related to theinterest rate balancing account that will be refunded to customers.

 

**Disposition of Chaparral CityWater Company**

 

On June 7, 2010, the Company entered into a stockpurchase agreement with EPCOR Water (USA) Inc. to sell all of the common sharesof CCWC. The consummation of the transaction contemplated by the agreement issubject to customary conditions, including among other things, regulatoryapproval by the ACC.  In July 2010, theCompany filed for approval of the transaction with the ACC.  The approval is anticipated to be received in2011.

 

**Affiliate Transaction Rules**

 

OnOctober 19, 2010, the CPUC issued a decision regarding affiliate transactionsand the use of regulated assets for non-tariff utility services (formerlycalled Excess Capacity).  The newaffiliate rules are intended to establish a standard set of rules to governtransactions between a regulated water utility, its parent, and otheraffiliated companies.  The affiliatedtransaction decision reaffirms previous industry practices, and the Companycontinues to monitor its cost allocation and management of the regulated andnon-regulated segments to ensure the affiliate transactions are in compliancewith the prescribed rulings.

 

**2010 Water Action Plan**

 

On October 28, 2010, the CPUC adopted the 2010 WaterAction Plan, highlighting the actions that the CPUC are considering toimplement in order to achieve the Commission’s objectives of providing qualitywater service through efficient use of water and reasonable rates.  The 2010 Water Action Plan represents anupdate to the Commission’s first Water Action Plan which was adopted in December2005.  The new plan identifies regulatoryactions that the Commission will consider including consideration of offeringincentives to promote acquisition of smaller utilities; updating industrystandards including revamping of the Uniform System of Accounts to convergewith the Securities and Exchange Commission and the Financial AccountingStandards Board standards; developing rules to increase the use of recycledwater and desalination; and streamline CPUC regulatory decision process.  The Company will work closely with the CPUC toassist in achieving these objectives.

 

**EnvironmentalMatters**

 

AWR’ssubsidiaries are subject to increasingly stringent environmental regulationsincluding the 1996 amendments to the Federal Safe Drinking Water Act; enhanced surface water treatmentrules; regulation of disinfectant/disinfection by-products; and the long-term enhanced surface water treatment rules; groundwater treatment rule; contaminant regulation of radon and arsenic; and unregulated contaminants monitoring rule.

 

There have been no material changesto AWR’s environmental matters since December 31, 2009. See *“Management’s Discussion and Analysis of Financial Condition andResults of Operation-Environmental Matters”*section of theRegistrant’s Form 10-K for the year-ended December 31, 2009 for a detaileddiscussion of environmental matters.

 

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**WaterSupply**

 

See *“Management’sDiscussion and Analysis of Financial Condition and Results of Operation—WaterSupply”*section of the Registrant’s Form 10-K for the year endedDecember 31, 2009 for a detailed discussion of water supply issues. Thediscussion below focuses on significant matters and changes since December 31,2009.

 

***State Water Project***

 

Watersupplies available to the Metropolitan Water District of Southern California (“MWD”)through the State Water Project (“SWP”) have historically varied from year toyear based on weather.  However, MWD hasgenerally been able to provide sufficient quantities of water to satisfy theneeds of its constituents.

 

Akey link in the SWP is the Sacramento/San Joaquin River Delta adjacent to theSan Francisco Bay (“Delta”).  The freshwater pathway through the Delta is supported by earthen levees, and thereliability of those levees has been called into question based on assessmentsby various federal, state and local agencies. In addition, many native species to the Delta are in dangerous decline,forcing restrictions on pumping through the Delta.  A series of legislative actions were approvedin 2009 to address the overall needs of the Delta.  A key component of the legislation included abond package which must be approved by voters in California; however, the bondinitiative has been postponed until at least 2012.  GSWC continues to participate in and monitordevelopments related to the Delta and efforts to craft a workable solution tothe risks presented by reliance on the Delta for water supply conveyance tosouthern California.

 

Everyyear, the Department of Water Resources (“DWR”) establishes the SWP allocationfor water deliveries to the state water contractors.  DWR generally establishes a percentageallocation of delivery requests based on a number of factors, including weatherpatterns, snow pack levels and reservoir levels.  The percent allocation given to statecontractors can vary throughout the year as weather and other factorschange.  DWR initially established anestimate of delivery of 5% of delivery requests for 2010.  In February 2010, DWR announced an increasein this allocation to 15% of delivery requests. In June 2010, DWR increased the allocation to 50%.  In 2009, the SWP delivered 40% of contractorrequests.

 

***Colorado River***

 

On October 17, 2003, the federalgovernment, acting through the United States Bureau of Reclamation in itscapacity as Colorado River watermaster, the State of California, and fourSouthern California water agencies, including MWD, reached an agreement, knownas the Quantification Settlement Agreement (“QSA”).  The QSA allocates California’s annual 4.4 millionacre-feet (“MAF”) share of the Colorado River among those agencies and providesthe framework for accounting and transfers among them. Under the QSA, MWD willcontinue to have access to its base allotment of Colorado River water eachyear, as well as excess Colorado River water until October 2016, and up to 1.6MAF of additional water that the Imperial Irrigation District proposes toconserve and sell to the state for use by MWD members.  The QSA has been subject to ongoinglitigation.  A trial court has ruled thatthe QSA is invalid to the extent that it relies upon an unconditionalappropriation from the State of California to fund environmental mitigation.  MWD and the other Southern California wateragencies intend to appeal.  There is no expecteddisruption in water supplies while the case awaits resolution of the appeal.

 

***Wholesale Water Supplier Responses***

 

Underits Integrated Resources Plan, MWD estimates that it can meet its memberagencies’ demands over at least the next 20 years.  However, in light of pressure on all of itssources of imported water, MWD adopted a Water Supply Allocation Plan (“thePlan”) on February 12, 2008.  MWDimplemented the Plan effective July 1, 2009 requiring a regional reduction indelivery of 10%.  GSWC also implementedmandatory and voluntary actions in areas relying on MWD as a supply, and metthe required reduction for the 2010 water year. As a result, GSWC has moved to voluntary actions in all MWD serviceareas.  MWD has also announcedrestrictions on water availability for groundwater replenishment and othersupply programs.  MWD has announced arate increase of 7.5% beginning January 2011, with another increase of 7.5% for2012.  Increases in prices fromwholesalers such as MWD flow through the modified cost balancing account forGSWC.

 

TheContra Costa Water District (“CCWD”), which also relies on water flow throughthe Delta, also announced plans for mandatory water allocations andrestrictions in 2009.  GSWC purchaseswater from the CCWD for use in its Bay Point service territory.  GSWC has implemented mandatory and voluntaryactions in this area

 

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similarto those by CCWD.  GSWC continues to workclosely with CCWD to ensure continued supply to customers in its Bay Pointservice territory through implementation of mandatory water conservationactivities.  Effective May 1, 2010, CCWDterminated their mandatory allocations as did GSWC.

 

GSWCis closely monitoring developments and working with its water suppliers tosafeguard the supply and evaluate potential emergency responses to prolongedreduction in imported supplies.

 

***Agreement with Cadiz Inc.***

 

In June 2010, GSWC signed anagreement with Cadiz Inc. to proceed with the Cadiz Water Conservation &Storage Project (“Cadiz Project”) and participate in the Cadiz Project’senvironmental review. GSWC will also commit funds to the environmental reviewand has committed to the goal of a general “environmental benefit” for theoperation of the project. Under the terms of the agreement, GSWC has the rightto acquire an annual supply of 5,000 acre-feet of water at a pre-determinedformula once the environmental review is complete. In addition, GSWC has theoption to acquire storage rights in the Cadiz Project to allow GSWC to managethe supply as part of its overall water supply portfolio. Cadiz Inc, is apublicly-held renewable resources company that owns 70 square miles of propertywith significant water resources and clean energy potential in eastern SanBernardino County, California.

 

**New Accounting Pronouncements**

 

Registrantis subject to newly issued requirements as well as changes in existingrequirements issued by the Financial Accounting Standards Board. Differences infinancial reporting between periods could occur unless and until the CPUC andthe ACC approve such changes for conformity through regulatory proceedings. See*Note 1**of UnauditedNotes to Consolidated Financial Statements.*

 

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**Item 3. Quantitative and QualitativeDisclosures About Market Risk**

 

Registrantis exposed to certain market risks, including fluctuations in interest rates,commodity price risk primarily relating to changes in the market price ofelectricity and the potential impact of financial market turmoil. Market riskis the potential loss arising from adverse changes in prevailing market ratesand prices.

 

Therehave been no other material changes regarding Registrant’s market risk positionfrom the information provided in its Annual Report on Form 10-K for the yearended December 31, 2009. The quantitative and qualitative disclosures aboutmarket risk are discussed in *Item 7A-Quantitative andQualitative Disclosures About Market Risk*, contained in Registrant’sAnnual Report on Form 10-K.

 

**Item 4. Controls and Procedures**

 

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

 

Asrequired by Rule 13a-15(b) under the Securities and Exchange Act of 1934 (the “ExchangeAct”), we have carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer (“CEO”)and our Chief Financial Officer (“CFO”), of the effectiveness, as of the end ofthe fiscal quarter covered by this report, of the design and operation of our “disclosurecontrols and procedures” as defined in Rule 13a-15(e) and 15d-15(e) promulgatedby the Securities and Exchange Commission (“SEC”) under the Exchange Act. Basedupon that evaluation, the CEO and the CFO concluded that disclosure controlsand procedures, as of the end of such fiscal quarter, were adequate andeffective to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms and that such information is accumulated and communicated to ourmanagement, including our CEO and CFO, as appropriate to allow timely decisionsregarding required disclosure.

 

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

 

Therehas been no change in our internal control over financial reporting during thequarter ended September 30, 2010, that has materially affected or is reasonablylikely to materially affect our internal control over financial reporting.

 

**Item 4T. Controls and Procedures**

 

Notapplicable.

 

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**PART II**

 

**Item 1. Legal Proceedings**

 

There have been no materialdevelopments in any of the legal proceedings described in our 2009 AnnualReport on Form 10-K.

 

Registrant is subject to ordinaryroutine litigation incidental to its business. Other than those disclosed inRegistrant’s Form 10-K for the year ended December 31, 2009 and the 2010 Form 10-Qs,no other legal proceedings are pending, which are believed to be material. Managementbelieves that rate recovery, proper insurance coverage and reserves are inplace to insure against property, general liability and workers’ compensationclaims incurred in the ordinary course of business.

 

**Item 1A. Risk Factors**

 

Therehave been no significant changes in the risk factors disclosed in our 2009Annual Report on Form 10-K.

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds**

 

The shareholders of AWR haveapproved the material features of all equity compensation plans under which AWRdirectly issues equity securities. AWR did not directly issue any unregisteredequity securities during the third quarter of 2010.  The following table provides informationabout repurchases of common shares by AWR during the third quarter of 2010:

 
| **Period**                | ** ** | **Total Number  of  Shares  Purchased** | ** ** | **Average Price  Paid  per Share** | ** ** | **Total Number  of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs (1)** | ** ** | **Maximum Number  of Shares That May  Yet Be Purchased  under the Plans or  Programs** | ** ** |
|---------------------------|------------|-----------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| July 1  - 31, 2010        |       | —                                  |       | $                                  | —     |                                                                                          | —     |                                                                                   | NA         |   |
| August 1  – 31, 2010 |       | 41,988                                  |       | $                                  | 33.11      |                                                                                          | —     |                                                                                   | NA         |   |
| September  1 - 30, 2010   |       | 44                                      |       | $                                  | 34.53      |                                                                                          | —     |                                                                                   | NA         |   |
| Total                     |       | 42,032                                  | (2)        | $                                  | 33.11      |                                                                                          | —     |                                                                                   | NA         | (3) |

 

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(1)         None of the commonshares were purchased pursuant to any publicly announced stock repurchaseprogram.

 

(2)         Ofthis amount, 41,900 Common Shares were acquired on the open market for employeespursuant to the Company’s 401(k) Plan. The remainder of the CommonShares were acquired on the open market for participants in the Company’sCommon Share Purchase and Dividend Reinvestment Plan.

 

(3)         None of these plans contain a maximum number ofcommon shares that may be purchased in the open market under the plans.

 

**Item 3. Defaults Upon Senior Securities**

 

None

 

**Item 4. [Removed and Reserved]**

 

**Item 5. Other Information**

 

(a)         On October 25, 2010, the Board of Directors of AWR declareda regular quarterly dividend of $0.26 per Common Share. The dividend will bepaid on December 1, 2010 to shareholders of record as of the close of businesson November 8, 2010.

 

(b)         There have been no material changes during the thirdquarter of 2010 to the procedures by which shareholders may nominate persons tothe Board of Directors of AWR.

 

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**Item 6. Exhibits**

 

(a)         The following documents are filed as Exhibits tothis report:

 
| 31.1   |   | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002 for AWR (1)  |
|--------|--------|-------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                              |
| 31.1.1 |   | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002 for GSWC (1) |
|   |   |                                                                                                              |
| 31.2   |   | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002 for AWR (1)  |
|   |   |                                                                                                              |
| 31.2.1 |   | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002 for GSWC (1) |
|   |   |                                                                                                              |
| 32.1   |   | Certification  of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002 (2)          |
|   |   |                                                                                                              |
| 32.2   |   | Certification  of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act  of 2002 (2)          |

 

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(1)         Filed concurrently herewith

 

(2)         Furnished concurrently herewith

 

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**SIGNATURE**

 

Pursuantto the requirements of Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized and as its principal financial officer.

 
|   |       | AMERICAN  STATES WATER COMPANY (“AWR”): |
|--------|------------|---------------------------------------------------|
|   |       |                                              |
|   |   By: | /s/  EVA G. TANG                                  |
|   |       | Senior  Vice President-Finance, Chief Financial   |
|   |       | Officer,  Corporate Secretary and Treasurer       |
|   |       |                                              |
|   |       | GOLDEN  STATE WATER COMPANY (“GSWC”):   |
|   |       |                                              |
|   |   By: | /s/  EVA G. TANG                                  |
|   |       | Senior  Vice President-Finance, Chief Financial   |
|   |       | Officer  and Secretary                            |
|   |       |                                              |
|   | Date:      | November  9, 2010                                 |

 

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