SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ýQuarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period ended September 30, 2005
or
oTransition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the transition period from to
x |
| Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2006 or |
o | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to |
Commission file number 001-14431
American States Water Company
(Exact Name of Registrant as Specified in Its Charter)
California |
| 95-4676679 |
(State or Other Jurisdiction of Incorporation or Organization) |
| (IRS Employer Identification No.) |
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630 |
| 91773-1207 |
(Address of Principal Executive Offices) |
| (Zip Code) |
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(909) 394-3600
(Registrant’s Telephone Number, Including Area Code)
Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Commission file number 001-12008
Golden State Water Company
(Exact Name of RegistrantRegistrant as Specified in Its Charter)
California |
| 95-1243678 |
(State or Other Jurisdiction of Incorporation or Organization) |
| (IRS Employer Identification No.) |
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630 |
| 91773-1212 |
(Address of Principal Executive Offices) |
| (Zip Code) |
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(909) 394-3600
(Registrant’s Telephone Number, Including Area Code)
Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
American States Water Company | Yes x
| |
Golden State Water Company | Yes x No o |
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, (as definedor a nonaccelerated file. See definition of “accelerated filer and large accelerated file” in Rule 12b-2 of the Exchange Act.). (Check one):
American States Water Company | Large accelerated filer
| Accelerated filer x | Nonaccelerated filer o |
Golden State Water Company | Large accelerated filer o | Accelerated filer o | Nonaccelerated filer x |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
American States Water Company Yes o No ý
American States Water Company Yes o No x Golden State Water Company Yes o No x As of November As of November AMERICAN STATES WATER COMPANY Financial Information 3-4 5 6 7 8-9 10 11 12 13 Management’s Discussion and Analysis of Financial Condition and Results of Operations 30 Quantitative and Qualitative Disclosures About Market 48 49 Other Information 50 50 50 50 50 51 51 52 1 General The basic financial statements included herein have been prepared by Registrant, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements, prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments consisting of normal recurring items and estimates necessary for a fair statement of results for the interim period have been made. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto in the latest Annual Report on Form 10-K of American States Water Company and its Filing Format This quarterly report on Form 10-Q is a combined report being filed by two separate Registrants: American States Water Company (hereinafter “AWR”) and Golden State Water Company (hereinafter “GSWC”) (formerly known as Southern California Water Company). For more information, please see Note 1 to the Notes to Consolidated Financial Statements and the heading entitled General in Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Certain matters discussed in this report (including the documents incorporated herein by reference) are forward-looking statements intended to qualify for the “safe harbor” from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as Registrant “believes,” “anticipates,” “expects” or words of similar import. Similarly, statements that describe Registrant’s future plans, objectives, estimates or goals are also forward-looking statements. Such statements address future events and conditions concerning capital expenditures, earnings, litigation, rates, water quality and other regulatory matters, adequacy of water supplies, GSWC’s ability to recover electric, natural gas and water supply costs from ratepayers, contract operations, liquidity and capital resources, and accounting matters. Actual results in each case could differ materially from those currently anticipated in such statements, by reason of factors such as changes in utility regulation, including ongoing local, state and federal activities; recovery of regulatory assets not yet included in rates; future economic conditions, including changes in customer demand and changes in water and energy supply costs; future climatic conditions; and legislative, legal proceedings, regulatory and other circumstances affecting anticipated revenues and costs. AMERICAN STATES WATER COMPANY (in thousands) September 30, December 31, Utility Plant, at cost Water $ 899,598 $ 869,471 Electric 62,197 61,386 961,795 930,857 Less - Accumulated depreciation (280,906 ) (259,915 ) 680,889 670,942 Construction work in progress 61,480 42,283 Net utility plant 742,369 713,225 Other Property and Investments Goodwill 11,778 11,841 Other property and investments 9,697 9,740 Total other property and investments 21,475 21,581 Current Assets Cash and cash equivalents 6,591 13,032 Accounts receivable-customers (less allowance for doubtful accounts of $780 in 2006 and $789 in 2005) 17,802 13,341 Unbilled revenue 18,762 15,195 Other accounts receivable (less allowance for doubtful accounts of $144 in 2006 and $337 in 2005) 9,923 10,844 Income taxes receivable 30 822 Materials and supplies, at average cost 1,545 1,421 Regulatory assets – current 3,233 3,946 Prepayments and other current assets 1,395 2,998 Unrealized gain on purchased power contracts — 3,417 Costs and estimated earnings in excess of billings on uncompleted contracts 2,231 — Deferred income taxes – current 4,709 1,692 Total current assets 66,221 66,708 Regulatory and Other Assets Regulatory assets 61,288 54,382 Other accounts receivable 9,148 8,820 Deferred income taxes 34 — Other 8,173 8,419 Total regulatory and other assets 78,643 71,621 Total Assets $ 908,708 $ 873,135 The accompanying notes are an integral part of these consolidated financial statements AMERICAN STATES WATER COMPANY September 30, December 31, (in thousands) 2005 2004 Utility Plant, at cost Water $ 806,873 $ 778,238 Electric 58,670 58,667 865,543 836,905 Less - Accumulated depreciation (257,622 ) (241,717 ) 607,921 595,188 Construction work in progress 90,309 68,977 Net utility plant 698,230 664,165 Other Property and Investments Goodwill 11,862 11,925 Other property and investments 9,765 9,792 Total other property and investments 21,627 21,717 Current Assets Cash and cash equivalents 5,691 4,303 Accounts receivable-customers (less allowance for doubtful 15,209 10,970 Unbilled revenue 17,400 13,743 Other accounts receivable (less allowance for doubtful 3,614 3,384 Income taxes receivable — 5,833 Materials and supplies, at average cost 1,435 1,496 Regulatory assets - current 4,569 7,104 Prepayments and other current assets 7,047 3,466 Deferred income taxes - current 1,490 2,725 Total current assets 56,455 53,024 Regulatory and Other Assets Regulatory assets 50,587 54,404 Other accounts receivable 8,713 8,400 Other 8,745 8,567 Total regulatory and other assets 68,045 71,371 Total Assets $ 844,357 $ 810,277 (in thousands) September 30, December 31, Capitalization Common shares, no par value, no stated value $ 174,330 $ 166,529 Earnings reinvested in the business 107,311 101,121 Accumulated other comprehensive loss (3,556 ) (3,556 ) Total common shareholders’ equity 278,085 264,094 Long-term debt 268,181 268,405 Total capitalization 546,266 532,499 Current Liabilities Notes payable to banks 25,000 27,000 Long-term debt – current 575 635 Accounts payable 23,284 19,653 Income taxes payable 4,392 1,534 Accrued employee expenses 4,428 5,879 Accrued interest 5,245 2,254 Regulatory liabilities – current 4,120 3,252 Deferred income taxes – current — 86 Unrealized loss on purchased power contracts 2,468 — Billings in excess of costs and estimated earnings on uncompleted contracts 1,910 — Other 13,268 14,952 Total current liabilities 84,690 75,245 Other Credits Advances for construction 86,961 85,168 Contributions in aid of construction – net 86,708 83,976 Deferred income taxes 76,042 69,669 Unamortized investment tax credits 2,450 2,518 Accrued pension and other postretirement benefits 14,955 13,562 Regulatory liabilities 571 521 Billings in excess of costs and estimated earnings on uncompleted contracts 2,092 2,207 Other 7,973 7,770 Total other credits 277,752 265,391 Commitments and Contingencies (Note 8) — — Total Capitalization and Liabilities $ 908,708 $ 873,135 The accompanying notes are an integral part of these consolidated financial statements AMERICAN STATES WATER COMPANY Three Months Ended (in thousands, except per share amounts) 2006 2005 Operating Revenues Water $ 64,962 $ 60,539 Electric 6,444 6,544 Other 2,335 1,008 Total operating revenues 73,741 68,091 Operating Expenses Water purchased 15,066 15,779 Power purchased for pumping 3,600 3,252 Groundwater production assessment 2,477 2,315 Power purchased for resale 2,659 3,075 Unrealized loss (gain) on purchased power contracts 2,807 (4,018 ) Supply cost balancing accounts 244 514 Other operating expenses 6,677 4,850 Administrative and general expenses 12,614 10,342 Depreciation and amortization 6,634 4,734 Maintenance 3,395 2,905 Property and other taxes 2,656 2,572 Net gain on sale of property (124 ) — Total operating expenses 58,705 46,320 Operating Income 15,036 21,771 Interest expense (5,349 ) 193 Interest income 695 745 Income from operations before income tax expense 10,382 22,709 Income tax expense 4,809 10,475 Net Income $ 5,573 $ 12,234 Weighted Average Number of Shares Outstanding 17,003 16,782 Basic Earnings Per Common Share $ 0.32 $ 0.72 Weighted Average Number of Diluted Shares 17,057 16,887 Fully Diluted Earnings Per Share $ 0.32 $ 0.72 Dividends Declared Per Common Share $ 0.225 $ 0.225 The accompanying notes are an integral part of these consolidated financial statements AMERICAN STATES WATER COMPANY Nine Months Ended (in thousands, except per share amounts) 2006 2005 Operating Revenues Water $ 166,233 $ 155,611 Electric 21,816 20,105 Other 8,437 2,721 Total operating revenues 196,486 178,437 Operating Expenses Water purchased 34,326 35,742 Power purchased for pumping 7,620 6,923 Groundwater production assessment 6,799 6,079 Power purchased for resale 10,470 9,922 Unrealized loss (gain) on purchased power contracts 5,886 (7,492 ) Supply cost balancing accounts (93 ) 1,042 Other operating expenses 17,264 15,138 Administrative and general expenses 34,628 32,456 Depreciation and amortization 19,726 16,123 Maintenance 9,113 7,522 Property and other taxes 7,674 7,111 Net gain on sale of property (124 ) — Gain on settlement for removal of wells — (760 ) Total operating expenses 153,289 129,806 Operating Income 43,197 48,631 Interest expense (16,037 ) (9,341 ) Interest income 2,643 801 Income from operations before income tax expense 29,803 40,091 Income tax expense 12,061 18,358 Net Income $ 17,742 $ 21,733 Weighted Average Number of Shares Outstanding 16,898 16,773 Basic Earnings Per Common Share $ 1.03 $ 1.29 Weighted Average Number of Diluted Shares 16,949 16,845 Fully Diluted Earnings Per Share $ 1.03 $ 1.29 Dividends Declared Per Common Share $ 0.675 $ 0.675 The accompanying notes are an integral part of these consolidated financial statements 6 AMERICAN STATES WATER COMPANY September 30, December 31, (in thousands) 2005 2004 Capitalization Common shares, no par value, no stated value $ 166,206 $ 165,270 Earnings reinvested in the business 99,866 89,454 Accumulated other comprehensive loss (3,259 ) (3,259 ) Total common shareholders’ equity 262,813 251,465 Long-term debt 228,685 228,902 Total capitalization 491,498 480,367 Current Liabilities Notes payable to banks 55,000 45,000 Long-term debt - current 658 880 Accounts payable 18,471 18,206 Income taxes payable 2,908 — Accrued employee expenses 4,240 4,260 Accrued interest 5,139 1,670 Regulatory liabilities - current 4,904 3,441 Other 12,607 12,879 Total current liabilities 103,927 86,336 Other Credits Advances for construction 83,522 81,351 Contributions in aid of construction - net 77,207 73,100 Deferred income taxes 65,046 59,839 Unamortized investment tax credits 2,541 2,609 Accrued pension and other postretirement benefits 9,994 8,793 Regulatory liabilities 2,180 9,731 Other 8,442 8,151 Total other credits 248,932 243,574 Commitments and Contingencies (Note 10) — — Total Capitalization and Liabilities $ 844,357 $ 810,277 Nine Months Ended (in thousands) 2006 2005 Cash Flows From Operating Activities: Net income $ 17,742 $ 21,733 Adjustments for non-cash items: Depreciation and amortization 19,726 16,123 Provision for doubtful accounts 538 311 Deferred income taxes, net regulatory asset for flow-through taxes, and investment tax credits 2,761 9,453 Unrealized loss (gain) on purchased power contracts 5,886 (7,492 ) Stock-based compensation expense 427 110 Other - net 585 (57 ) Changes in assets and liabilities: Accounts receivable - customers (4,849 ) (4,517 ) Unbilled revenue (3,567 ) (3,657 ) Other accounts receivable 443 (576 ) Materials and supplies (124 ) 61 Prepayments and other current assets 1,603 1,884 Regulatory assets - supply cost balancing accounts (93 ) 1,042 Other assets (6,906 ) (2,143 ) Accounts payable 3,631 265 Income taxes receivable/payable 3,650 8,741 Other liabilities 4,196 3,906 Net cash provided 45,649 45,187 Cash Flows From Investing Activities: Construction expenditures (51,069 ) (51,958 ) Net cash used (51,069 ) (51,958 ) Cash Flows From Financing Activities: Proceeds from issuance of common shares 1,625 830 Proceeds from stock option exercises 4,383 — Tax benefits from exercise of stock-based awards 1,142 — Receipt of advances for and contributions in aid of construction 6,718 10,350 Refunds on advances for construction (3,072 ) (3,147 ) Repayments of long-term debt (329 ) (560 ) Net change in notes payable to banks (2,000 ) 10,000 Cash received on financing portion of purchased power contracts 2,007 2,007 Dividend equivalent rights paid (187 ) — Tax benefits from payment of dividend equivalent rights 80 — Dividends paid (11,388 ) (11,321 ) Net cash (used) provided (1,021 ) 8,159 Net (decrease) increase in cash and cash equivalents (6,441 ) 1,388 Cash and cash equivalents, beginning of period 13,032 4,303 Cash and cash equivalents, end of period $ 6,591 $ 5,691 The accompanying notes are an integral part of these consolidated financial statements Three Months Ended September 30, (in thousands, except per share amounts) 2005 2004 Operating Revenues Water $ 60,539 $ 62,455 Electric 6,544 6,208 Other 988 298 68,071 68,961 Operating Expenses Water purchased 15,779 15,339 Power purchased for pumping 3,252 2,971 Power purchased for resale 3,075 3,107 Unrealized (gain) loss on purchased power contracts (4,018 ) 224 Groundwater production assessment 2,315 2,120 Supply cost balancing accounts 514 1,016 Other operating expenses 4,850 4,818 Administrative and general expenses 10,074 10,591 Depreciation and amortization 4,705 5,589 Maintenance 3,080 2,593 Taxes on income 10,558 5,692 Other taxes 2,548 2,235 Total operating expenses 56,732 56,295 Operating Income 11,339 12,666 Other Income (Loss) Other income (loss), net (148 ) (160 ) Taxes on other income (loss) 84 76 Total other income (loss), net (64 ) (84 ) Interest Charges Interest on long-term debt 4,092 4,047 Other interest and amortization of debt expense (5,051 ) 517 Total interest charges, net (959 ) 4,564 Net Income $ 12,234 $ 8,018 Weighted Average Number of Shares Outstanding 16,782 15,318 Basic Earnings Per Common Share $ 0.72 $ 0.52 Weighted Average Number of Diluted Shares 16,887 15,338 Fully Diluted Earnings Per Share $ 0.72 $ 0.52 Dividends Declared Per Common Share $ 0.225 $ 0.221 (in thousands) September 30, December 31, Utility Plant, at cost Water $ 848,250 $ 819,958 Electric 62,196 61,386 910,446 881,344 Less - Accumulated depreciation (266,178 ) (246,649 ) 644,268 634,695 Construction work in progress 58,735 38,334 Net utility plant 703,003 673,029 Other Property and Investments Other property and investments 7,312 7,364 Total other property and investments 7,312 7,364 Current Assets Cash and cash equivalents 2,657 8,788 Accounts receivable-customers (less allowance for doubtful accounts of $753 in 2006 and $765 in 2005) 17,323 12,919 Unbilled revenue 18,361 14,856 Inter-company receivable 258 226 Other accounts receivable (less allowance for doubtful accounts of $141 in 2006 and $334 in 2005) 2,869 6,106 Materials and supplies, at average cost 1,530 1,404 Regulatory assets - current 3,162 3,875 Prepayments and other current assets 1,238 2,795 Unrealized gain on purchased power contracts — 3,417 Deferred income taxes - current 4,666 1,693 Total current assets 52,064 56,079 Regulatory and Other Assets Regulatory assets 61,288 54,382 Other accounts receivable 9,148 8,820 Other 7,407 7,575 Total regulatory and other assets 77,843 70,777 Total Assets $ 840,222 $ 807,249 The accompanying notes are an integral part of these LIABILITIES Nine Months Ended September 30, (in thousands, except per share amounts) 2005 2004 Operating Revenues Water $ 155,587 $ 154,773 Electric 20,105 19,284 Other 2,669 899 178,361 174,956 Operating Expenses Water purchased 35,742 37,022 Power purchased for pumping 6,923 7,103 Power purchased for resale 9,922 10,474 Unrealized gain on purchased power contracts (7,492 ) (257 ) Gain on settlement for removal of wells (760 ) — Gain on sale of water rights — (5,675 ) Groundwater production assessment 6,079 5,280 Supply cost balancing accounts 1,042 4,835 Other operating expenses 15,137 14,538 Administrative and general expenses 31,698 31,166 Depreciation and amortization 16,036 15,840 Maintenance 8,068 7,529 Taxes on income 18,582 11,720 Other taxes 7,041 6,566 Total operating expenses 148,018 146,141 Operating Income 30,343 28,815 Other Income (Loss) Other income (loss), net (390 ) 509 Taxes on other income (loss) 225 (138 ) Total other income (loss), net (165 ) 371 Interest Charges Interest on long-term debt 12,198 12,149 Other interest and amortization of debt expense (3,753 ) 1,163 Total interest charges 8,445 13,312 Net Income $ 21,733 $ 15,874 Weighted Average Number of Shares Outstanding 16,773 15,264 Basic Earnings Per Common Share $ 1.29 $ 1.04 Weighted Average Number of Diluted Shares 16,845 15,288 Fully Diluted Earnings Per Share $ 1.29 $ 1.04 Dividends Declared Per Common Share $ 0.675 $ 0.663 (in thousands) September 30, December 31, Capitalization Common shares, no par value, no stated value $ 161,179 $ 159,429 Earnings reinvested in the business 104,447 99,645 Accumulated other comprehensive loss (3,556 ) (3,556 ) Total common shareholder’s equity 262,070 255,518 Long-term debt 261,316 261,540 Total capitalization 523,386 517,058 Current Liabilities Long-term debt – current 305 295 Accounts payable 20,430 17,914 Inter-company payable 3,488 65 Income taxes payable to Parent 7,174 2,268 Accrued employee expenses 4,063 5,507 Accrued interest 5,179 2,218 Regulatory liabilities – current 4,120 3,252 Unrealized loss on purchased power contracts 2,468 — Deferred income taxes – current — 109 Other 12,772 12,390 Total current liabilities 59,999 44,018 Other Credits Advances for construction 76,153 74,790 Contributions in aid of construction - net 84,917 83,055 Deferred income taxes 71,478 65,469 Unamortized investment tax credits 2,450 2,518 Accrued pension and other postretirement benefits 14,955 13,562 Other 6,884 6,779 Total other credits 256,837 246,173 Commitments and Contingencies (Note 8) — — Total Capitalization and Liabilities $ 840,222 $ 807,249 The accompanying notes are an integral part of these INCOME 2005 Nine Months Ended September 30, (in thousands) 2005 2004 Cash Flows From Operating Activities: Net income $ 21,733 $ 15,874 Adjustments for non-cash items: Depreciation and amortization 16,036 15,840 Provision for doubtful accounts 311 495 Deferred income taxes and investment tax credits 9,453 608 Unrealized gain on purchased power contracts (7,492 ) (257 ) Impairment loss on assets removed from rate-base — 482 Non-cash compensation expense on stock units issued 110 794 Other - net 30 1,175 Changes in assets and liabilities: Accounts receivable - customers (4,517 ) (3,243 ) Unbilled revenue (3,657 ) (3,761 ) Other accounts receivable (576 ) 8,307 Materials and supplies 61 (139 ) Prepayments and other current assets 1,884 2,009 Regulatory assets - supply cost balancing accounts 1,042 4,835 Other assets (2,143 ) (789 ) Accounts payable 265 191 Income taxes receivable/payable 8,741 5,693 Other liabilities 3,906 (63 ) Net cash provided 45,187 48,051 Cash Flows From Investing Activities: Construction expenditures (51,958 ) (57,531 ) Net cash used (51,958 ) (57,531 ) Cash Flows From Financing Activities: Proceeds from issuance of common shares, net of issuance costs 830 35,256 Receipt of advances for and contributions in aid of construction 10,350 8,308 Refunds on advances for construction (3,147 ) (2,947 ) Repayments of long-term debt (560 ) (541 ) Net change in notes payable to banks 10,000 (28,000 ) Cash received on financing portion of purchased power contracts 2,007 1,339 Dividends paid (11,321 ) (10,108 ) Net cash provided 8,159 3,307 Net increase (decrease) in cash and cash equivalents 1,388 (6,173 ) Cash and cash equivalents, beginning of period 4,303 12,775 Cash and cash equivalents, end of period $ 5,691 $ 6,602 Three Months Ended (in thousands) 2006 2005 Operating Revenues Water $ 62,842 $ 58,568 Electric 6,443 6,544 Other 325 21 Total operating revenues 69,610 65,133 Operating Expenses Water purchased 14,696 15,446 Power purchased for pumping 3,394 3,080 Groundwater production assessment 2,477 2,316 Power purchased for resale 2,659 3,074 Unrealized loss (gain) on purchased power contracts 2,807 (4,018 ) Supply cost balancing accounts 244 514 Other operating expenses 5,528 4,346 Administrative and general expenses 10,893 9,010 Depreciation and amortization 6,171 4,460 Maintenance 3,217 2,830 Property and other taxes 2,579 2,481 Net gain on sale of property (132 ) — Total operating expenses 54,533 43,539 Operating Income 15,077 21,594 Interest expense (4,861 ) 519 Interest income 479 735 Income from operations before income tax expense 10,695 22,848 Income tax expense 4,943 10,475 Net Income $ 5,752 $ 12,373 The accompanying notes are an integral part of these GOLDEN STATE WATER COMPANY Nine Months Ended (in thousands) 2006 2005 Operating Revenues Water $ 160,282 $ 150,519 Electric 21,816 20,105 Other 3,244 76 Total operating revenues 185,342 170,700 Operating Expenses Water purchased 33,573 35,116 Power purchased for pumping 7,127 6,537 Groundwater production assessment 6,799 6,115 Power purchased for resale 10,470 9,921 Unrealized loss (gain) on purchased power contracts 5,886 (7,492 ) Supply cost balancing accounts (93 ) 1,042 Other operating expenses 14,961 13,656 Administrative and general expenses 29,988 27,958 Depreciation and amortization 18,336 15,290 Maintenance 8,559 7,085 Property and other taxes 7,372 6,799 Net gain on sale of property (132 ) — Total operating expenses 142,846 122,027 Operating Income 42,496 48,673 Interest expense (14,538 ) (8,381 ) Interest income 2,203 767 Income from operations before income tax expense 30,161 41,059 Income tax expense 12,305 18,710 Net Income $ 17,856 $ 22,349 GOLDEN STATE WATER COMPANY September 30, December 31, (in thousands) 2005 2004 Utility Plant, at cost Water $ 761,510 $ 734,662 Electric 58,670 58,667 820,180 793,329 Less - Accumulated depreciation (244,746 ) (229,664 ) 575,434 563,665 Construction work in progress 85,090 65,136 Net utility plant 660,524 628,801 Other Property and Investments 7,388 7,419 Current Assets Cash and cash equivalents 4,129 2,702 Accounts receivable-customers (less allowance for doubtful accounts of $703 in 2005 and $758 in 2004) 14,968 10,818 Unbilled revenue 17,066 13,466 Inter-company receivable 335 1,126 Other accounts receivable (less allowance for doubtful accounts of $234 in 2005 and $201 in 2004) 1,504 2,465 Income taxes receivable from Parent — 4,187 Materials and supplies, at average cost 1,410 1,473 Regulatory assets - current 4,496 7,104 Prepayments and other current assets 6,943 3,248 Deferred income taxes - current 1,511 2,795 Total current assets 52,362 49,384 Regulatory and Other Assets Regulatory assets 50,330 54,219 Other accounts receivable 8,713 8,400 Other 7,880 8,053 Total regulatory and other assets 66,923 70,672 Total Assets $ 787,197 $ 756,276 Nine Months Ended (in thousands) 2006 2005 Cash Flows From Operating Activities: Net income $ 17,856 $ 22,349 Adjustments for non-cash items: Depreciation and amortization 18,336 15,290 Provision for doubtful accounts 528 280 Deferred income taxes, net regulatory asset for flow-through taxes, and investment tax credits 2,452 8,684 Unrealized loss (gain) on purchased power contracts 5,886 (7,492 ) Stock-based compensation expense 402 110 Other – net 401 162 Changes in assets and liabilities: Accounts receivable – customers (4,782 ) (4,397 ) Unbilled revenue (3,505 ) (3,600 ) Other accounts receivable 2,759 615 Materials and supplies (126 ) 63 Prepayments and other current assets 1,557 1,770 Regulatory assets - supply cost balancing accounts (93 ) 1,042 Other assets (4,764 ) (1,959 ) Accounts payable 2,516 465 Inter-company receivable/payable 891 3,182 Income taxes receivable/payable from/to Parent 4,906 7,867 Other liabilities 2,526 2,723 Net cash provided 47,746 47,154 Cash Flows From Investing Activities: Construction expenditures (49,465 ) (48,756 ) Net cash used (49,465 ) (48,756 ) Cash Flows From Financing Activities: Tax benefits from exercise of stock-based awards 1,131 — Receipt of advances for and contributions in aid of construction 5,798 8,745 Refunds on advances for construction (2,591 ) (2,801 ) Repayments of long-term debt (259 ) (222 ) Net change in inter-company borrowings 2,500 7,300 Cash received on financing portion of purchased power contracts 2,007 2,007 Dividend equivalent rights paid (171 ) — Tax benefits from payment of dividend equivalent rights 73 — Dividends paid (12,900 ) (12,000 ) Net cash (used) provided (4,412 ) 3,029 Net (decrease) increase in cash and cash equivalents (6,131 ) 1,427 Cash and cash equivalents, beginning of period 8,788 2,702 Cash and cash equivalents, end of period $ 2,657 $ 4,129 The accompanying notes are an integral part of these financial statements September 30, December 31, (in thousands) 2005 2004 Capitalization Common shares, no par value $ 159,396 $ 159,290 Earnings reinvested in the business 98,166 87,817 Accumulated other comprehensive loss (3,259 ) (3,259 ) Total common shareholder’s equity 254,303 243,848 Long-term debt 221,649 221,697 Total capitalization 475,952 465,545 Current Liabilities Long-term debt - current 229 282 Accounts payable 17,661 17,196 Inter-company payable 33,616 23,925 Income taxes payable to Parent 3,680 — Accrued employee expenses 3,920 3,951 Accrued interest 5,014 1,636 Regulatory liabilities - current 4,904 3,441 Other 12,160 12,601 Total current liabilities 81,184 63,032 Other Credits Advances for construction 71,378 70,206 Contributions in aid of construction-net 76,351 72,574 Deferred income taxes 61,136 56,684 Unamortized investment tax credits 2,541 2,609 Accrued pension and other postretirement benefits 9,994 8,793 Regulatory liabilities 1,419 9,731 Other 7,242 7,102 Total other credits 230,061 227,699 Commitments and Contingencies (Note 10) — — Total Capitalization and Liabilities $ 787,197 $ 756,276 Three Months Ended September 30, (in thousands) 2005 2004 Operating Revenues Water $ 58,568 $ 60,506 Electric 6,544 6,208 65,112 66,714 Operating Expenses Water purchased 15,446 15,150 Power purchased for pumping 3,080 2,806 Power purchased for resale 3,074 3,107 Unrealized (gain) loss on purchased power contracts (4,018 ) 224 Groundwater production assessment 2,316 2,120 Supply cost balancing accounts 514 1,016 Other operating expenses 4,346 4,467 Administrative and general expenses 8,749 8,712 Depreciation and amortization 4,431 5,346 Maintenance 2,998 2,472 Taxes on income 10,561 6,145 Other taxes 2,457 2,138 Total operating expenses 53,954 53,703 Operating Income 11,158 13,011 Other Income (Loss) Other income (loss), net (157 ) (161 ) Taxes on other income (loss) 87 84 Total other income (loss), net (70 ) (77 ) Interest Charges Interest on long-term debt 3,991 3,946 Other interest and amortization of debt expense (5,276 ) 371 Total interest charges (1,285 ) 4,317 Net Income $ 12,373 $ 8,617 Nine Months Ended September 30, (in thousands) 2005 2004 Operating Revenues Water $ 150,519 $ 149,864 Electric 20,105 19,284 170,624 169,148 Operating Expenses Water purchased 35,116 36,479 Power purchased for pumping 6,537 6,741 Power purchased for resale 9,921 10,474 Unrealized gain on purchased power contracts (7,492 ) (257 ) Gain on sale of water rights — (5,675 ) Groundwater production assessment 6,115 5,280 Supply cost balancing accounts 1,042 4,835 Other operating expenses 13,656 13,474 Administrative and general expenses 27,221 25,866 Depreciation and amortization 15,203 15,118 Maintenance 7,611 7,100 Taxes on income 18,947 13,505 Other taxes 6,729 6,278 Total operating expenses 140,606 139,218 Operating Income 30,018 29,930 Other Income (Loss) Other income (loss), net (421 ) 503 Taxes on other income (loss) 237 (137 ) Total other income (loss), net (184 ) 366 Interest Charges Interest on long-term debt 11,894 11,820 Other interest and amortization of debt expense (4,409 ) 821 Total interest charges 7,485 12,641 Net Income $ 22,349 $ 17,655 Nine Months Ended September 30, (in thousands) 2005 2004 Cash Flows From Operating Activities: Net income $ 22,349 $ 17,655 Adjustments for non-cash items: Depreciation and amortization 15,203 15,118 Provision for doubtful accounts 280 313 Deferred income taxes and investment tax credits 8,684 303 Unrealized gain on purchased power contracts (7,492 ) (257 ) Impairment loss on assets removed from rate-base — 482 Non-cash compensation expense on stock units issued 110 794 Other - net 249 1,072 Changes in assets and liabilities: Accounts receivable - customers (4,397 ) (3,066 ) Unbilled revenue (3,600 ) (3,695 ) Other accounts receivable 615 8,341 Materials and supplies 63 (138 ) Prepayments and other current assets 1,770 2,004 Regulatory assets - supply cost balancing accounts 1,042 4,835 Other assets (1,959 ) (741 ) Accounts payable 465 534 Inter-company receivable/payable 3,182 (358 ) Income taxes receivable/payable from/to Parent 7,867 7,800 Other liabilities 2,723 (390 ) Net cash provided 47,154 50,606 Cash Flows From Investing Activities: Construction expenditures (48,756 ) (54,793 ) Net cash used (48,756 ) (54,793 ) Cash Flows From Financing Activities: Proceeds from issuance of common shares — 28,000 Receipt of advances for and contributions in aid of construction 8,745 7,922 Refunds on advances for construction (2,801 ) (2,576 ) Repayments of long-term debt (222 ) (226 ) Net change in intercompany borrowings 7,300 (24,500 ) Cash received on financing portion of purchased power contracts 2,007 1,339 Dividends paid (12,000 ) (11,550 ) Net cash provided (used) 3,029 (1,591 ) Net increase (decrease) in cash and cash equivalents 1,427 (5,778 ) Cash and cash equivalents, beginning of period 2,702 8,306 Cash and cash equivalents, end of period $ 4,129 $ 2,528 12 AMERICAN STATES WATER COMPANY Note 1 More than 90% of AWR’s assets consist of the common stock of GSWC and its revenues and operations are primarily those of GSWC. GSWC is a public utility engaged principally in the purchase, production, distribution and sale of water in FBWS Basis of GSWC’s New Accounting Pronouncements: Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” which requires the recognition of compensation expense related to the fair value of stock-based compensation awards. See Note 6 for further details. In March 2006, the FASB Emerging Issues Task Force (“EITF”) issued EITF No. 06-03, “How Sales Taxes Collected fr om Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)”, which provides clarifying guidance on how to present sales taxes in the income statement. This guidance is effective for periods beginning after December 15, 2006, with early application of the guidance permitted. Registrant is currently assessing the impact of the EITF on its financial statements. In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is encouraged, provided that Registrant has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. Registrant will implement the new standard effective January 1, 2008. Registrant is currently evaluating the impact SFAS No. 157 may have on its financial statements and disclosures. In September 2006, the FASB also issued SFAS No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R).SFAS 158 requires that Registrant recognize the overfunded or underfunded status of its defined benefit and retiree medical plans as an asset or liability in its 2006 year-end balance sheet, with changes in the funded status recognized through comprehensive income in the year in which they occur. Registrant is currently evaluating the impact of adopting SFAS No. 158 on its financial statements including the possible regulatory accounting treatment and will implement the new standard by December 31, 2006. In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”. This SAB provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB No. 108 establishes an approach that requires quantification of financial statement errors based on the effects of the error on each of the company’s financial statements and the related financial statement disclosures. SAB No. 108 is effective as of the end of Registrant’s 2006 fiscal year, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006 for errors that were not previously deemed material, but are material under the guidance in SAB 108. Registrant is currently evaluating the impact of adopting SAB No. 108 on its financial statements and will implement the new guidance by December 31, 2006. Registrant believes SAB No. 108 will not have a material impact on its results of operations or financial position. Note 2 In accordance with accounting principles for rate-regulated enterprises, Registrant records regulatory assets, which represent probable future Regulatory assets, less regulatory liabilities, included in the consolidated balance sheets are as follows: September 30, December 31, (In thousands) 2005 2004 September 30, December 31, GSWC Supply cost balancing accounts $ 17,277 $ 23,537 $ 16,920 $ 19,624 Supply cost memorandum accounts net under-collections 6,043 3,151 Costs deferred for future recovery on Aerojet case 21,254 15,347 21,334 21,109 Flow-through taxes, net 4,717 7,733 7,346 6,939 Electric transmission line abandonment costs 3,459 3,546 3,333 3,428 Asset retirement obligations 3,326 3,038 3,189 2,928 Low income balancing accounts 2,601 2,134 3,503 2,846 General rate case memorandum accounts 923 2,168 — 209 Refund of water right lease revenues (6,323 ) (5,889 ) Revenues subject to refund — (3,487 ) Supply cost memorandum accounts net over-collections — (1,818 ) Refund of water rights lease revenues (3,732 ) (6,474 ) Other regulatory assets 1,269 1,842 2,394 1,245 Total GSWC $ 48,503 $ 48,151 $ 60,330 $ 55,005 CCWC Asset retirement obligations $ 43 $ 41 47 44 Other regulatory assets/liabilities, net (474 ) 144 (547 ) (494 ) Total AWR $ 48,072 $ 48,336 $ 59,830 $ 54,555 Supply Cost Balancing Electric Supply Cost Balancing Account – Electric power costs incurred by GSWC’s Bear Valley Electric division continue to be charged to its electric supply cost balancing account. The under-collection in the electric supply cost balancing account is The CPUC has authorized GSWC to collect a surcharge from its customers of 2.2¢ per kilowatt hour through August 2011, to enable GSWC to recover an under-collection of approximately $23.1 million at the end of 2001 which had been incurred during the energy crisis in late 2000 and 2001. GSWC sold 2006 and 2005, there was no expense over the $77 per MWh cap because of increases in GSWC’s sales of surplus energy into the spot market. During the nine months ended September 30, Charges to GSWC by Southern California Edison (“Edison”) associated with the transportation of energy over Edison’s power system and the abandonment of a transmission line upgrade have increased under Edison’s tariff to levels that exceed the amounts authorized by the CPUC in Bear Valley Electric’s retail power rates to its customers. The incremental cost increase to GSWC from this tariff above the amounts included in rates is $38,137 per month. These increases have been included in the balancing account for subsequent recovery from customers. The incoming power system delivery costs are not subject to any price caps. Other components, such as interest accrued on cumulative under-collected balance and power loss during transmission, also affect the Water Costs Deferred for Future In 1999, GSWC sued Aerojet-General Corporation (“Aerojet”) for contaminating the Sacramento County Groundwater Basin, which affected certain GSWC wells. On a related matter, GSWC also filed a lawsuit against the State of California (the “State”). The CPUC authorized memorandum accounts to allow for recovery, from customers, of costs incurred by GSWC in prosecuting the cases against Aerojet and the State, less any recovery from the defendants or others. On July 21, 2005, the CPUC authorized GSWC to collect approximately $21.3 million of the Aerojet litigation memorandum account, through a rate surcharge, which will continue for no longer than 20 years. Amount Increase / (Decrease) Operating Expenses Power purchased for resale $ (31,230 ) Other operating expenses (459,415 ) Administrative and general expenses (16,963 ) Depreciation and amortization (992,232 ) Total pre-tax impact to operating expenses (1,499,840 ) Interest Charges Other interest and amortization of debt expense (5,691,634 ) Total pre-tax impact to results of operations $ 7,191,474 Impact to taxes on income 2,930,238 Total impact to net income $ 4,261,236 2006, respectively. GSWC will keep the Aerojet memorandum account open until it is fully It is management’s intention to offset any settlement proceeds from Aerojet that may occur upon the issuance of land use approvals for development in a defined area within Aerojet Refund of Water In 1994, GSWC entered into a contract to lease to the City of Folsom, 5,000 acre-feet per year of water rights from the American River. GSWC included all associated revenues in a Pursuant to the March 2004 CPUC order, the apportionment of any lease revenues that GSWC In Note 3 In Basic For The Three Months For The Nine Months (in thousands, except per share amounts) 2006 2005 2006 2005 Net income $ 5,573 $ 12,234 $ 17,742 $ 21,733 Less: (a) distributed earnings to common shareholders 3,826 3,776 11,406 11,322 distributed earnings to participating securities 80 — 234 — Undistributed earnings 1,667 8,458 6,102 10,411 (b) Undistributed earnings allocated to common 1,633 8,315 5,980 10,235 Undistributed earnings allocated to participating 34 143 122 176 Total income available to common shareholders, basic (a)+(b) $ 5,459 $ 12,091 $ 17,386 $ 21,557 Weighted average Common Shares outstanding, basic 17,003 16,782 16,898 16,773 Basic earnings per Common Share $ 0.32 $ 0.72 $ 1.03 $ 1.29 Diluted EPS is based upon the weighted average number of Common Shares including both outstanding shares and shares potentially issuable in connection with stock options and restricted stock units granted under Registrant’s 2000 Stock Incentive Plan and Diluted For The Three Months For The Nine Months (in thousands, except per share amounts) 2006 2005 2006 2005 Common shareholders earnings, basic $ 5,459 $ 12,091 $ 17,386 $ 21,557 Undistributed earnings for dilutive stock options (1) — — — — Total common shareholders earnings, diluted $ 5,459 $ 12,091 $ 17,386 $ 21,557 Weighted average Common Shares outstanding, basic 17,003 16,782 16,898 16,773 Stock-based compensation (2) 54 105 51 72 Weighted average Common Shares outstanding, diluted 17,057 16,887 16,949 16,845 Diluted earnings per Common Share $ 0.32 $ 0.72 $ 1.03 $ 1.29 (1) Undistributed earnings allocated to participating securities were not included due to their antidilutive effect on diluted earnings per share. (2) In applying the Stock options of 403,427 and restricted stock units of 47,629 were outstanding at September 30, 2006, but not included in the computation of diluted EPS because they were antidilutive. The Company has a Shareholder Rights Plan designed to protect the Company’s shareholders in the event of an unsolicited unfair offer to acquire the Company. The rights for Junior Participating Preferred Shares (the “Rights”) are exercisable based solely on “a non-market-based contingency”, and are not contingent upon the market price of the Company’s stock. Therefore, the shares that would be issued During the three months ended September 30, 2005, In addition, during the three months ended September 30, 2006 and 2005, Registrant During the three months ended September 30, Note 4 Registrant has certain block-forward purchase power contracts that are subject to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS Nos. 138 and 149. A derivative financial instrument or other contract derives its value from another investment or designated benchmark. SFAS No. 133 requires companies to record derivatives on the balance sheet as assets and liabilities, and to measure those instruments at their fair value. Certain of these contracts qualify as an exception provided under SFAS No. 133 for activities that are considered normal purchases and normal sales. These contracts are reflected in the statements of income at the time of contract settlement. During 2002, GSWC The market prices used to determine the fair value for this derivative instrument were estimated based on independent sources such as broker quotes and publications. Note As a regulated utility, GSWC treats certain temporary differences as flow-through adjustments in computing its income tax provision consistent with the income tax approach approved by the CPUC for ratemaking purposes. Flow-through adjustments increase or decrease tax expense in one period, with an offsetting reviews were completed and AWR received a refund in the amount of its original claim of $3.0 million, with interest. Consequently, in the second quarter of 2006, AWR recorded a tax benefit of approximately $400,000, of which $351,000 was attributable to GSWC. Note 6 — Stock-Based Compensation: Summary Description of Stock Incentive Plans AWR currently has two primary stock incentive plans for employees and for non-employee directors: the 2000 Stock Incentive Plan (the “2000 Employee Stock Plan”) and the 2003 Non-Employee Directors Stock Plan (the “Directors Stock Plan”), more fully described below. 2000 Employee Stock Plan– AWR adopted the 2000 Employee Stock Plan at the annual meeting of shareholders in 2000 to provide stock-based incentive awards in the form of stock options, and restricted stock to employees as a means of promoting the success of the Company by attracting, retaining and aligning the interests of employees with those of shareholders generally. The 2000 Employee Stock Plan was amended in January 2006 to also permit the grant of restricted stock units. There are 1,050,000 Common Shares reserved for issuance under the 2000 Employee Stock Plan, approximately 277,400 of which remain available for issuance as of September 30, 2006. The 2000 Employee Stock Plan is administered by the Compensation Committee of the Board of Directors (the “Committee”). For stock options, the Committee determines, among other things, the date of grant, the form, term, option exercise price, vesting and exercise terms of each option. Stock options granted by AWR have been in the form of nonqualified stock options, expire ten years from the date of grant, vest over a period of three years and are subject to earlier termination as provided in the form of option agreement approved by the Committee. The option price per share is determined by the Committee at the time of grant, but may not be less than 100% of the fair market value of Common Shares on the date of grant. In addition, AWR may grant employees receiving a grant of stock options the right to receive cash dividends pursuant to the terms of a dividend equivalent rights agreement for a period of up to three years from the date of the option grant. For restricted stock, the Committee determines, among other things, the dividend, voting and other rights prior to vesting and the restrictions (which may be based on performance criteria, passage of time or other factors) imposed on the shares. For restricted stock units, the Committee determines, among other things, the vesting terms and form of pay-out. Each employee who receives a grant of a restricted stock unit is also generally entitled to dividend equivalents rights in the form of additional restricted stock units until vesting of the restricted stock units. The restricted stock units are a non-voting unit of measurement relative to one Common Share. Directors Stock Plan– On May 20, 2003, the Board of Directors adopted the Directors Stock Plan, subject to shareholder approval. The shareholders approved the Directors Stock Plan at the May 2004 Annual Meeting. The Directors Stock Plan provides the non-employee directors with supplemental stock-based compensation and encourages them to increase their stock ownership in AWR. There are 250,000 Common Shares reserved for issuance under the Directors Stock Plan, approximately 168,900 of which remain available for issuance as of September 30, 2006. Pursuant to the Directors Stock Plan, non-employee directors are entitled to receive options to purchase 3,000 Common Shares at each annual meeting of shareholders commencing with the 2005 annual meeting of shareholders. AWR also granted options to each non-employee director to purchase 1,000 Common Shares at its annual shareholder meetings in 2003 and 2004. In addition, each non-employee director with no more than ten years of service with AWR is entitled to receive restricted stock units at each annual meeting in an amount equal to the then current annual retainer payable by AWR to each non-employee director divided by the fair market value of Common Shares on the last trading day prior to the annual meeting. All grants of stock options and restricted stock units are entitled to dividend equivalent rights payable in the form of additional restricted stock units under the terms of the Directors Stock Plan. The stock options granted under the Directors Stock Plan are 10-year nonqualified stock options. The exercise price of the stock options must be 100% of the fair market value of Common Shares on the date of grant. Stock options granted under the Directors Stock Plan are fully vested and exercisable upon the date of grant. The restricted stock units are a non-voting unit of measurement relative to one Common Share. Restricted stock units with respect to dividend equivalent rights on stock options credited to the non-employee director are payable in Common Shares on the earlier of the date on which the stock option is exercised and three years from the date of grant of the stock option. Restricted stock units granted at each annual meeting of shareholders and restricted stock units with respect to dividend equivalent rights with respect thereto are payable solely in Common Shares on the date that the participant terminates service as a director. Restricted stock units credited to each non-employee director’s account are at all times fully vested and non-forfeitable. Change in Accounting Principle Prior to January 1, 2006, Registrant accounted for share-based compensation to employees in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Registrant also followed the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”. Except for costs related to restricted stock units and restricted stock granted to directors and employees, no stock-based compensation cost was recognized in net income. Effective January 1, 2006, the Company adopted the provisions of SFAS No. 123(R), “Share-Based Payment,” which requires the recognition of compensation expense related to the fair value of stock-based compensation awards. Under the provisions of SFAS No. 123(R), share-based compensation cost is measured by the Registrant at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity grant). Registrant elected to adopt the modified prospective transition method as provided by SFAS No. 123(R). Accordingly, financial statement amounts for the prior periods presented in this Form 10-Q have not been restated to reflect the fair value method of expensing share-based compensation. Effect of Stock-Based Compensation on Net Income Prior to January 1, 2006, Registrant had previously adopted the “disclosure-only” provisions of SFAS No. 123, as amended by SFAS No. 148. Had Registrant accounted for stock-based compensation plans using the fair value based accounting method described by SFAS No. 123 for the periods prior to fiscal year 2006, Registrant’s net income For The Three Months For The Nine Months Ended September 30, Ended September 30, (dollars in thousands, except EPS) 2005 2004 2005 2004 Three Months Nine Months Net income, as reported $ 12,234 $ 8,018 $ 21,733 $ 15,874 $ 12,234 $ 21,733 Add: Stock-based compensation expense included in reported net income, net of tax 7 6 64 474 7 64 Less: Stock-based compensation expense determined under the fair-value accounting method, net of tax (10 ) (6 ) (682 ) (928 ) (10 ) (682 ) Pro forma net income $ 12,231 $ 8,018 $ 21,115 $ 15,420 Pro forma $ 12,231 $ 21,115 Basic earnings per share: As reported $ 0.72 $ 0.52 $ 1.29 $ 1.04 $ 0.72 $ 1.29 Pro forma $ 0.72 $ 0.52 $ 1.25 $ 1.01 $ 0.72 $ 1.25 Diluted earnings per share: As reported $ 0.72 $ 0.52 $ 1.29 $ 1.04 $ 0.72 $ 1.29 Pro forma $ 0.72 $ 0.52 $ 1.25 $ 1.01 $ 0.72 $ 1.25 21 The following table presents share-based compensation expenses for the three and nine months ended September 30, 2006 and 2005 and included in administrative and general expenses in AWR and GSWC’s statements of income resulting from stock options, restricted stock and restricted stock units: AWR GSWC Three Months Ended September 30, Nine Months Ended September 30, Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2006 2005 2006 2005 2006 2005 2006 2005 Stock-based compensation related to: Stock options granted to employees and directors $ 60 $ — $ 279 $ — $ 54 $ — $ 263 $ — Restricted stock units granted to employees 42 — 120 — 38 — 111 — Restricted stock units granted to directors — 12 28 110 — 12 28 110 Stock-based compensation recognized in the income statement, before taxes $ 102 $ 12 $ 427 $ 110 $ 92 $ 12 $ 402 $ 110 Income tax benefit (41 ) (5 ) (171 ) (46 ) (37 ) (5 ) (161 ) (46 ) Total stock-based compensation after income taxes $ 61 $ 7 $ 256 $ 64 $ 55 $ 7 $ 241 $ 64 Compensation cost capitalized as part of utility plant for the three and nine months ended September 30, 2006 was approximately $38,000 and $166,000, respectively. In addition, pursuant to SFAS No. 123(R), dividend equivalent rights paid in cash in the amount of approximately $187,000 and $171,000 for AWR and GSWC, respectively, for the nine months ended September 30, 2006 were recognized as a reduction to retained earnings, net of tax benefit of approximately $80,000 and $73,000, respectively. With the adoption of SFAS No. 123(R), Registrant elected to amortize stock-based compensation for awards granted on or after the adoption of SFAS No. 123(R) on January 1, 2006 on a straight-line basis over the requisite (vesting) period for the entire award. Registrant did not recognize compensation expense for employee share-based awards for the three and nine months ended September 30, 2005, when the exercise price of Registrant’s employee stock awards equaled the market price of the underlying stock on the date of grant. Registrant did recognize compensation expense under APB No. 25 relating to restricted stock units granted to directors. Non-vested stock options granted to employees prior to January 1, 2006 have terms that provide for the continuation of vesting upon termination of employment. Accordingly, these awards were deemed to be granted for past services from an accounting standpoint and any measured compensation cost was recognized in full in the pro forma disclosures at the date of grant. Therefore, upon implementation of SFAS No. 123(R), there was no remaining compensation cost to be recognized for these options granted prior to, but not yet vested as of January 1, 2006. Valuation of Stock Options Registrant estimated the fair value of stock options granted during the three and nine months ended September 30, 2006 and 2005 using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the exercise price of the award, the expected option term, the expected volatility of the Registrant’s stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and the Registrant’s expected annual dividend yield. Registrant believes that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of Registrant’s stock options granted during the three and nine months ended September 30, 2006 and 2005. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards. The fair value of stock units and restricted stock was determined based on the closing trading price of Common Shares on the grant date. The fair value of each option grant during the three and nine months ended September 30, 2006 and 2005 was estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions: 2006 2005 Weighted-average fair value of option granted $ 8.01 - $10.46 $5.63 Risk-free interest rate 4.40% - 5.02% 3.93% Expected annual dividend yield 2.77% - 3.08% 3.68% Expected volatility factor 24.90% - 26.43% 26.23% Expected option term (in years) 6 7 �� Summary of key assumptions – The risk-free interest rate for periods equal to the expected term of the share option was based on the U.S. Treasury yield curve in effect at the time of grant. Dividend yield reflects the current dividend rate at the date of grant. The stock volatility for each grant is measured using the weighted average of historical monthly and daily price changes of the Common Shares over the most recent period equal to the expected option life of the grant. For the three and nine months ended September 30, 2006, the option term was determined using the simplified method for estimating expected option life, which qualify as “plain-vanilla” options and is derived from the average midpoint between vesting and the contractual term, as described in SEC’s SAB No. 107, “Share-Based Payment.” As permitted by SFAS No. 123(R), underlying assumptions used for stock options granted prior to January 1, 2005 were retained. SFAS No. 123(R) requires entities to estimate the number of forfeitures expected to occur and record expense based upon the number of awards expected to vest. Prior to adoption, the Company accounted for forfeitures as they occurred as permitted under previous accounting standards. The cumulative effect of adopting the change in estimating forfeitures was not material to the Company’s financial statements for the nine months ended September 30, 2006. Stock Options– A summary of stock option activity as of September 30, 2006, and changes during the nine months ended September 30, 2006, is presented below: Number of Weighted Weighted Average Aggregate Options outstanding at January 1, 2006 684,304 $ 24.31 Granted 109,917 34.85 Exercised (190,976 ) 22.95 Forfeited or expired — — Options outstanding at September 30, 2006 603,245 $ 26.66 7.45 $ 6,993,336 Options exercisable at September 30, 2006 345,296 $ 25.15 6.66 $ 4,523,945 The weighted-average grant-date fair value of options granted by Registrant during the nine months ended September 30, 2006 was $8.34. There were no options granted during the three months ended September 30, 2006. The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between the closing price of the Common Shares on the last trading day of the third quarter of 2006 and the exercise price, times the number of shares) that would have been received by the option holders had all option holders exercised their option on September 30, 2006. This amount changes if the fair market value of the Common Shares changes. The total intrinsic value of options exercised during the three and nine months ended September 30, 2006 was approximately $602,000 and $2,803,000, respectively. During the three and nine months ended September 30, 2006, Registrant received approximately $962,000 and $4,383,000, respectively, in cash proceeds from the exercise of its stock options and realized approximately $245,000 and $1,142,000, respectively, of tax benefit for the tax deduction from awards exercised. As of September 30, 2006, approximately $530,000 of total unrecognized compensation cost related to outstanding stock options is expected to be recognized over a remaining period of 2.34 years. Restricted Stock and Stock Units–A summary of the status of Registrant’s outstanding restricted stock units to employees and directors as of September 30, 2006, and changes during the nine months ended September 30, 2006, is presented below: Number of Weighted Average Restricted share units at January 1, 2006 31,166 $ 25.02 Granted 17,065 34.37 Vested (602 ) 26.68 Forfeited — — Restricted share units at September 30, 2006 47,629 $ 28.34 As of September 30, 2006, there was approximately $330,000 of total unrecognized compensation cost related to restricted stock units granted under Registrant’s employee and director’s stock plans. That cost is expected to be recognized over a remaining period of 2.34 years. AWR has no restricted stock outstanding as of September 30, 2006. Note The components of net periodic benefit costs, before allocation to the overhead pool, for Registrant’s pension plan, For The Three Months Ended September 30, 2005 and 2004 Pension Benefits Other SERP (dollars in thousands) 2005 2004 2005 2004 2005 2004 Components of Net Periodic Benefits Cost: Service Cost $ 933 $ 724 $ 109 $ 97 $ 32 $ 32 Interest Cost 1,088 936 151 146 28 31 Expected Return on Plan Assets (922 ) (834 ) (74 ) (63 ) — — Amortization of Transition — — 105 105 — — Amortization of Prior Service Cost 41 41 (50 ) (50 ) 38 37 Amortization of Actuarial (Gain) Loss 313 129 41 32 (10 ) — Net Periodic Pension Cost $ 1,453 $ 996 $ 282 $ 267 $ 88 $ 100 For The Nine Months Ended September 30, 2005 and 2004 For The Three Months Ended September 30, 2006 and 2005 Pension Benefits Other SERP Pension Benefits Other SERP (dollars in thousands) 2005 2004 2005 2004 2005 2004 2006 2005 2006 2005 2006 2005 Components of Net Periodic Benefits Cost: Service Cost $ 2,799 $ 2,172 $ 327 $ 291 $ 96 $ 96 $ 963 $ 933 $ 107 $ 109 $ 55 $ 32 Interest Cost 3,264 2,808 453 438 84 93 1,170 1,088 155 151 36 28 Expected Return on Plan Assets (2,766 ) (2,502 ) (222 ) (189 ) — — (990 ) (922 ) (50 ) (74 ) — — Amortization of Transition — — 315 315 — — — — 105 105 — — Amortization of Prior Service Cost 123 123 (150 ) (150 ) 114 111 41 41 (50 ) (50 ) 39 38 Amortization of Actuarial (Gain) Loss 939 387 123 96 (30 ) — Amortization of Actuarial Loss (Gain) 291 313 37 41 (5 ) (10 ) Net Periodic Pension Cost $ 4,359 $ 2,988 $ 846 $ 801 $ 264 $ 300 $ 1,475 $ 1,453 $ 304 $ 282 $ 125 $ 88 For The Nine Months Ended September 30, 2006 and 2005 Pension Other SERP (dollars in thousands) 2006 2005 2006 2005 2006 2005 Components of Net Periodic Benefits Cost: Service Cost $ 2,889 $ 2,799 $ 321 $ 327 $ 165 $ 96 Interest Cost 3,510 3,264 465 453 108 84 Expected Return on Plan Assets (2,970 ) (2,766 ) (150 ) (222 ) — — Amortization of Transition — — 315 315 — — Amortization of Prior Service Cost 123 123 (150 ) (150 ) 117 114 Amortization of Actuarial Loss (Gain) 873 939 111 123 (15 ) (30 ) Net Periodic Pension Cost $ 4,425 $ 4,359 $ 912 $ 846 $ 375 $ 264 Registrant contributed In August 2006, the Board of Directors approved an amendment to the SERP for executive officers of the Company. Under the SERP, the formula for calculating benefits was revised to provide that the benefit is calculated based on 2% of compensation per year of credited service before 2006 and 3% of compensation per year of credited service after 2005 up to a combined maximum of 60% of compensation, except that participants who were employed with the Company on January 1, 2006 are entitled to receive the greater of the benefit calculated under the new formula or the benefit calculated under the previous formula. The Board’s approval of the new SERP formula is subject to the receipt of a confirming example, showing the effect of the change on an executive officer. The effect of this change on the 2006 net periodic benefit cost is not material. Note Water Quality-Related Litigation: In 1997, GSWC was named as a defendant in nineteen lawsuits that alleged that GSWC and other water utilities delivered unsafe water to their customers in the San Gabriel Valley and Pomona Valley areas of Los Angeles County. Plaintiffs in these actions sought damages, including general, special, and punitive damages, as well as attorney’s fees on certain causes of action, costs of suit, and other unspecified relief. On August 4, 2004, GSWC is subject to self-insured retention (deductible) provisions in its applicable insurance policies and has either expensed the self-insured amounts or has reserved against payment of these amounts as appropriate. GSWC’s various insurance carriers have, to date, provided reimbursement for much of the costs incurred above the self-insured amounts for defense against these lawsuits, subject to a reservation of rights. In addition, the CPUC has issued certain decisions, which authorize GSWC to establish a memorandum account to accumulate costs for future Perchlorate and/or Volatile Organic Compounds (“VOC”) have been detected in five wells servicing GSWC’s San Gabriel System. GSWC filed suit in federal court, along with two other affected water purveyors and the San Gabriel Basin Water Quality Authority (“WQA”), against some of those allegedly responsible for the contamination. Some of the other potential defendants settled with GSWC, other water purveyors and the WQA (the “Water Entities”) on VOC related issues prior to the filing of the lawsuit. In response to the filing of the Federal lawsuit, the Potentially Responsible Party (“PRP”) defendants filed motions to dismiss the suit or strike certain portions of the suit. The judge issued a ruling on April 1, 2003 granting in part and denying in part the A key ruling of the court was that the water purveyors, including Registrant has, pursuant to permission of the court, amended its suit to claim certain affirmative defenses as an “innocent” party under CERCLA. Registrant is presently unable to predict the outcome of this ruling on its ability to fully recover from the PRPs future costs associated with the treatment of these wells. In this same suit, the PRPs have filed cross-complaints against the Water Entities, the Metropolitan Water District, the Main San Gabriel Basin Watermaster and others on the theory that they arranged for and did transport contaminated water into the Main San Gabriel Basin for use by Registrant and the other two affected water purveyors and for other related claims. On August 29, 2003, the US Environmental Protection Agency (“EPA”) issued Unilateral Administrative Orders (“UAO”) against 41 parties deemed responsible for polluting the groundwater in that portion of the San Gabriel Valley from which two of GSWC’s impacted wells draw water. GSWC was not named as a party to the UAO. The UAO requires that these parties remediate the contamination. The judge in the Federal lawsuit has appointed a special master to oversee mandatory settlement discussions between the PRPs and the Water Entities. EPA is also conducting settlement discussions with several PRPs regarding the UAO. The Water Entities and EPA are working to coordinate their settlement discussions under the special master in order to arrive at a complete resolution of all issues affecting the Federal lawsuits and the UAO. Registrant is presently unable to predict the ultimate outcome of these settlement discussions. Registrant is unable to predict an estimate of the loss, if any, resulting from any of these litigations or administrative proceedings. Condemnation of Properties: The laws of the State of California and the State of Arizona provide for the acquisition of public utility property by governmental agencies through their power of eminent domain, also known as condemnation, where doing so is necessary and in the public interest. In addition, however, the laws of the State of California also provide: Although the City of Claremont, California located in GSWC’s Region III, has not initiated the formal condemnation process pursuant to California law, the City has expressed various concerns to GSWC about the rates charged by GSWC and the effectiveness of the CPUC’s rate setting procedures. The City hired a consultant to perform an appraisal of the value of Registrant’s water system serving the City. On April 12, 2005, the Town Council of the Town of Apple Valley located in GSWC’s Region III, voted 5-0 to authorize Town staff to prepare a Request for Proposal for an evaluation of the feasibility and estimated cost of and a timeframe for the potential takeover of GSWC’s Apple Valley water systems as well as the water systems of another utility serving the Town. On April 11, 2006 the Town Council unanimously decided to move forward with efforts to acquire all the water systems serving the Town, based on a study authorized by the Town Council. On July 25, 2006, the Town Council voted 4-0 to defer any further consideration of a takeover pending preparation by Town staff of financing options and costs to residents of any acquisition. No time frame was set for staff to report back to the Council. GSWC has not received any formal notice from the Town of its intention to condemn the Registrant’s Apple Valley water systems. Management will vigorously represent Registrant’s interests in any condemnation proceeding to ensure that the Company receives full value for assets that become subject to condemnation. As of September 30, 2006, management believes that the fair market value of GSWC’s system exceeds the recorded net book value of the Except for the City of Claremont and the Town of Apple Valley, Registrant has not been, within the last three years, involved in activities related to the condemnation of any of its water customer service areas or in its Bear Valley Electric customer service area. Santa Maria Groundwater Basin Adjudication: In 1997, the Santa Maria Valley Water Conservation District (“plaintiff”) filed a lawsuit against multiple defendants, including GSWC, the City of Santa Maria, and several other public water purveyors. The plaintiff’s lawsuit seeks an adjudication of the Santa Maria Groundwater Basin. As of September 30, 2006, GSWC has incurred costs of approximately $6.3 million in defending its rights in the Santa Maria Basin, including legal and expert witness fees, which have been recorded in Utility Plant for rate recovery. However, as stated earlier, the stipulation between the parties requires GSWC to go to the CPUC to seek recovery of these costs that have been incurred by GSWC in this lawsuit. In February 2006, GSWC filed with the CPUC for recovery of these costs. Management believes that the recovery of these costs through rates is probable. Air Quality Management District: In 1998, the South Coast Air Quality Management District (“AQMD”) issued a permit to GSWC for the installation and use of air stripping equipment at one of GSWC’s groundwater treatment systems in its Region II service area. In 2005, the AQMD conducted an inspection of this facility and issued a Notice of Violation (“NOV”) for exceeding the amount of groundwater permitted to be treated by the treatment system during calendar year 2004. Since receiving the NOV, changes in GSWC procedures have prevented additional violations at the facility. The AQMD could assess penalties associated with an NOV that can range from $10,000 up to $75,000 per day of violation. GSWC estimates that it was in violation approximately 180 days in 2004. GSWC has met with AQMD to ensure future compliance and resolve the NOV. As part of this, GSWC also promptly submitted an application to amend the permit as an amendment may have been necessary for continued operation of the subject air stripping equipment. The AQMD has recently recommended that GSWC be allowed to pursue a Supplemental Environmental Program (“SEP”) as part of the settlement of the NOV. A SEP typically involves capital expenditures resulting in a change of process, equipment, material, or indirect source reduction for the purposes of eliminating or reducing air contaminant emissions. As part of going forward with its permit amendment application, GSWS would amend its current application to also include the addition of additional controls to the facility to reduce emissions. The penalties which GSWC has been informed might be assessed, could likely be reduced or avoided through the settlement of this matter based on the possible funding of a SEP. In October 2006, GSWC submitted initial capital cost estimates to the AQMD for the installation and operation of granular activated carbon filters at the facility as a proposed SEP which would eliminate the use of the air stripping equipment. Initial discussions indicate that AQMD staff has favorably received GSWC’s proposal and if approved, it could result in the imposition of only a nominal monetary penalty. However, until further notice from the AQMD on the proposed SEP, GSWC cannot reasonably estimate the amount of penalties which might be assessed. Other Litigation: An officer of the Company has asserted a potential claim against the Company for retaliation against the officer and others in connection with alleged discriminatory conduct by the Company and its Board of Directors. Although management believes that the allegations are without merit and intends to vigorously defend against them, the Company retained an independent investigator to review the allegations and investigate the facts. Based upon the results of such investigation, the Company does not believe, but can give no assurance, that the ultimate resolution of this matter will have a material adverse effect on its financial position, results of operations, or cash flows. Registrant is also subject to ordinary routine litigation incidental to its business. Other than those disclosed above, no other legal proceedings are pending, which are believed to be material. Management believes that rate recovery, proper insurance coverage and reserves are in place to insure against property, general liability and workers’ compensation claims incurred in the ordinary course of business. Note AWR has three reportable segments, water, electric and contracts operations, whereas GSWC has two, water and electric. Within the segments, AWR has three principal business units: water and electric As of and for the Three Months Ended September 30, 2005 As of and for The Three Months Ended September 30, 2006 GSWC CCWC Consolidated GSWC CCWC Consolidated (dollars in thousands) Water Electric Water Other* Eliminations AWR Water Electric Water Other* AWR Operating revenues $ 58,568 $ 6,544 $ 1,971 $ 988 $ 68,071 $ 63,166 (1) $ 6,444 $ 2,120 $ 2,011 $ 73,741 Operating income (loss) before income taxes 16,825 4,894 (1) 322 (144 ) 21,897 Operating income (loss) 17,780 (2,703 )(2) 301 (342 ) 15,036 Interest expense, net (1,167 ) (118 ) 122 204 (959 ) 3,975 407 113 159 4,654 Identifiable assets 620,844 39,680 37,028 678 698,230 661,847 41,156 38,521 845 742,369 Depreciation and amortization expense 3,919 512 263 11 4,705 5,717 454 420 43 6,634 Capital additions 15,031 288 805 16,124 16,044 305 509 89 16,947 As of and for the Three Months Ended September 30, 2004 GSWC CCWC Consolidated (dollars in thousands) Water Electric Water Other* Eliminations AWR Operating revenues $ 60,506 $ 6,208 $ 1,973 $ 298 $ (24 ) $ 68,961 Operating income (loss) before income taxes 18,472 684 681 (1,479 ) 18,358 Interest expense, net 3,916 401 108 139 4,564 Identifiable assets 571,587 37,963 33,619 318 643,487 Depreciation and amortization expense 4,935 411 236 7 5,589 Capital additions 24,769 757 1,259 153 26,938 As of and for the Nine Months Ended September 30, 2005 GSWC CCWC Consolidated (dollars in thousands) Water Electric Water Other* Eliminations AWR Operating revenues $ 150,519 $ 20,105 $ 5,068 $ 2,704 $ (35 ) $ 178,361 Operating income (loss) before income taxes 39,729 9,236 (1) 1,588 (1,628 ) 48,925 Interest expense, net 6,789 696 346 614 8,445 Identifiable assets 620,844 39,680 37,028 678 698,230 Depreciation and amortization expense 13,684 1,519 788 45 16,036 Capital additions 47,108 1,648 2,843 359 51,958 As of and for The Three Months Ended September 30, 2005 GSWC CCWC Consolidated (dollars in thousands) Water Electric Water Other* AWR Operating revenues $ 58,589 (1) $ 6,544 $ 1,971 $ 987 $ 68,091 Operating income (loss) 16,700 4,894 (2) 322 (145 ) 21,771 Interest expense, net (1,587 ) 333 114 202 (938 ) Identifiable assets 620,844 39,680 37,028 678 698,230 Depreciation and amortization expense 3,948 512 263 11 4,734 Capital additions 15,031 288 805 16,124 (1) For the three months ended September 30, 2006, it includes $325,000 of GSWC other operating revenues, $311,000 of which reflects water rights lease revenues received from the City of Folsom (Note 2). For the three months ended September 30, 2005, it also includes $21,000 of GSWC other operating revenues. (2) Includes $2,807,000 and ($4,018,000) unrealized As of and for The Nine Months Ended September 30, 2006 GSWC CCWC Consolidated (dollars in thousands) Water Electric Water Other* AWR Operating revenues $ 163,526 (3) $ 21,816 $ 5,951 $ 5,193 $ 196,486 Operating income (loss) 46,380 (3,884 )(4) 1,026 (325 ) 43,197 Interest expense, net 11,339 996 377 682 13,394 Identifiable assets 661,847 41,156 38,521 845 742,369 Depreciation and amortization expense 16,806 1,530 1,258 132 19,726 Capital additions 47,784 1,681 1,313 291 51,069 As of and for The Nine Months Ended September 30, 2005 GSCW CCWC Consolidated (dollars in thousands) Water Electric Water Other* Eliminations AWR Operating revenues $ 150,595 (3) $ 20,105 $ 5,068 $ 2,704 $ (35 ) $ 178,437 Operating income (loss) 39,439 9,234 (4) 1,586 (1,628 ) 48,631 Interest expense, net 6,632 982 325 601 8,540 Identifiable assets 620,844 39,680 37,028 678 698,230 Depreciation and amortization expense 13,771 1,519 788 45 16,123 Capital additions 47,108 1,648 2,843 359 51,958 *Includes amounts from AWR and ASUS and its subsidiaries’ contracted operations (including FBWS, ODUS and TUS for the nine months ended September 30, 2006 and FBWS for the nine months ended September 30, 2005.) (3) For the nine months ended September 30, 2006, it also includes $3,244,000 of GSWC other operating revenues, $3,190,000 of which reflects water rights lease revenues received from the City of Folsom (Note 2). For the nine months ended September 30, 2005, As of and for the Nine Months Ended September 30, 2004 GSWC CCWC Consolidated (dollars in thousands) Water Electric Water Other* Eliminations AWR Operating revenues $ 149,864 $ 19,284 $ 4,982 $ 899 $ (73 ) $ 174,956 Operating income (loss) before income taxes 42,744 691 915 (3,815 ) — 40,535 Interest expense, net 11,468 1,173 351 320 — 13,312 Identifiable assets 571,587 37,963 33,619 318 — 643,487 Depreciation and amortization expense 13,990 1,129 706 15 — 15,840 Capital additions 51,698 3,095 2,502 236 — 57,531 (4) Includes $5,886,000 and ($7,492,000) unrealized loss (gain) on purchased power contracts for the 29 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of American States Water Company (“AWR”) is the parent company of Golden State Water Company (“GSWC”), Chaparral City Water Company (“CCWC”) and American States Utility Services, Inc. (“ASUS”) GSWC is a California public utility company engaged principally in the purchase, production and distribution of water. GSWC also distributes electricity in one customer service area. GSWC is regulated by the California Public Utilities Commission (“CPUC”) and was incorporated as a California corporation on December 31, 1929. GSWC is organized into one electric customer service area and three water service regions operating within 75 communities in 10 counties in the State of California and provides water service in 21 customer service areas. Region I consists of 7 customer service areas in northern and central California; Region II consists of 4 customer service areas located in Los Angeles County; and Region III consists of 10 customer service areas in eastern Los Angeles County, Orange, San Bernardino and Imperial counties. GSWC also provides electric service to the City of Big Bear Lake and surrounding areas in San Bernardino County through its Bear Valley Electric Service division. GSWC served CCWC is an Arizona public utility company serving ASUS contracts, either directly or through wholly-owned subsidiaries, with various municipalities, the U.S. Government and private entities to provide water and wastewater services, including billing and meter reading, water marketing and the operation and maintenance of water and wastewater systems. On October 1, 2004, ASUS commenced operation of the water and wastewater systems at Fort Bliss located near El Paso, Texas, through FBWS, pursuant to the terms of a ASUS ASUS and GSWC have been pursuing an opportunity to provide retail water services within the service area of the Natomas Central Mutual Water Company (“Natomas”). Natomas is a California mutual water company which currently provides water service to its shareholders, primarily for agricultural irrigation in portions of Sacramento and Sutter counties in northern California. GSWC filed a Certificate of Public Convenience and Necessity application in May 2006, as mentioned below. In August 2004, Natomas granted ASUS the exclusive right to market water that has become “temporarily surplus” that may arise under water rights permits and contracts owned or controlled by it, to third parties outside the Natomas service area. On January 31, 2006, ASUS entered into a water purchase agreement to acquire 5,000 acre-feet of permanent Sacramento River water diversion rights from Natomas. Pursuant to the terms of this agreement, Natomas will sell, transfer and convey to ASUS, in perpetuity, water rights and entitlements to divert from the Sacramento River up to 5,000 acre-feet of water per year, subject to certain regulatory approvals. Terms of the acquisition, among other things, include a base price of $2,500 per acre-foot of water, with payments contingent on meeting specific milestones and events over a GSWC has also entered into a water transfer agreement with Natomas for 30,000 acre-feet of water to be used exclusively by GSWC to serve Sutter County, California. Additionally, GSWC filed for a Certificate of Public Convenience and Necessity with the CPUC on May 31, 2006 to provide retail water service in a portion of Sutter County, California. CPUC review of the application is pending, subject to Overview Registrant’s revenues, income, and cash flows are earned primarily through delivering potable water to homes and businesses. Rates charged to customers of GSWC and CCWC are determined by either the CPUC or ACC. These rates are intended to allow recovery of operating costs and a fair rate of return on capital. Factors recently affecting our financial performance include the process and timing of setting rates charged to customers; our ability to recover, and the process for For the three months ended September 30, 2006, net income was $5.6 million compared to $12.2 million for the Registrant plans to continue to seek additional rate increases in future years to recover operating and supply costs and receive reasonable returns on invested capital. Capital expenditures in future years are expected to remain at much higher levels than depreciation expense. Cash solely from operations is not expected to be sufficient to fund Registrant’s needs for capital expenditures, dividends, investments in the contract business and other cash needs. Registrant expects to fund these needs through a combination of debt and common share offerings in the next five years. Unless specifically noted, the following discussion and analysis provides information on AWR’s consolidated operations and assets. For the three and nine months ended September 30, 2006 and 2005, there is generally no material difference between the consolidated operations and assets of AWR and the operations and assets of GSWC. However, where necessary, the following discussion and analysis includes references specifically to AWR’s other subsidiaries — CCWC and ASUS and its subsidiaries. Consolidated Results of Operations 3 MOS 3 MOS ENDED ENDED $ % 9/30/2005 9/30/2004 CHANGE CHANGE 3 MOS 3 MOS $ % OPERATING REVENUES Water $ 60,539 $ 62,455 $ (1,916 ) -3.1 % $ 64,962 $ 60,539 $ 4,423 7.3 % Electric 6,544 6,208 336 5.4 % 6,444 6,544 (100 ) -1.5 % Other 988 298 690 231.5 % 2,335 1,008 1,327 131.6 % Total operating revenues 68,071 68,961 (890 ) -1.3 % 73,741 68,091 5,650 8.3 % OPERATING EXPENSES Water purchased 15,779 15,339 440 2.9 % 15,066 15,779 (713 ) -4.5 % Power purchased for pumping 3,252 2,971 281 9.5 % 3,600 3,252 348 10.7 % Groundwater production assessment 2,315 2,120 195 9.2 % 2,477 2,315 162 7.0 % Power purchased for resale 3,075 3,107 (32 ) -1.0 % 2,659 3,075 (416 ) -13.5 % Unrealized gain on purchased power contracts (4,018 ) 224 (4,242 ) -1893.8 % Unrealized loss (gain) on purchased power contracts 2,807 (4,018 ) 6,825 -169.9 % Supply cost balancing accounts 514 1,016 (502 ) -49.4 % 244 514 (270 ) -52.5 % Other operating expenses 4,850 4,818 32 0.7 % 6,677 4,850 1,827 37.7 % Administrative and general expenses 10,074 10,591 (517 ) -4.9 % 12,614 10,342 2,272 22.0 % Depreciation and amortization 4,705 5,589 (884 ) -15.8 % 6,634 4,734 1,900 40.1 % Maintenance 3,080 2,593 487 18.8 % 3,395 2,905 490 16.9 % Taxes on income 10,558 5,692 4,866 85.5 % Other taxes 2,548 2,235 313 14.0 % Property and other taxes 2,656 2,572 84 3.3 % Net gain on sale of property (124 ) - 124 100.0 % Total operating expenses 56,732 56,295 437 0.8 % 58,705 46,320 12,385 26.7 % Operating income 11,339 12,666 (1,327 ) -10.5 % OTHER INCOME (LOSS) - NET (64 ) (84 ) 20 -23.8 % INTEREST CHARGES (959 ) 4,564 (5,523 ) -121.0 % OPERATING INCOME 15,036 21,771 (6,735 ) -30.9 % Interest expense (5,349 ) 193 5,542 2871.5 % Interest income 695 745 (50 ) -6.7 % INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE 10,382 22,709 (12,327 ) -54.3 % Income tax expense 4,809 10,475 (5,666 ) -54.1 % NET INCOME $ 12,234 $ 8,018 $ 4,216 52.6 % $ 5,573 $ 12,234 $ (6,661 ) -54.4 % Net income for the Operating Expenses Amount Increase / (Decrease) Power purchased for resale ($31,230 ) Other operating expenses (459,415 ) Administrative and general expenses (16,963 ) Depreciation and amortization (992,232 ) Total pre-tax impact to operating expenses (1,499,840 ) Interest Interest expense (5,084,551 ) Interest income (607,083 ) Total net interest charges (5,691,634 ) Total pre-tax impact to results of operations $ 7,191,474 Impact to taxes on income 2,930,238 Total impact to net income $ 4,261,236 Impact to Basic Earnings per Share $ 0.25 Impact to Diluted Earnings per Share $ 0.25 Amount Increase / (Decrease) Operating Expenses Power purchased for resale $ (31,230 ) Other operating expenses (459,415 ) Administrative and general expenses (16,963 ) Depreciation and amortization (992,232 ) Total pre-tax impact to operating expenses (1,499,840 ) Interest Charges Other interest and amortization of debt expense (5,691,634 ) Total pre-tax impact to results of operations $ 7,191,474 Impact to taxes on income 2,930,238 Total impact to net income $ 4,261,236 Impact to Basic Earnings per Share $ 0.25 Impact to Diluted Earnings per Share $ 0.25 Operating Revenues For the three months ended September 30, For the three months ended September 30, reflects lower new connection, reconnection and miscellaneous fees charged to customers during the three months ended September 30, 2006 as compared to same period in 2005. This decrease was partially offset by a slight increase Registrant relies upon rate For the three months ended September 30, Operating Expenses For the three months ended September 30, For the three months ended September 30, For the three months ended September 30, Changes in the water resource mix between water supplied from purchased sources and that supplied from Registrant’s own wells can increase/decrease actual supply-related costs relative to that approved for recovery through rates, thereby impacting earnings either negatively or positively. Registrant has the opportunity to change the supply-related costs recovered through rates by application to the appropriate regulatory body. Registrant believes that its applications for recovery of supply-related costs accurately reflect the water supply situation as it is known at the For the three months ended September 30, Unrealized A decrease of For the three months ended September 30, For the three months ended September 30, For the three months ended September 30, For the three months ended September 30, For the three months ended September 30, 2006, property and other taxes increased by 3.3% to $2.7 million compared to $2.6 million for the three months ended September 30, For the three months ended September 30, 2005, Interest Expense For the three months ended September 30, 2006, interest expense increased by Interest Income Interest income decreased by 6.7% during the three months ended September 30, 2006 as compared to the same period in 2005 reflecting primarily the decision from the CPUC in 2005 on the Aerojet matter, which resulted in the recognition of interest income totaling approximately $607,000 earned on the $8.0 million Aerojet long-term note receivable. The recording of the interest income had been deferred pending this final CPUC decision. This decrease was offset by increases due primarily to: (i) interest accrued on the uncollected balance of the Aerojet litigation memorandum account authorized by the CPUC of $279,000; (ii) interest income totaling $173,000 earned from the U.S. Government for costs incurred on capital upgrade projects at Andrews Air Force Base, and (iii) interest earned on short-term cash surplus. Income Tax Expense For the three months ended September 30, 2006, income tax expense decreased by 54.1% to $4.8 million compared to Consolidated Results of Operations 9 MOS 9 MOS ENDED ENDED $ % 9/30/2005 9/30/2004 CHANGE CHANGE 9 MOS 9 MOS $ % OPERATING REVENUES Water $ 155,587 $ 154,773 $ 814 0.5 % $ 166,233 $ 155,611 $ 10,622 6.8 % Electric 20,105 19,284 821 4.3 % 21,816 20,105 1,711 8.5 % Other 2,669 899 1,770 196.9 % 8,437 2,721 5,716 210.1 % Total operating revenues 178,361 174,956 3,405 1.9 % 196,486 178,437 18,049 10.1 % OPERATING EXPENSES Water purchased 35,742 37,022 (1,280 ) -3.5 % 34,326 35,742 (1,416 ) -4.0 % Power purchased for pumping 6,923 7,103 (180 ) -2.5 % 7,620 6,923 697 10.1 % Groundwater production assessment 6,079 5,280 799 15.1 % 6,799 6,079 720 11.8 % Power purchased for resale 9,922 10,474 (552 ) -5.3 % 10,470 9,922 548 5.5 % Unrealized gain on purchased power contracts (7,492 ) (257 ) (7,235 ) 2815.2 % Gain on settlement for removal of wells (760 ) — (760 ) -100.0 % Gain on sale of water rights — (5,675 ) 5,675 -100.0 % Unrealized loss (gain) on purchased power contracts 5,886 (7,492 ) 13,378 -178.6 % Supply cost balancing accounts 1,042 4,835 (3,793 ) -78.4 % (93 ) 1,042 (1,135 ) -108.9 % Other operating expenses 15,137 14,538 599 4.1 % 17,264 15,138 2,126 14.0 % Administrative and general expenses 31,698 31,166 532 1.7 % 34,628 32,456 2,172 6.7 % Depreciation and amortization 16,036 15,840 196 1.2 % 19,726 16,123 3,603 22.3 % Maintenance 8,068 7,529 539 7.2 % 9,113 7,522 1,591 21.2 % Taxes on income 18,582 11,720 6,862 58.5 % Other taxes 7,041 6,566 475 7.2 % Property and other taxes 7,674 7,111 563 7.9 % Net gain on sale of property (124 ) - 124 100.0 % Gain on settlement for removal of wells - (760 ) (760 ) -100.0 % Total operating expenses 148,018 146,141 1,877 1.3 % 153,289 129,806 23,483 18.1 % Operating income 30,343 28,815 1,528 5.3 % OTHER INCOME (LOSS) - NET (165 ) 371 (536 ) -144.5 % INTEREST CHARGES 8,445 13,312 (4,867 ) -36.6 % OPERATING INCOME 43,197 48,631 (5,434 ) -11.2 % Interest expense (16,037 ) (9,341 ) 6,696 71.7 % Interest income 2,643 801 1,842 230.0 % INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE 29,803 40,091 (10,288 ) -25.7 % Income tax expense 12,061 18,358 (6,297 ) -34.3 % NET INCOME $ 21,733 $ 15,874 $ 5,859 36.9 % $ 17,742 $ 21,733 $ (3,991 ) -18.4 % Net income decreased by 18.4% for the nine months ended September 30, million to net income in July of 2005 or approximately $0.25 per share. The impact to · Water rate increases contributed approximately $8.8 million to revenues, or $0.31 per share for the nine months ended September 30, · A lower effective tax rate · Higher operating expenses, other than those described above, which lowered 2006 net income by an additional $0.19 per share, as more fully described below. Operating Revenues For the nine months ended September 30, For the nine months ended September 30, The Registrant relies upon rate approvals by state regulatory agencies in California and Arizona, in order to recover operating expenses and provide for a fair return on invested and borrowed capital used to fund utility plant. Without adequate rate relief granted in a timely manner, revenues and earnings can be negatively impacted. For the nine months ended September 30, Operating Expenses For the nine months ended September 30, For the nine months ended September 30, For the nine months ended September 30, Changes in the water resource mix between water supplied from purchased sources and that supplied from Registrant’s own wells can increase/decrease actual supply-related costs relative to that approved for recovery through rates, thereby impacting earnings either negatively or positively. For the nine months ended September 30, Unrealized market prices since December 31, 2005. There was a $7.5 million pretax unrealized gain on purchased power contracts for the nine months ended September 30, For the nine months ended September 30, 2006, other operating expenses increased by 14.0% to $17.3 million compared to $15.1 million for the nine months ended September 30, 2005 due primarily to higher operating expenses of $1.2 million at ODUS and TUS due to the commencement of operation of the water and wastewater systems at military bases in Maryland and Virginia. There was also a net increase of $1.3 million at GSWC primarily due to: (i) a $459,000 downward adjustment in July of 2005 reflecting the approval from the CPUC of previously incurred operating expenses in the Aerojet matter, previously discussed; (ii) higher chemicals and water treatment costs of $386,000 at GSWC; (iii) approximately $292,000 of higher labor costs as a result of higher wages at GSWC, and (iv) an increase of $248,000 in bad debt expense at GSWC relating to miscellaneous accounts receivable balances. These increases were partially offset by the increase in reimbursement of $560,000 from the U.S. Government and a contractor, for operating expenses incurred at Fort Bliss. FBWS was separately hired by the U.S. Government as a subcontractor for certain related projects at the same base. For the nine months ended September 30, 2006, administrative and general expenses increased by 6.7% to $34.6 million compared to $32.5 million for the nine months ended September 30, 2005 caused primarily by higher administrative and general expenses of $804,000 at ODUS and TUS due to the commencement of operation of the water and wastewater systems at military bases in Maryland and Virginia in early 2006. This increase at ODUS and TUS is net of the recovery of transition period operating expenses of about $672,000 at these military bases. Other changes at ASUS include decreases due to: (i) an increase of $284,000 in reimbursements by the U.S. Government of indirect costs incurred by FBWS, and (ii) lower outside services and other expenses at ASUS totaling $380,000. General and administrative expenses also increased by $2.0 million at GSWC primarily due to increases in: (i) pensions and benefits of $170,000 caused by actuarial assumption changes in the mortality tables, and increases of approximately $378,000 in various other benefit costs due primarily to increases in medical and labor costs; (ii) stock-based compensation expense of $402,000 due to the adoption of SFAS No. 123(R) effective January 1, 2006; (iii) labor cost increases of $762,000 due to higher wages, and (iv) various other office, supplies and rent expenses of $314,000. For the nine months ended September 30, 2006, depreciation and amortization expense increased by 22.3% to $19.7 million compared to $16.1 million for the nine months ended September 30, 2005 reflecting, among other things, the effects of closing approximately $100 million of additions to utility plant during 2005, depreciation on which began in January 2006. In addition, there was a decrease in depreciation expense in 2005 resulting from the favorable CPUC decision on the Aerojet matter, discussed previously, which ordered GSWC to restore approximately $1 million to the appropriate plant accounts and decrease depreciation expense in July of 2005. There was no such adjustment in 2006. Registrant anticipates that depreciation expense will continue to increase due to Registrant’s on-going construction program at its regulated subsidiaries. Registrant believes that depreciation expense related to property additions approved by the appropriate regulatory agency will be recovered through water and electric rates. For the nine months ended September 30, 2006, maintenance expense increased by 21.2% to $9.1 million compared to $7.5 million for the nine months ended September 30, 2005 due principally to an increase in required maintenance on GSWC’s wells and water supply sources at all Regions. There were also increases in well treatment and emergency repair costs. Furthermore, there was an increase of: (i) $451,000 at GSWC’s electric division due to the new 8.4 MW natural gas-fueled generation facility, and (ii) $175,000 at ODUS and TUS due to the commencement of the operations of the water and wastewater systems pursuant to new military contracts in Maryland and Virginia. 40 For the nine months ended September 30, 2006, property and other taxes increased by 7.9% to $7.7 million compared to $7.1 million for the nine months ended September 30, 2005 reflecting additional property taxes resulting from higher assessed values, and increases in payroll taxes based on increased labor costs. For the nine months ended September 30, 2005, Registrant recorded a net pretax gain of $124,000 on the sale of non-utility property. There was no similar gain in the same period of 2005. For the nine months ended September 30, 2005, Registrant also recorded a net pre-tax gain of $760,000 on a settlement reached with the Fountain Hills Sanitary District (“FHSD”) in February 2005 for the capping of two CCWC wells in order to facilitate FHSD’s ability to secure certain permits. Pursuant to the settlement agreement, CCWC agreed to permanently remove from service and cap one of its wells, and cap another well which had never been used as a potable source of supply. There was no similar gain in the same period of 2006. Interest Expense For the nine months ended September 30, Interest Income For the nine months ended September 30, Income Tax Expense For the nine months ended September 30, Critical Accounting Policies and Estimates Critical accounting policies and estimates are those that are important to the portrayal of AWR’s financial condition, results of operations and cash flows, and require the most difficult, subjective or complex judgments of AWR’s management. The need to make estimates about the effect of items that are uncertain is what makes these judgments difficult, subjective and/or complex. Management makes subjective judgments about the accounting and regulatory treatment of many items. These judgments are based on AWR’s historical experience, terms of existing contracts, and AWR’s observance of trends in the industry, information provided by customers and information available from other outside sources, as appropriate. Actual results may differ from these estimates under different assumptions or conditions. The critical accounting policies used in the preparation of the Registrant’s financial statements that we believe affect the more significant judgments and estimates used in the preparation of our consolidated financial statements presented in this report are described in “Management’s Discussion and Analysis of Financial Condition and Results of Liquidity and Capital Resources AWR AWR funds its operating expenses and pays dividends on its outstanding Net cash provided by operating activities was Net cash used in investing activities Net cash used in financing activities was $1.0 million for the nine months ended September 30, Registrant has paid common In June 2005, AWR amended and restated its credit agreement which increased its borrowing limit under this facility to $85 million and extended the maturity date to June 2010. Up to $20 million of this facility may be used for letters of credit. As of September 30, Registrant anticipates that interest costs will increase in future periods due to potential market interest rate increases and the need for additional external capital to fund its construction GSWC Net cash provided by operating activities was Net cash used in investing activities Net cash GSWC funds the majority of its operating expenses, payments on its debt, and dividends on its outstanding common shares through internal sources. Internal sources of cash flow are provided 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 regulatory decisions affecting GSWC’s ability to recover these supply costs, and the timing of rate relief. GSWC also relies on external sources, including equity investments and short-term borrowings from AWR, long-term debt, On October 11, 2005, CoBank, ACB purchased a 5.87% Senior Note due December 20, 2028 In February 2005, Moody’s Investor Services (“Moody’s”) changed the rating outlook for $175 million of senior unsecured debt at GSWC from A2 negative to A2 stable. Moody’s debt ratings range from Aaa (best quality) to C (lowest quality). CCWC CCWC funds the majority of its operating expenses, payments on its debt and dividends, if any, through internal operating sources or short-term borrowings from AWR. CCWC also relies on external sources, including long-term debt, ASUS ASUS funds its operating expenses primarily through management fees and investments by or loans from AWR. ASUS, in turn, provides funding to Contractual Obligations and Other Commitments In addition to contractual maturities, Registrant has certain debt instruments that contain annual sinking fund or other principal payments. Registrant believes that it will be able to refinance debt instruments at their maturity through public issuance, or private placement, of debt or equity. Annual principal and interest payments are generally made from cash flow from operations. There have been no material changes to AWR’s contractual obligations and other Regulatory Matters GSWC is subject to regulation by the CPUC, which has broad powers with respect to service and facilities, rates, Rates that GSWC and CCWC are authorized to charge are determined by the CPUC and the GSWC is required to file a general rate case (“GRC”) application every three years for each of its water rate-making areas according to a schedule established by the CPUC. GRCs typically include an increase in year one and step increases for the second and third years. Rates are based on a forecast of expenses and capital investments. GRCs have a typical regulatory processing time of one year. In California, rates may be increased by offsets for certain expense increases, including but not limited to supply cost offset and balancing account amortization, and advice letter filings related to certain plant additions and other operating cost increases. Offset rate increases and advice letter filings typically have a two to four month regulatory lag. Neither the operations nor rates of AWR and ASUS are directly regulated by the CPUC or the ACC. The CPUC and the ACC do, however, regulate certain transactions between GSWC and CCWC and their affiliates. The amounts charged by the subsidiaries of ASUS for water and wastewater services at military bases are based upon the terms of 50-year contracts with the U.S. Government. Prices will be re-determined at the end of two years after commencement of operations at each military base and generally every three years thereafter. In addition, prices may be equitably adjusted for changes in law, wage and benefit increases and other circumstances. Recent Changes in Rates On November Pending Rate Changes in 2006 In February Other Regulatory Matters New Service Territiory Application GSWC has entered into a water transfer agreement with Natomas for 30,000 acre-feet of water to be used exclusively by GSWC to serve Sutter County, California. GSWC filed for a Certificate of Public Convenience and Necessity with the CPUC on May 31, 2006 to provide retail water service in a portion of Sutter County, California. CPUC review of the application is pending, subject to completion of an environmental assessment. Finance Application In October of 2006, GSWC filed with the CPUC an application requesting authorization for it to issue, sell and deliver by public offering or private placement securities not exceeding $200.0 million in aggregate offering amount, said securities consisting of, but not limited to, common shares and preferred shares, bonds, debentures, medium-term notes, loans and tax exempt debt. GSWC will use the net proceeds to first pay down all or a portion of its then outstanding short-term debt, fund its construction expenditures, and acquire utility properties. State-Wide Rate Application In September 2006, GSWC filed an application with the CPUC for authority to implement changes in certain ratemaking mechanisms and reallocation of rates within its entire service territory in California. The application requests authority from the CPUC to implement certain rate setting mechanisms, including the following: ·Establishment of a Water Quality Memorandum Account or Water Quality Compliance Offset Account to, among other things, permit full recovery of costs relating to water quality compliance. ·Measures to encourage and support water supply planning and investment. ·Changes to existing GSWC water shortage or emergency procedures and mandatory conservation and rationing penalties. ·Establishment of an Infrastructure System Replacement Surcharge to encourage and support infrastructure replacement needs. ·To eliminate disincentives to conserve water and eliminate fluctuations in revenues due to weather, the establishment of a Water Revenue Adjustment Mechanism to decouple sales from revenues. ·Consolidation of GSWC’s existing offset balancing accounts, allowance for full cost recovery of supply offset costs, and elimination of a related earnings test. ·Establishment of an increasing block rate structure to promote water conservation and rates that more accurately reflect the value of service. ·Consolidation of GSWC’s existing ratemaking districts into a state-wide, single tariff price rate structure to encourage and support long-term rate stability and affordability. ·Measures to provide appropriate incentives and procedures to carry out the Commission's objective of consolidation of non-viable water companies. GSWC’s overall revenues are not intended to increase or decrease as a result of this Application. Memorandum Supply Cost Accounts In a CPUC decision issued on June 19, 2003 related to memorandum supply cost accounts, all water utilities regulated by the CPUC GSWC intends to file for recovery of the net under-collected supply costs with the CPUC in 2006 or in subsequent general rate case proceedings. GSWC filed advice letters in Santa Maria Groundwater Basin Adjudication In 1997, the Santa Maria Valley Water Conservation District (“plaintiff”) filed a lawsuit against multiple defendants, including GSWC, the City of Santa Maria, and As of September 30, 2006, GSWC has incurred costs of approximately $6.3 million in Utility Plant for rate recovery. In February 2006, GSWC Refund of Water Rights Lease Revenues In 1994, GSWC entered into a contract to lease to the customers. On Recovery of cost of tree removal and mitigation for Bark Beetle Infestation In a Proclamation issued on March 7, 2003 former Governor Gray Davis declared a State of Emergency with respect to a severe fire risk caused by dead and dying trees plagued by drought and a major bark beetle infestation in the counties of Riverside, San Bernardino, and San Diego. On April 3, 2003, the CPUC issued an order requiring Southern California Edison Company, San Diego Gas & Electric Company and Bear Valley Electric to take all reasonable and necessary actions to mitigate the increased fire hazard by removing dead, dying or diseased trees from falling or contacting distribution and transmission lines within their rights of way and to ensure compliance with existing vegetation clearance statutes and regulations. The utilities, including Bear Valley Electric, are authorized to make annual advice letter filings requesting recovery of the costs of complying with this order. On April 13, 2006, the CPUC approved GSWC’s request for the amortization of about $351,000 for costs incurred through June 30, 2005 plus interest in the Bark Beetle Catastrophic Event Memorandum Account. At September 30, 2006, approximately $596,000, which includes the $351,000, has been incurred and is recorded as a regulatory asset on the balance sheets. Outside Services Memorandum Account In April 2006, the CPUC approved GSWC’s Region II advice letter which requested recovery of the expenses recorded in the Outside Services Memorandum Account (“OSMA”), as of December 31, 2005. The decision authorized the recovery of this Environmental Matters Additional information on these requirements and other significant environmental matters are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operation” included in our In 1998, the South Coast Air Quality Management District (“AQMD”) issued a permit to GSWC for the installation and use of air stripping equipment at one of GSWC’s groundwater treatment systems in its Region II service area. In 2005, the AQMD conducted an inspection of this facility and issued a Notice of Violation (“NOV”) for exceeding the amount of groundwater permitted to be treated by the treatment system during calendar year 2004. The AQMD has recently recommended that GSWC be allowed to pursue a Supplemental Environmental Program (“SEP”) as part of the settlement of the NOV. A SEP typically involves capital expenditures resulting in a change of process, equipment, material, or indirect source reduction for the purposes of eliminating or reducing air contaminant emissions. As part of going forward with its permit amendment application, GSWS would amend its current application to also include the addition of additional controls to the facility to reduce emissions. The penalties which GSWC has been informed might be assessed, could likely be reduced or avoided through the settlement of this matter based on the possible funding of a SEP. In October 2006, GSWC submitted initial capital cost estimates to the AQMD for the installation and operation of granular activated carbon filters at the facility as a proposed SEP which would eliminate the use of the air stripping equipment. Initial discussions indicate that AQMD staff has favorably received GSWC’s proposal and if approved, it could result in the There have been no other material changes in any of the environmental matters discussed in the Form 10-K since December 31, Water Supply The adequacy of Population growth and increases in the amount of water used have increased limitations on use in order to prevent over-drafting of groundwater basins. The importation of water from the Colorado River, one of GSWC’s important sources of supply, is expected to decrease in future years due to the requirements of the Central Arizona Project (“CAP”) and other limitations on the amount of water that the Metropolitan Water District of Southern California (“MWD”) is entitled to take from the Colorado River. MWD is expected to increase its efforts to secure additional supplies from conservation, desalination and water exchanges with the agricultural water users. CCWC obtains its water supply from operating wells and from the Colorado River through the CAP. CCWC’s water supply may be subject to interruption or reduction if there is an interruption or reduction in CAP water. In addition, CCWC’s ability to provide water service to new real estate developments is dependent upon The U.S. Government is responsible for supplying water on military bases under the terms of contracts of the New Accounting Pronouncements Registrant is subject to newly issued requirements as well as changes in existing requirements issued by the Financial Accounting Item 3. Quantitative and Qualitative Disclosures About Market Risk Registrant is exposed to certain market risks, including fluctuations in interest rates, and commodity price risk primarily relating to changes in the market price of electricity. Market risk is the potential loss arising from adverse changes in prevailing market rates and prices. There have been no material changes regarding Registrant’s market risk position from the information provided in its Annual Report on Form 10-K for the year ended December 31, Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures As required by Rule 13a-15(b) under the Securities and Exchange Act of 1934 (the “Exchange Act”), we have carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”), of the effectiveness, as of the end of the fiscal quarter covered by this report, of the design and operation of our “disclosure controls and procedures” as defined in Rule 13a-15(e) and 15d-15(e) promulgated by the Securities and Exchange Commission (b) Changes in Internal Controls over Financial Reporting There has been no change in our internal control over financial reporting during the quarter ended September 30, An officer of the Company has asserted a potential claim against the Company for retaliation against the officer and others in connection with alleged discriminatory conduct by the Company and its Board of Directors. Although management believes that the allegations are without merit and intends to vigorously defend against them, the Company retained an independent investigator to review the allegations and investigate the facts. Based upon the results of such investigation, the Company does not believe, but can give no assurance, that the ultimate resolution of this mater will have a material adverse effect on its financial position, results of operations, or cash flows. There have been no material developments in any of the legal proceedings described in our 2005 Annual Report on Form 10-K. Registrant is subject to ordinary routine litigation incidental to its business. Other than those disclosed in this section and in the Notes to the Consolidated Financial Statements in Registrant’s Form 10-K for the year ended December 31, There have been no significant changes in the risk factors disclosed in our 2005 Annual Report on Form 10-K. The shareholders of AWR have approved the material features of all equity compensation plans under which AWR directly issues equity securities. AWR did not directly issue any unregistered equity securities during the third quarter of The following table provides information about repurchases of Period Total Average Price Paid Total Number of Maximum Number July 1 – 31, 2005 393 (2) $ 30.31 — NA (3) August 1 – 31, 2005 16,403 (4) $ 29.96 — NA (3) September 1 – 30, 2005 9,213 (4) $ 31.94 — NA (3) Total 26,009 $ 30.66 — NA (3) Period Total Number of Average Price Total Number of Maximum Number July 1 – 31, 2006 891 (2) $ 36.64 — NA(3) August 1 - 31, 2006 80 (2) $ 37.50 — NA(3) September 1 - 30, 2006 57 (2) $ 38.07 — NA(3) Total 1,028 $ 36.79 — NA(3) (1) None of the (2)All of these Common Shares were acquired on the open market for new participants in the Company’s Common Share Purchase and Dividend Reinvestment Plan. (3) None of these plans contain a maximum number of Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders No items were submitted during the third quarter of the (a) On Mr. Gary King was elected as a Class II director of Under the The Company amended its bylaws on November 7, 2006 to increase the (b) There have been no material changes during the third quarter of (a) The following documents are filed as Exhibits to this report: 3.1 Bylaws of American States Water Company, as amended (1) 3.2 Bylaws of Golden State Water Company, as amended (1) 10.1 Form of Non-Employee Director Stock Option Agreement (1) (3) 10.2 Form of Indemnification Agreement for Directors (1) (3) 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for AWR (1) 31.1.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for GSWC (1) 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for AWR (1) 31.2.1 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for GSWC (1) 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2) 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2) (1) Filed concurrently (2) Furnished concurrently herewith (3) Pursuant to the requirements of Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized and as its principal financial officer. AMERICAN STATES WATER COMPANY By: /s/ Robert J. Sprowls Robert J. Sprowls Senior Vice President-Finance, Chief Financial Officer, Treasurer and Corporate Secretary Dated: November 52Golden State Water Company Yes o No ý9, 2005,8, 2006, the number of Common Shares outstanding, of American States Water Company was 16,789,53317,038,477 shares.9 2005,8, 2006, all of the 122 outstanding Common Shares of Golden State Water Company were owned by American States Water Company.
and
GOLDEN STATE WATER COMPANY
FORM 10-QINDEX
PagePage(s)RisksRiskPART I
wholly ownedwholly-owned subsidiary, Golden State Water Company.Operation.Operations. References in this report to “Registrant” are to AWR and GSWC collectively, unless otherwise specified. GSWC makes no representations as to the information contained in this report relating to AWR and its subsidiaries, other than GSWC.2Forward-Looking Information
CONSOLIDATED BALANCE SHEETS
ASSETS
(Unaudited)ASSETS
2006
2005
CONSOLIDATED BALANCE SHEETS
CAPITALIZATION AND LIABILITIES
(Unaudited)
accounts of $750 in 2005 and $782 in 2004)
accounts of $234 in 2005 and $201 in 2004)
2006
2005
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS
ENDED SEPTEMBER 30, 2006 AND 2005
(Unaudited)
September 30,
CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 2006 AND 2005
(Unaudited)
September 30,3
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(Unaudited)CONSOLIDATED BALANCE SHEETSCAPITALIZATION AND LIABILITIES(Unaudited)
September 30,4AMERICAN STATESGOLDEN STATE WATER COMPANY
BALANCE SHEETSCONSOLIDATED STATEMENTS OF INCOMEFOR THE THREE MONTHSENDED SEPTEMBER 30, 2005 AND 2004
ASSETS
(Unaudited)
2006
2005consolidated financial statements5AMERICAN STATESGOLDEN STATE WATER COMPANYCONSOLIDATED STATEMENTS OF INCOME
BALANCE SHEETSFOR THE NINE MONTHS ENDEDSEPTEMBER 30, 2005
CAPITALIZATION AND 2004
(Unaudited)
2006
2005consolidated financial statements6AMERICAN STATESGOLDEN STATE WATER COMPANYCONSOLIDATED
STATEMENTS OF CASH FLOW
FOR THE NINETHREE MONTHS
ENDED SEPTEMBER 30, 20052006 AND 2004
(Unaudited)
September 30,consolidated financial statements7
STATEMENTS OF INCOME
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 2006 AND 2005
(Unaudited)BALANCE SHEETS
September 30,ASSETSThe accompanying notes are an integral part of these financial statements
CASH FLOW STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(Unaudited)
September 30,8GOLDEN STATE WATER COMPANYBALANCE SHEETSCAPITALIZATION AND LIABILITIES(Unaudited)The accompanying notes are an integral part of these financial statements9STATEMENTS OF INCOMEFOR THE THREE MONTHSENDED SEPTEMBER 30, 2005 AND 2004(Unaudited)The accompanying notes are an integral part of these financial statements10GOLDEN STATE WATER COMPANYFOR THE NINE MONTHS ENDEDSEPTEMBER 30, 2005 AND 2004(Unaudited)The accompanying notes are an integral part of these financial statements11GOLDEN STATE WATER COMPANYFOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(Unaudited)The accompanying notes are an integral part of these financial statements
AND
GOLDEN STATE WATER COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)(Unaudited)–— Summary of Significant Accounting PoliciesPolicies:General:General / Nature of Operations: American States Water Company (“AWR”) is the parent company of Golden State Water Company (“GSWC”), American States Utility Services, Inc. (“ASUS”) (and its subsidiary,subsidiaries: Fort Bliss Water Services Company (“FBWS”), Terrapin Utility Services, Inc. (“TUS”) and Old Dominion Utility Services, Inc. (“ODUS”)), and Chaparral City Water Company (“CCWC”). Unless otherwise stated in this report, the term Registrant applies to both AWR and GSWC, collectively. GSWC changed its name from Southern California Water Company to Golden State Water Company by amendment to its Restated Articles of Incorporation on September 30, 2005.three regions in California.California serving approximately 254,000 water customers. GSWC also distributes electricity in the Big Bear Lake area in California.several California mountain communities serving approximately 23,000 electric customers. The California Public Utilities Commission (“CPUC”) regulates GSWC’s water and electric businesses, including properties, rates, services, facilities and other matters. CCWC is a public utility regulated by thethe Arizona Corporation Commission (“ACC”). serving approximately 13,000 customers in the town of Fountain Hills, Arizona and a portion of the City of Scottsdale, Arizona. ASUS performs water relatedwater-related services and operations on a contract basis. On October 1, 2004, There is no direct regulatory oversight by either the CPUC or the ACC of the operation or rates of the contracted services provided by ASUS and its wholly owned subsidiaries or by AWR.commenced operation ofoperates the water and wastewater systems at Fort Bliss located near El Paso, Texas pursuant to the terms of a 50-year contract with the U.S. Government. FBWS holds a Certificatecertificate of Public Convenienceconvenience and Necessitynecessity from the Texas Commission on Environmental Quality (“TCEQ”). There is no direct regulatory oversight by eitherTUS took over the CPUC or the ACCoperation and maintenance of the water and wastewater systems at Andrews Air Force Base in Maryland on February 1, 2006 and commenced operation or rates of ASUS’s contracted services or AWR.these systems on that date pursuant to the terms of a 50-year contract with the U.S. Government. On December 14, 2005, the Maryland Public Service Commission determined it was in the public interest and consistent with public convenience and necessity to conditionally approve the right of TUS to operate in accordance with the terms and conditions of the contract with the U.S. Government. ODUS assumed the operation and maintenance of the wastewater systems at Fort Lee in Virginia on February 23, 2006 and the water and wastewater systems at Fort Eustis, Fort Monroe and Fort Story in Virginia on April 3, 2006 and commenced operation and maintenance of these systems on those dates pursuant to the terms of 50-year contracts with the U.S. Government. The Virginia State Corporation Commission exercises jurisdiction over ODUS as a public service company.Presentation:Presentation: The consolidated financial statements of AWR include the accounts of AWR and its wholly-owned subsidiaries, GSWC, ASUS (and itsall of which are wholly owned subsidiary, FBWS), and CCWC, andowned. These financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. IntercompanyInter-company transactions and balances have been eliminated in the AWR consolidated financial statements. The consolidated financial statements included herein have been prepared by Registrant, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America for annual financial statements have been condensed or omitted pursuantpursu ant to such rules and regulations. The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments, consisting of normal recurring items and estimates necessary for a fair statement of the results for the interim periods, have been made. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements, and the notes thereto, included in the Form 10-K for the year ended December 31, 20042005 filed with the SEC. Certain prior yearprior-period amounts have beenwere reclassified to conform to current year presentation. None of these reclassifications had an impact on Registrant’s Shareholders’ Equity or Net Income.13the September 30, 2006 financial statement pre sentation.Related-PartyRelated Party Transactions: GSWC and other subsidiaries provide and receive various services to and from their parent, AWR, and among themselves. In addition, AWR has an $85 million syndicated credit facility. AWR borrows under this facility and provides funds to its subsidiaries, including GSWC, in support of itstheir operations. Amounts owed to AWR for borrowings under this facility represent the majority of GSWC’s intercompanyinter-company payables on GSWC’s balance sheets as of September 30, 20052006 and December 31, 2004. Interest is2005. The interest rate charged to GSWC in an amountis sufficient to cover AWR’s interest cost under AWR’s syndicated revolvingthe credit facility. GSWC also allocates certain corporate office administrative and general costs to its affiliates using CPUC approved and/agreed upon allocation factors.allocation factors believedexpected to be reasonable.taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 31, 2006. Registrant will implement the new guidance effective January 1, 2007 and is currently assessing the impact of the Interpretation on its financial statements.–— Regulatory MattersMatters:revenuerevenues associated with certain costs that will be recovered from customers through the rate-makingratemaking process, and regulatory liabilities, which represent probable future reductions in revenuerevenues associated with amounts that are to be credited to customers through the rate-makingratemaking process. At September 30, 2005,2006, Registrant had $27.9$8.9 million of regulatory assets not accruing carrying costs. Of this amount, $21.3$7.3 million relates to the regulatory asset for costs deferred on the Aerojet matter disclosed below as a “non-yielding” regulatory asset. In addition, other regulatory assets not accruing carrying costs include arepresents deferred income tax balance of $4.7 million representingtaxes due to accelerated tax benefits previously flowed-through to ratepayers, which will be included in rates concurrently with recognition of the associated tax expense. Finally, there areIn addition, $1.6 million in deferred charges for rate case applications was recorded as other expensesregulatory assets that Registrant recovers in rates over a short period that do not provideand for which no recovery of carrying costs. At September 30, 2005, $1.9 million was recorded as other regulatory assets for such expenses to be recovered.costs is earned.
2006
200514Accounts:and Memorandum Accounts:$21.3$19.6 million at September 30, 2005. 2006. The balance in the electric supply balancing account is primarily impacted by (i) a surcharge to decrease previously under-collected energy costs; (ii) changes in purchased energy costs; and (iii) changes in power system delivery costs.31,123,83332,049,785 and 32,084,99531,123,833 kilowatt hours of electricity to its Bear Valley Electric division customers for the three months ended September 30, 20052006 and 2004,2005, respectively, and 101,438,647109,125,050 and 102,040,970101,438,647 kilowatt hours for the nine months ended September 30, 20052006 and 2004,2005, respectively. As a result, the supply cost balancing account was reduced by $664,000approximately $710,000 and $685,000$689,000 for the three month periodmonths ended September 30, 20052006 and September 30, 2004,2005, respectively, and $2.1 millionapproximately $2,416,000 and $2.0 million$2,246,000 for the nine month periodmonths ended September 30, 20052006 and September 30, 2004,2005, respectively. Approximately $9.9$14.3 million of the under-collection incurred during the energy crisis in late 2000 and 2001 has been recovered through this surcharge. GSWC anticipates the surcharge, based on electricity sales, to be sufficient for it to recover the amount of the under-collected balance incurred during the energy crisis by August 2011.GSWC records both purchased energy and power system delivery costs in the supply cost balancing account. By terms of the settlement with the CPUC, theThe purchased energy costs that are recorded in the supply cost balancing account are subject to a price cap.cap by terms of the 2001 settlement with the CPUC. The Bear Valley Electric division of GSWC is allowed to include only up to a weighted average annual energy purchase cost of $77 per MWh each yearmegawatt-hour (“MWh”) through August 2011 in its electric supply cost balancing account for purchased energy costs. To the extent that the actual weighted average annual cost for power purchased exceeds the $77 per MWh amount, GSWC will not be able to include these amounts in its balancing account and such amounts will be expensed. During the three months ended September 30,20052006 and 2004,2005, GSWC expensed approximately $6,400$40,400 and $290,400, respectively,$6,400 for costs over $77 per MWh. MWh, respectively.The ability of GSWC to deliver purchased power to customers in its Bear Valley Electric service area is limited by the ability of the transmission facilities owned by Southern California Edison Company (“Edison”) to transmit this power. GSWC filed a lawsuit against Edison in 2000 for breach of contract as a result of delays in upgrading these transmission facilities as well as for other reasons. In March 2004, GSWC and Edison agreed to settle this suit. Under the terms of the settlement agreement, GSWC agreed to pay a $5 million project abandonment fee to Edison. Edison filed an application to the Federal Energy Regulatory Commission ("FERC") for approval to treat the entire $5 million settlement payment as an abandoned project cost to be included in Edison’s wholesale tariff charged to GSWC.GSWC made an initial lump sum payment of $1.4 million to Edison during the first quarter of 2004 and agreed to pay Edison the remaining $3.6 million over a 15 year term through 180 equal monthly payments of $38,137 to be included in Edison’s monthly tariff. The $1.4 million lump sum payment was recorded as a regulatory asset pending FERC approval of Edison’s application. FERC approved Edison’s application in August 2004 and as a result, GSWC transferred the $1.4 million lump sum payment to the electric supply cost balancing account. In addition, monthly payments of $38,137 per month, totaling $114,411 and $76,274 made to Edison duringsummary, for the three months ended September 30, 2006 and 2005, approximately $867,000 and 2004,$355,000 of over-collections, respectively, were recorded in the electric supply cost balancing account, net of amortization of approximately $710,000 and $343,233 and $76,274 made during$689,000, respectively. For the nine months ended September 30, 2006 and 2005, approximately $1.5 million and 2004, respectively, have also been included$1.6 million of over-collections were recorded in the electric supply cost balancing account. Management believes that it is probable thataccount, respectively, net of amortization of approximately $2.4 million and $2.2 million, respectively.CPUC will permit GSWC to recover the rates authorized by and on file with FERC in connection with the Edison settlement; however, management cannot give assurance that the CPUC will ultimately allow recoverybalance of all or any of the these costs that are included in the electric supply cost balancing account.15Memorandum Supply Cost Memorandum/Balancing Accounts -– In a CPUC decision issued on June 19, 2003 related to memorandum supply cost accounts, all water utilities regulated by the CPUC arewere required to seek review of under- and over- collections by filing an advice letter annually. GSWC filed advice letters in 2004annually and 2005 with respect to its cumulative net over-collection for Regions I and II for the period from November 29, 2001 to December 31, 2004, whichutility’s recovery of such expenses has been recorded as a regulatory liability. In June 2005,reduced by the amount exceeding the authorized rate of return. On April 13, 2006, the CPUC approved these advice letters, as filed, fora decision eliminating the 2001, 2002 andearnings test adopted in the June 2003 years and asdecision. The recent decision also eliminated the need to make an annual filing. Pursuant to this order, GSWC recognized a result a $1.4 million over-collection was transferredcumulative under-collection of approximately $636,000 to the supply cost balancing accounts. The advice letters for the 2004 year totaling $4.2 million net over-collection were approved by the CPUC in August of 2005. The $4.2 million net over-collection includes approximately $3.5 million of the net proceeds received from potentially responsible parties in the Charnock Groundwater Basin, which was recorded as a regulatory liability (see “Revenues Subject to Refund” discussed below). The amount was transferred to the supply cost balancing accounts in August 2005. There was no impact to earnings as these over-collections had been recorded as regulatory liabilities in prior years.GSWC also filed advice letters with the CPUC for review of the activity in the Region III memorandum supply cost account for the period from November 29, 2001 to December 31, 2004 totaling a cumulative $4.2 million under-collection. A regulatory asset with respect to this under-collection was not recorded pending receipt of a CPUC decision authorizing the recovery of the under-collection. In June 2005, the CPUC approved the transfer of an approximate $1.3 million under-collection in Region III’s 2004 memorandum supply cost account into the water supply cost balancing account, income of which was recordedprovisions in the second quarter of 2005. The advice letters2006 for the 2001-2003 yearsunder-collected balances not recognized at March 31, 2006 and began recording under- and over- collections on a monthly basis thereafter commencing with the second quarter of 2006. For the three months ended September 30, 2006 and 2005, approximately $645,000 of under-collections and $130,000 of over-collections, respectively, were approved in October 2005. As a result, GSWC will be allowed to recover an under-collection of $2.9 million recorded in the water supply cost memorandum account between November 2001memorandum/balancing accounts, net of amortization of approximately $730,000 and December 2003. This will result in an increase to pre-tax income$75,000, respectively. For the nine months ended September 30, 2006 and 2005, approximately $1.6 million and $670,000 of $2.9 millionunder-collections were recorded in the fourth quartermemorandum/balancing accounts, respectively, net of 2005.amortization of approximately $1.3 million and $367,000, respectively.Recover:Recovery:On October 30, 2003, GSWC, in its Region I abbreviated general rate case, filed for recovery of the cumulative balance of approximately $22 million in its memorandum account. This balance consisted primarily of deferred litigation costs and carrying costs. The filing with the CPUC requested recovery of the balance over a 20-year amortization period.AtBeginning in October 2005, new rates went into effect to begin amortizing the time of the decision,memorandum account over a 20-year period. A rate surcharge generating approximately $15.1 million had been recorded as a non-yielding regulatory asset representing primarily the legal costs incurred$328,000 and $791,000 was billed to date in connection with prosecuting the cases. The difference between the amount filed with the CPUC for recovery in rates and those recorded primarily relate to previously incurred carrying costs for certain capital investments required to restore the water supply. As a result of this decision, GSWC reflected an increase of approximately $6.2 million in its regulatory assets to include previously expensed carrying and other costs and recorded a corresponding pre-tax gain in its results of operationscustomers during the third quarter of 2005. In addition, GSWC was ordered to restore to the appropriate plant accounts those amounts that have been reimbursed by Aerojet pursuant to the settlement. This resulted in GSWC recording an approximate $1.0 million decrease to depreciation expense during the third quarter of 2005.16As a result of the favorable CPUC decision on the Aerojet matter, the following is a summary of the impact to the Statement of Income for the three and nine months ended September 30, 2005:amortized.amortized, but no longer than 20 years. However, no costs will be added to the memorandum account, other than cumulativeon-going interest charges approved by the decision. Pursuant to the decision, additional interest of approximately $279,000 and $1.1 million were added to the Aerojet litigation memorandum account during the three and nine months ended September 30, 2006, respectively.from these actionspursuant to the settlement agreement against the balance in the memorandum account, atwith the timeexception of settlement. See Note 10an $8 million payment guaranteed by Aerojet (for capital investments), with interest due GSWC, to be paid in full over 5 years, beginning in 2009. Pursuant to such settlement agreement, Aerojet has agreed to reimburse GSWC $17.5 million, plus interest accruing from January 1, 2004, for further discussionits past legal and expert costs. The recovery of the $17.5 million is contingentmatter.property in Eastern Sacramento County and the receipt of certain fees in connection with such development. On April 7, 2006, GSWC filed an advice letter with the CPUC to incorporate the Westborough development into the Arden Cordova service area and to provide water service to that new development. The City of Folsom filed a protest of GSWC’s advice letter on April 27, 2006. GSWC cannot predict the outcome of the City’s protest nor the future development within Aerojet’s property.RightRights Lease Revenues:non-operatingnonoperating income account. In a decision issued on March 16, 2004, the CPUC ordered GSWC to refund 70 percent of the total amount of lease revenues received since 1994, plus interest, to customers. Pursuant to the order, GSWC recorded a $6.2 million regulatory liability with a corresponding charge against non-operating income, netrefunds of taxes,approximately $170,000 and $186,000 were provided to customers during the fourth quarter of 2003. A final amount of the refund was approved by the CPUC in June 2004three months ended September 30, 2006 and GSWC adjusted its estimate to the approved refund amount of $5.2 million. Refunds of2005, respectively, and approximately $194,000$426,000 and $455,000 were provided to customers during the three and nine months ended September 30, 2006 and 2005, respectively. The refunds will be made over a 9-year period.Management disagreed with the CPUC’s decision and filed an application for rehearing of that decision. The CPUC denied GSWC’s application for rehearingperiod which commenced in June 2004. GSWC next filed a petition for review with the California Supreme Court to hear the matter, which was denied in February of 2005. Subsequently, GSWC filed a petition for review with the Supreme Court of the United States, asking the Court to direct the California Supreme Court to accept GSWC’s petition for review and to order the CPUC to reverse the underlying decision. The US Supreme court denied the petition for review in October of 2005. With the denial of the petition for review, GSWC has exhausted its appellate process of the original CPUC decision. GSWC is now procedurally situated to institute a new action against the CPUC in federal district court concerning the taking of water rights, which it plans to do in the near future.17may collectcollects commencing in January 2004 willwas to be determined by a later decision. Hearings on this matter have concludedPending that later decision and a decision is expected in either late 2005 or early 2006. Beginningbeginning in the first quarter of 2004, all amounts billed to the City of Folsom arehad been included in a regulatory liability account and no amounts have beenwere recognized as revenue for 2004 and 2005 until all uncertainties about this matter arewere resolved with the CPUC. ForOn April 13, 2006, the CPUC authorized GSWC to reinvest all lease revenues received from the City of Folsom since January, 2004, inclusive of the balances in the regulatory liability accounts, in water system infrastructure and to include such investments in the rate base upon which GSWC earns a rate of return. As a result, GSWC transferred approximately $2.3 million of water rights lease revenues received from the City of Folsom in 2004 and 2005 from the regulatory liability account into other operating revenues in the first quarter of 2006. GSWC also recorded additional other operating revenues of approximately $311,000 and $909,000 reflecting water rights revenues for the three and nine months ended September 30, 2005, GSWC recorded an additional $317,000 and $889,000 in the regulatory liability account,2006, respectively.Revenues Subject to RefundOutside Services Memorandum Account:March 2002, GSWC and the City of Santa Monica (“City”) reached a settlement agreement in which GSWC sold its water rights in the Charnock Groundwater Basin (“Basin”) to the City and assigned to the City its rights against all potentially responsible parties (“PRPs”) who stored, transported and dispensed gasoline containing methyl tertiary butyl ether (“MTBE”) in underground storage tanks, pipelines or other related infrastructure in the Basin. The City also indemnified GSWC from related claims.On July 8, 2004,April 2006, the CPUC approved GSWC’s Region II advice letter which requested recovery of the settlement agreementexpenses recorded in the Outside Services Memorandum Account (“OSMA”), as of December 31, 2005. The decision authorized the recovery of this memorandum account to record costs incurred while working with the Water Replenishment District (“WRD”), WRD Technical Advisory Committee, Central and directedWest Basin Municipal Water Districts, Metropolitan Water District, West Basin Water Association and Central Basin Water Association on water supply reliability and rate-related issues in Region II. GSWC among other things,incurred approximately $374,000 and $345,000 in the OSMA in 2004 and 2005, respectively. GSWC sought and received authorization to refundamortize the cumulative total of approximately $719,000 over a 12-month period through customer rates. Accordingly, GSWC recorded a regulatory asset for this amount in April of 2006 with an offset and reduction to ratepayersoutside legal services recorded in administrative and general expenses during the net proceedssecond quarter of $3.5 million2006. A surcharge went into effect in April of 2006 and accordingly, GSWC began amortizing the OSMA account. Revenues of approximately $200,000 and $304,000 were received from PRPs, which was recorded as a regulatory liability in December 2003 on the basis of a proposed decision by the CPUC. As a result of the approval of the 2004 advice letters for Region’s II memorandum supply cost accounts in August of 2005, which included the $3.5 million received from the PRPs and to be refunded to customers the regulatory liability was transferred to the supply cost balancing accounts. There was no impact to earnings as this refund had been recorded in prior years.CCWC Other Regulatory Assets/LiabilitiesFountain Hills Sanitary District (“FHSD”) is a political subdivision of the State of Arizona that provides sanitary sewer service to customers residing within CCWC’s water service area. In connection with its sanitary system, FHSD constructed a recharge system whereby it recharges treated effluent through multiple aquifer storage and recovery wells. In order for FHSD to secure an Aquifer Protection Permit for its recharge system, FHSD requested CCWC to permanently cease using one of its wells. As a possible replacement for this well, FHSD constructed a new well adjacent to the community center (“Community Center Well”). However, this well was not able to produce an equivalent amount of water to CCWC’s well that was taken out of production. Accordingly, in February 2005, CCWC entered into an agreement with FHSD whereby CCWC agreed to permanently remove from service this well and in return CCWC received a settlement fee of $1,520,000 from FHSD. Pursuant to the agreement, CCWC will: (i) permanently remove from service and cap this well, and cap another well which had never been used as a potable source of supply; (ii) relinquish any legal claim or interest that CCWC may otherwise possess in the Community Center Well; and (iii) grant an option to FHSD to acquire one of the wells at a future date at fair market value. The removal of these two wells from service did not have a significant impact on CCWC’s water supply.For the nine months ended September 30, 2005, CCWC has recognized a net gain of $760,000 related to this settlement agreement and has established a regulatory liability for the remaining $760,000 pending Arizona Corporation Commission’s (“ACC”) review of this matter.Except as discussed above, there were no other significant changes in regulatory assets and liabilities during the three and nine months ended September 30, 2005.2006, respectively, relating to this surcharge. GSWC also booked the amortization for these amounts received to its OSMA memorandum account; therefore, there was no net impact on earnings. The surcharge will be in place for a 12-month period from the effective date.18-— Earnings Per Share / per Share/Capital StockStock:March 2004,accordance with the Emerging Issues Task Force (“EITF”) issued EITF No. 03-06, “Participating Securities and the Two-Class Method under FASB Statement No. 128”. EITF No. 03-06 was effective in, Registrant uses the second quarter“two-class” method of 2004 and provided new accounting guidance for the effect of participating securities oncomputing earnings per share (“EPS”) calculations and the use of the “two-class” method. The new guidance requires the use of the “two-class” method of computing EPS for companies with participating securities.. The “two-class” method is an earnings allocationsallocation formula that determines EPS for each class of common stock and participating security. RegistrantAWR has participating securities related to stock options and restricted stock units that earn dividend equivalents on an equal basis with common shares. Registrant determinedAWR’s Common Shares (the “Common Shares”) that the effect on 2004,have been issued under AWR’s 2000 Stock Incentive Plan and 2003 and 2002 was immaterial.Basic EPS is computed, utilizingNon-Employee Directors Stock Plan. In applying the “two-class” method, by dividingundistributed earnings are allocated to both common shares and participating securities. The following is a reconciliation of Registrant’s net income availableand weighted average Common Shares outstanding for common shareholders by the weighted-average number of common shares outstanding. Netcalculating basic net income available for common shareholders, which exclude earnings available and allocated to participating securities, was $12.1 million and $8.0 million for the three months ended September 30, 2005 and 2004, respectively, and was $21.6 million and $15.9 million for the nine months ended September 30, 2005 and 2004, respectively.per share:
Ended September 30,
Ended September 30, the 2003 Non-Employee Directors Stock Plan, and net income. At September 30, 20052006 and 20042005 there were 686,600603,245 and 498,320686,600 options outstanding, respectively, under these Plans. At September 30, 20052006 and 2004,2005, there were also approximately47,629 and 30,800 and 32,000restricted stock units outstanding, respectively, pursuantrespectively. The following is a reconciliation of Registrant’s net income and weighted average Common Shares outstanding for calculating diluted net income per share:
Ended September 30,
Ended September 30,2003 Non-Employee Directors Stock Plan. Outstandingtreasury stock method of reflecting the dilutive effect of outstanding stock-based compensation in calculation of diluted EPS, 199,818 stock options at September 30, 2006 were deemed to be outstanding in accordance with SFAS No. 128, “Earnings Per Share”. All of the stock options and restricted stock unit awards, including thoseunits at September 30, 2005 were included in the calculation of diluted EPS for the three and nine months ended September 30, 2005.for dividend equivalent rights, issued byif the Registrant representRights are exercised are not included in the only dilutive effect reflected incalculation of diluted weighted average shares outstanding.earnings per share.20052006 and 2004,2005, Registrant issued 16,168 and 9,468 Common Shares, for approximately $602,000 and 20,725 common shares, which totaled approximately $274,000, and $494,000,respectively, under the Registrant’s Common Share Purchase and Dividend Reinvestment Plan (“DRP”), and the 401(k) Plan, respectively.Plan. During the nine months ended September 30, 2006 and and 2004, Registrant issued 45,270 and 30,153 Common Shares, for approximately $1,625,000 and 70,391 common shares, which totaled approximately $830,000, and $1,699,000,respectively, under the Registrant’s Common Share Purchase and Dividend Reinvestment PlanDRP and 401(k) Plan, respectively.Plan. In addition, during the three and nine months ended September 30, 2006, Registrant issued 42,144 and 190,976 Common Shares for approximately $962,000 and $4,383,000, respectively, as a result of the exercise of stock options. No cash proceeds received by AWR as a result of the exercise of these stock options have been distributed to any subsidiaries of AWR.repurchased inpurchased 1,028 and 26,009, respectively, Common Shares on the open market 26,009 and 47,515 common shares, respectively, under the Registrant’s Common Share PurchaseDRP and Dividend Reinvestment Plan, 401(k) Plan, and anniversary stock grant program, which were used to satisfy the stock delivery requirements of these plans.Onplans and programs. During the nine months ended September 22, 2004, AWR also issued 1,400,000 shares in a registered public offering30, 2006 and received proceeds of $33.6 million, net of underwriter fees2005, Registrant purchased 25,849 and other issuance costs of $1.8 million. The proceeds recorded in common shares were reduced by direct issuance costs. On October 12, 2004,47,515, respectively, Common Shares on the underwriters partially exercised an over-allotment optionopen market under the Registrant’s DRP and 401(k) Plan, for an additional 50,000 shares. The Company received proceeds of $1,212,500, which was net of underwriter fees and other issuance costs of $50,500, from the issuance of these shares.same reason.In September 2004, the Board approved the issuance of 10 additional GSWC common shares to AWR for $28.0 million. GSWC used the proceeds to pay down debt owed to AWR. In November 2004, the Board approved the issuance of 2 additional GSWC common shares to AWR for $7.1 million.1920052006 and 2004,2005, AWR paid quarterly dividends to the shareholders, totaling approximately $3.8 million or $0.225 per share and $3.4 million or $0.221 per share, respectively.share. During the nine months ended September 30, 20052006 and 2004,2005, AWR paid quarterly dividends to the shareholders, totaling approximately $11.4 million and $11.3 million, respectively, or $0.675 per share and $10.1 million or $0.663 per share, respectively.share.– Credit FacilityIn June 2005, AWR amended and restated its credit agreement which increased its borrowing limit under this facility to $85 million and extended the maturity date to June 2010. Up to $20 million of this facility may be used for letters of credit. As of September 30, 2005, an aggregate of $55 million in cash borrowings are included in current liabilities and approximately $11.2 million of letters of credit were outstanding under this facility.Note 5 –— Derivative InstrumentsInstruments:entered intobecame a party to block-forward purchase power purchase contracts that qualified as derivative instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS Nos. 138 and 139.133. Contracts with Pinnacle West Capital Corporation (“PWCC”) which became effective in November 2002 and dohave not qualify for designationbeen designated as normal purchases and normal sales. As a result, GSWC has recognized these contracts at fair market value on its balance sheets resulting in a cumulative unrealized gain of $5.5 million as of September 30, 2005. This also resulted in a pre-tax unrealized gain of $4,018,000 and a pre-tax unrealized loss of $224,000 for the three months ended September 30, 2005 and 2004, respectively, and a pre-tax unrealized gain of $7,492,000 and $257,000 for the nine months ended September 30, 2005 and 2004, respectively, due to increases in energy prices. On a monthly basis, the related asset or liability is adjusted to reflect the fair market value at the end of the month. For the three months ended September 30, 2006 and 2005, GSWC recognized a pretax unrealized loss of approximately $2.8 million and a pretax unrealized gain of approximately $4.0 million, respectively. For the nine months ended September 30, 2006 and 2005, GSWC recognized a pretax unrealized loss of approximately $5.9 million and a pretax unrealized gain of approximately $7.5 million, respectively. As this contract moves forward in time and is settled, the realized gains or losses are recorded in power purchased for resale, and the unrealized gains or losses are reversed. These contracts have been recognized at fair market value on the balance sheets resulting in a cumulative unrealized loss of approximately $2.5 million as of September 30, 2006 since the inception of the contracts.SettlementMonthly, settlement of this contract occurs on a cash or net basis through 2006 and by physical delivery through 2008. Registrant has no other derivative financial instruments.206 – Income Taxes5 — Taxes:increasedecrease or decreaseincrease occurring in another period. Giving effect to these temporary differences as flow-through adjustments typically results in a greater variance between the effective tax rate (“ETR”) and the statutory federal income tax rate in any given period than would otherwise exist if GSWC were not required to account for its income taxes as a regulated enterprise. During the second quarter of 2005, the recognition of the federal benefiteffect of state taxes was adjusted to conform to the flow-through method reflected in the tax calculation for ratemaking purposes, which partially defers the recognition of the benefiteffect to the subsequent tax year. This resultedincreased income tax expense by approximately $33,000 for the three months ended September 30, 2006 and decreased income tax expense by approximately $171,000 for the nine months ended September 30, 2006. During the third quarter of 2005, AWR filed an amended tax return for 2001 with the Internal Revenue Service (“IRS”) which was subject to IRS and Congressional Joint Committee of Taxation (“JCT”) review. During the second quarter of 2006, the IRS and JCTtaxes of $801,000 and $1,190,000earnings per share for the three and nine months ended September 30, 2005 respectively.In October 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law and provides a new federal income tax deduction from qualified U.S. production activities, which is being phased in from 2005 through 2010. Under the Act, qualified production activities include Registrant’s production of electricity and potable water. In December 2004, the FASB issued FASB Staff Position No. 109-1 and proposed that the deduction should be accounted for as a “special deduction” in accordance with SFAS No. 109. As such, the special deduction had no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of the deduction is to be reported in the period in which the deduction is claimed on Registrant’s tax return. During the first quarter of fiscal 2005, Registrant completed its initial evaluation of the provisions of the Act. The amount of the benefit for the three and nine months ended September 30, 2005 was not material.Note 7 – Stock Incentive PlansRegistrant applies Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”, in accounting for its stock options under its 2000 Stock Incentive Plan. Accordingly, no compensation cost for the Plan has been recognized for options granted at fair value at the date of grant. Registrant has also adopted the disclosure only requirements of SFAS No. 123, “Accounting for Stock-Based Compensation”.At the May 2004 Annual Meeting, the shareholders adopted the 2003 Non-Employee Directors Stock Plan (“New Directors Plan”). The New Directors Plan provides the non-employee directors with supplemental stock-based compensation. Pursuant to the New Directors Plan, directors are entitled to receive stock options and stock unit awards. As of September 30, 2005, an aggregate of 27,000 stock options have been granted to the directors under the New Director’s Plan. Registrant also applies APB No. 25 in accounting for the director’s stock options. The director’s stock options were granted at fair value at the date of grant; therefore no compensation cost has been recognized for these options. The stock units are a non-voting unit of measurement which is deemed for bookkeeping and payment purposes to represent outstanding AWR common shares. Upon adoption of the New Directors Plan in May 2004, Registrant began recording compensation expense on the stock unit awards. As of September 30, 2005, the directors have been credited with approximately 30,800 stock units. Stock units will be paid only in AWR common shares on the date that the participant terminates service as a director.21If Registrant had elected to adopt the optional recognition provisions of SFAS No. 123 for its stock options and stock units under the 2000 Stock Incentive Plan and the New Directors Plan, net income and earnings per share would have been changed to the pro forma amounts indicated below:
Ended
September 30,
2005
Ended
September 30,
200522There were no material differences between the consolidated 2005 pro forma disclosures for AWR and the 2005 pro forma disclosures for GSWC.
Options
Average
Exercise Price
Remaining
Contractual Term
Intrinsic Value
Restricted Share
Units
Grant-Date Value8 –7 — Employee Benefit PlansPlans:other postretirement (medical)benefits plan, and Supplemental Executive Retirement Plan (“SERP”) for the three and nine months ended September 30, 20052006 and 20042005 are as follows:
Postretirement
Benefits
Postretirement
Benefits
Postretirement
BenefitsA decrease in the discount rate from 6.25% to 5.75%, and the update of mortality rate tables resulted in increases in pension and other postretirement benefits in 2005.
Benefits
Postretirement
Benefits$4,338,000approximately $4,414,000 to the pension plan during the third quarter of 2005.2006. Registrant expects to contribute $754,000approximately $795,000 to the postretirement benefit plan by the end of 2005.2006.9 - New Accounting PronouncementsIn March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations,” which clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated even though uncertainty exists about the timing and (or) method of settlement. Registrant is required to adopt Interpretation No. 47 by the end of 2006. Registrant is currently evaluating the impact Interpretation No. 47 will have on its results of operations and financial condition. However, since Registrant follows accounting principles for rate-regulated enterprises and receives recovery of these costs through rates, implementation of this interpretation at GSWC is not expected to affect earnings.23In December 2004, the FASB issued a revision to SFAS No. 123, “Share-Based Payment,” (“SFAS No. 123R”) which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”). SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on fair values. The pro forma disclosures previously permitted under SFAS No. 123 no longer will be an alternative to financial statement recognition. In April 2005, the Securities and Exchange Commission deferred the adoption date of SFAS No. 123R to the beginning of the fiscal year that begins after June 15, 2005, (January 1, 2006 for calendar year companies) from a July 1, 2005 adoption date previously set by the FASB. Registrant expects to adopt this standard on January 1, 2006. Based on stock option grants made in 2005 and currently anticipated for 2006, Registrant estimates it will (assuming the modified prospective method is used) recognize expense for stock options for the year ending December 31, 2006 in an amount consistent with that disclosed in Note 7 which summarizes the pro forma impact of recognizing stock expense under the fair value accounting method. Registrant assumes that stock options will be granted in 2006 upon similar terms to options granted in 2005, which provide for continued vesting of the options following termination of employment, unless the grantee is terminated for cause. If these assumptions change, the impact of recognizing stock expense under the fair value accounting method will differ from amounts disclosed in Note 7.In October 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law and provides a new federal income tax deduction from qualified U.S. production activities, which will be phased in from 2005 through 2010. During the first quarter of fiscal 2005, Registrant completed its initial evaluation of the provisions of the Act. See Note 6 for further information.Note 10 – Contingencies8 — Contingencies:the Trial JudgeGSWC was dismissed GSWC from all nineteen Los Angeles County cases. The order was issued by the Trial Judge presiding over these matters, and followed a lengthy legal proceeding dating back to April 1997 when the first of the cases was filed by over 140 customers in the San Gabriel Valley, alleging their water had caused personal injuries of varying types and degrees. The Court found GSWC did not violate established water quality standards and dismissed the cases after allowing reasonable time and opportunity for the plaintiffs to prove otherwise. GSWC has long asserted that it meets or exceeds the requirements to provideprovides water within the standards established by the health authorities. On September 21, 2004, GSWC received notice that several plaintiffs filed an appeal to the trial court’s order to dismiss GSWC. Briefs and reply briefs on the appeal have been filed; however, no date for a hearing beforefiled. On February 7, 2006, the Second Appellate District in which the briefs were filed moved the California Supreme Court to transfer the appeal to the First Appellate District, the District in which prior appeals court hasregarding these cases had been set yet.heard. GSWC is unable to predict the outcome of this appeal. GSWC was also dismissed from three similar lawsuits in Northern California in 2004; the plaintiffs in those cases have not filed an appeal.24recovery, to comply with certain contamination remediation requirements for future recovery.AerojetOn October 25, 1999, GSWC sued Aerojet for contaminating eastern portions of the Sacramento County groundwater basin. On October 12, 2004, Registrant reached a final settlement with Aerojet. Under the terms of the settlement, Aerojet paid GSWC $8.7 million in the first quarter of 2004. Aerojet has also agreed to pay GSWC an additional $8 million, plus interest accruing beginning January 1, 2004, over a five year period beginning in December 2009. The $8.7 million payment and the $8 million receivable have been applied directly to reduce GSWC’s costs of utility plant and purchased water by $16 million and $735,000, respectively. Prior to the settlement, Aerojet had reimbursed GSWC $4.3 million in capital costs and $171,000 for additional water supply costs.Aerojet has also agreed to reimburse GSWC $17.5 million, plus interest accruing from January 1, 2004, for its past legal and expert costs. The recovery of the $17.5 million is contingent upon the issuance of land use approvals for development in a defined area within Aerojet property in Eastern Sacramento County and the receipt of certain fees in connection with such development.Aerojet has transferred its remediated groundwater to the Sacramento County Water Agency, which will provide treated water for distribution to GSWC and other water purveyors affected by the contamination. GSWC has entered into an agreement with Sacramento County Water Agency to receive water. Aerojet has also paid for certain transmission pipelines and upgrades to GSWC’s Coloma Treatment Plant as a contingency plan, should additional wells be impacted. The pipelines are now in service and the upgraded treatment facilities are expected to be fully operational by the end of 2005.Other Water Quality Litigationdefendant’spotentially responsible party’s motions.the Registrant,GSWC, by virtue of their ownership of wells contaminated with hazardous chemicals are themselves PRPs under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”).25(1)(i) that the owner of the utility property may contest whether the condemnation is actually necessary and in the public interest; and (2)(ii) that the owner is entitled to receive the fair market value of its property if the property is ultimately taken.SuchThe value was determinedestimated in 2004 by the consultant at $40 - $45 million. GSWC disagrees with the City’s valuation assessment. Under California law, the condemning City would be required to pay fair market value for the water system. As of September 30, 2005,2006, management believes that the fair market value of the system far exceeds the $33$37.0 million recorded net book value and also exceeds the consultant’s estimates of the Claremont water system.ClaremontApple Valley water system.systems. However, on April 12, 2005, the Town Council of the Town of Apple Valley voted 5-0 to authorize Town staff to prepare a Request for Proposal for an evaluation of the feasibility and potential cost of and a timeframe for the potential takeover of GSWC’s Apple Valley water systems as well as the water systems of another utility serving the Town. On August 23, 2005, the Town Council authorized staff to hire a firm to perform a feasibility study and financial analysis regarding the potential takeover. It is presently unknown when the results of the study will be presented to the Town.26GSWC has not received any formal notice from the Town of its intention to condemn the Registrant’s Apple Valley water systems. Management is unable to predict what the results of the Town’s evaluation might be and what action, if any, the Town might take as a result of the evaluation. However, GSWC will vigorously defend itself should the Town determine to proceed towards condemning its Apple Valley water systems. As of September 30, 2005, management believes that the fair value market of the system far exceeds the recorded net book value of the Apple Valley water systems.As of September 30, 2005, GSWC has incurred costs in defending its rights in the Basin, including legal and expert witness fees, which have been deferred in Utility Plant for rate recovery. Management believes that the recovery of these costs through rates is probable. However, management cannot give assurance that the CPUC will ultimately allow recovery of all or any A settlement of the costs that have been incurred by GSWC in this lawsuit. A settlementlawsuit has been reached, subject to CPUC approval. The settlement, among other things, if approved, would preserve GSWC’s historical pumping rights and secure supplemental water rights for use in case of drought or other reductions in the natural yield of the Basin. There are also a small number of nonsettling parties, and the case is going forward as to these parties. The stipulation, if approved, would preserve GSWC’s position with the settling parties independent of the outcome of the case as it moves forward with the nonsettling parties. GSWC cannot predict the outcome of the case as to the nonsettling parties.2711 -9 — Business SegmentsSegments:distribution units,service utility operations conducted through its GSWC, subsidiary, a water-service utility operation conducted through its CCWC, unit, and a contracted services unit through the ASUS subsidiary.and its subsidiaries. All activities of GSWC are geographically located within California. All activities of CCWC are located in the state of Arizona. All activities of ASUS have beenare conducted in Arizona, California, ArizonaMaryland, New Mexico, Texas and Texas for the periods set forth below.Virginia. Both GSWC and CCWC are regulated utilities. On a stand-alone basis, AWR has no material assets other than its investments in its subsidiaries. The tables below set forth information relating to GSWC’s operating segments, CCWC and other matters which includes ASUS and its subsidiaries. Included in the amounts set forth, certainCertain assets, revenues and expenses have been allocated.allocated in the amounts set forth. The identifiable assets are net of respective accumulated provisions for depreciation. Capital additions reflect capital expenditures paid in cash and exclude property installed by developers and conveyed to the Company.GSWC or CCWC.(1) *Includes $4,018,000amounts from AWR and $7,492,000ASUS and its subsidiaries’ contracted operations (including FBWS, ODUS and TUS for the three months ended September 30, 2006 and FBWS for the three months ended September 30, 2005.)gainloss (gain) on purchased power contracts for the three months ended September 30, 2006 and 2005, respectively.respectively.28*Includes amounts from AWR and ASUS’s contracted services. Beginning on October 1, 2004, it also includes ASUS’s wholly-owned subsidiary FBWS.Note 12 - Subsequent EventsAs discussed in Note 2, on October 6, 2005, the CPUC approved an advice letter allowing GSWC to impose temporary surcharges in its Region III water service area to recover an under-collection of $2.9 million recorded in the supply cost memorandum account between November 2001 and December 2003. The surcharges went into effect on October 11, 2005 and are expected to recover the $2.9 million over a twelve month period. This will result in an increase to pre-tax income of $2.9 million in the fourth quarter of 2005.On October 11, 2005, CoBank, ACB (“CoBank”), purchased a 5.87% Senior Note due December 20, 2028 (the “Note”) in the aggregate principal amount of $40,000,000 from GSWC pursuant to the terms of a Note Purchase Agreement (the “Agreement”) dated as of October 11, 2005 between GSWC and CoBank. The Agreement contains customary events of default, including failure to pay any debt with an aggregate principal amount of more than $2.5 million for a period or more than 60 days from the date due, whether at stated maturity or upon acceleration, and failure to pay a final judgment of more than $2.5 million within 60 days after entry, unless bonded, discharged or stayed pending appeal or payment over time is permitted by the order of a governmental agency or by agreement of the parties. The proceeds were used to pay down GSWC’s intercompany short-term borrowings.This Agreement contains restrictions on (i) incurring liens and entering into sale and leaseback transactions, with customary exceptions, (ii) dispositions of property with a book value of more than 15% of total capitalization (as defined) in any fiscal year, unless the proceeds are used within one year to purchase public utility property or redeem all or a portion of the amount borrowed from CoBank or other debt ranking pari passu with the debt owed to CoBank, (iii) merging or consolidating with any other person, unless GSWC is the survivor or the survivor is principally engaged in the business of a water or wastewater public utility and the financial covenants described below are satisfied on a pro forma basis at the end of the quarter immediately preceding the merger or consolidation, after giving effect to the transaction, (iv) incurring any indebtedness if, as a result an event of default would occur or the total indebtedness to EBITDA ratio ( as defined)$76,000 of GSWC atother operating revenues.end of the quarter preceding the transaction would exceed 8 to 1 or the total indebtedness to capitalization ratio (as defined) would exceed .6667 to 1, or (v) declaring or paying any dividends in cash or property if at the time of the distribution or payment, an event of default would occur or, if after giving effect to the distribution, the total indebtedness to capital ratio (as defined) of GSWC would be more than .6667 to 1.nine months ended September 30, 2006 and 2005, respectively.OperationOperationsForward-Looking InformationCertain matters discussed in this report (including the documents incorporated herein by reference) are forward-looking statements intended to qualify for the “safe harbor” from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as Registrant “believes,” “anticipates,” “expects” or words of similar import. Similarly, statements that describe Registrant’s future plans, objectives, estimates or goals are also forward-looking statements. Such statements address future events and conditions concerning capital expenditures, earnings, litigation, rates, water quality and other regulatory matters, adequacy of water supplies, GSWC’s ability to recover electric, natural gas and water supply costs from ratepayers, contract operations, liquidity and capital resources, and accounting matters. Actual results in each case could differ materially from those currently anticipated in such statements, by reason of factors such as changes in utility regulation, including ongoing local, state and federal activities; recovery of regulatory assets not yet included in rates; future economic conditions, including changes in customer demand and changes in water and energy supply costs; future climatic conditions; and legislative, legal proceedings, regulatory and other circumstances affecting anticipated revenues and costs.The following discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes thereto and the consolidated financial statements and the notes thereto contained in our 2004 Annual Report on Form 10-K.General
(andand its subsidiary,subsidiaries, Fort Bliss Water Services Company (“FBWS”)), Terrapin Utility Services, Inc. (“TUS”) and Chaparral City Water CompanyOld Dominion Utility Services, Inc. (“CCWC”ODUS”). AWR was incorporated as a California corporation in 1998 as a holding company for GSWC.its subsidiaries.252,802254,063 water customers and 22,90423,177 electric customers at September 30, 2005,2006, or a total of 275,706277,240 customers, compared with 274,041275,706 total customers at September 30, 2004.2005. GSWC’s utility operations exhibit seasonal trends. Due to changes in weather, water revenues are higher during the summer months and lower during the cooler months of each year. Although GSWC’s water utility operations have a diversified customer base, residential and commercial customers account for the majority of GSWC’s water sales and revenues. Revenues derived from commercial and residential water customers accounted for approximately 90.2% and 88.8%89.6% of total water revenues for the three months ended September 30, 2006, as compared to 90.2% for the three months ended September 30, 2005. Revenues derived from commercial and residential water customers accounted for approximately 88.5% of total water revenues for the nine months ended September 30, 2005, respectively, 2006, as compared to 87.4% and 88.5%88.8% for the three and nine months ended September 30, 2004, respectively.2005.12,95913,294 customers as of September 30, 2005,2006, compared with 12,48512,959 customers at September 30, 2004.2005. Located in the town of Fountain Hills, Arizona and a portion of the City of Scottsdale, Arizona, the majority of CCWC’s customers are residential. The Arizona Corporation Commission (“ACC”) regulates CCWC.50-year50 year contract with the U.S. Government.30is also an active participant in bidding on other contracts for the privatizationcommenced operation and maintenance of military bases. ASUS entered into agreements to operate and maintain the water and wastewater systems at Andrews Air Force Base in Maryland dated September 30, 2005,on February 1, 2006 through TUS pursuant to the terms of a 50 year contract. ASUS commenced operation and Fort Story, Fort Eustis, Fort Monroe andmaintenance of the wastewater systemsystems at Fort Lee in Virginia dated September 28, 2005. Underthrough ODUS on February 23, 2006 pursuant to the terms of these agreements,a 50 year contract. ASUS also commenced operation of the aggregate amountwater and wastewater systems at Fort Eustis, Fort Story and Fort Monroe in Virginia through ODUS on April 3, 2006 pursuant to the terms of a 50 year contract. These contracts are each subject to termination for convenience by the U.S. Government. The contract price for each of these contracts is estimated at more than $238 millionsubject to re-determination two years after commencement of operations and every three years thereafter to the extent provided in each of the contracts. Prices are also subject to equitable adjustment based upon changes in circumstances and changes in wages and fringe benefits to the extent provided in each of the contracts.50-year10-year period. Natomas will pay to ASUS a commission of 16% of the sale price over the same 10-year period under an existing agreement between the two companies. At the same time that the water purchase agreement was completed, Natomas and ASUS also entered into a settlement agreement that released Natomas from previously established reimbursement obligations under existing agreements. ASUS may use this 5,000 acre-feet of water rights acquired from Natomas to engage in transactional opportunities with developers or water purveyors.periodic price re-determination adjustmentscompletion of an environmental assessment. In addition, both agreements are subject to and modificationsbecome effective upon various regulatory approvals.changesrecovering, the costs of water and electricity in circumstances. Terrapin Utility Services, Inc. (“TUS”)rates; weather; the impact of increased water quality standards on the cost of operations and capital expenditures; pressures on water supply caused by population growth, more stringent water quality standards, deterioration in Marylandwater quality and Old Dominion Utility Services, Inc. (“ODUS”) in Virginia, wholly-owned subsidiarieswater supply from a variety of ASUS, will furnish all necessary labor, management, supervision, permits, equipment, supplies, materials, transportationcauses; capital expenditures needed to upgrade water systems and any other incidentalsincreased costs and risks associated with litigation relating to water quality and water supply, including suits initiated by Registrant to protect its water supply.complete operation, maintenance, repair, upgradessame period in 2005, a decrease of 54.4%. Basic and improvementsdiluted earnings per share for the third quarter of 2006 were $0.32 when compared to the utility systems following$0.72 for the expirationthird quarter of a 90-day transition period. TUS will also undertake certain capital projects at Andrews Air Force Base2005. Two factors contributed to the significant decrease in net income: first there was the favorable CPUC decision on July 21, 2005 regarding the Aerojet matter which added about $4.3 million to net income in July 2005 or approximately $0.25 per share with no similar gain in 2006; and second, due to decreasing energy prices, the pretax unrealized loss on purchased power contracts of $2.8 million decreased net income by $0.10 per share during the 90-day transition period. FBWS, TUSthird quarter of 2006 in contrast to a pretax unrealized gain of $4.0 million which increased net income by $0.14 per share for the same period of 2005. Offsetting these decreases were higher revenues due to increases in customer rates and ODUS are referred to herein as the “Military Utility Privatization Subsidiaries”.consumption, partially offset by higher operating expenses.31For the nine months ended September 30, 2006, net income was $17.7 million compared to $21.7 million for the same period in 2005, a decrease of 18.4%. Basic and diluted earnings per share for the nine months ended September 30, 2006 were $1.03, compared to $1.29 for the same period of 2005. Similar to the quarterly results, the decrease in earnings per share was primarily due to decreasing energy prices which resulted in a pretax unrealized loss on purchased power contracts of $5.9 million or a $0.21 per share decrease to net income during the third quarter of 2006, in contrast to a pretax unrealized gain of $7.5 million which increased net income by $0.26 per share for the same period of 2005. In addition, there was the favorable CPUC decision on July 21, 2005 regarding the Aerojet matter which added about $4.3 million to net income in July 2005 or approximately $0.25 per share. Offsetting these 2006 decreases was another favorable decision issued by the CPUC in April 2006 regarding GSWC’s water rights lease revenues received from the City of Folsom, increased rates approved by the CPUC and ACC, and an increase in water consumption over the prior period, partially offset by higher operating expenses.–— Three Months Ended September 30, 20052006 and 20042005 (dollars in thousands)thousand)
ENDED
9/30/2006
ENDED
9/30/2005
CHANGE
CHANGEthree monthsthird quarter ended September 30, 2005 increased2006 decreased by 52.6%54.4% to $12.2$5.6 million, equivalent to $0.72$0.32 per common share on both a basic and fully diluted basis, compared to $8.0$12.2 million or $0.52$0.72 per common share on a basic and fully diluted basis for the three months ended September 30, 2004. Impacting2005. Significantly impacting the comparability in the results of the two periods are the following significanttwo items:•· A favorable decision issued by the CPUC on July 21, 2005 regarding the Aerojet memorandum account which added about $4.3 million to net income in July 2005 or approximately $0.25 per share. GSWC was authorized to collect the balance of the Aerojet litigation memorandum account of approximately $21.3 million, through a rate surcharge, which will continue for no longer than 20 years. As a result of this decision, in July 2005 GSWC recorded an increase of approximately $6.2 million to the Aerojet regulatory asset to include previously expensed carrying and other costs, and recorded a corresponding pre-tax gain. In addition, GSWC was ordered to restore to the appropriate plant accounts, those amounts that have been reimbursed by Aerojet pursuant to the settlement. This resulted in GSWC recording an approximate $1.0 million decrease to depreciation expense during the third quarter of 2005. There were no similar entries during the third quarter of 2006. The following is a summary of the impact on the results of operations for the three months ended September 30, 2005 resulting from this decision:32•· A significant increaseThere was a pretax unrealized loss on purchased power contracts in the2006 due to decreasing energy prices versus a pretax unrealized gain on purchased power contracts due to an increase in forward energy prices. This2005. The cumulative unrealized gain addedloss on purchased power contracts decreased pretax income by approximately $0.14$2.8 million, or $0.10 per share, tofor the three months ended September 30, 2005,2006, as compared to thea cumulative unrealized loss of $0.01gain on purchased power contracts that increased pretax income by $4.0 million, or $0.14 per share, for the same period of 2004.in 2005.• The increases were partially offset by approximately $0.08Eliminating the effects of the two items discussed above, basic and diluted earnings per share due to retroactive revenues recorded infor the third quarter of 20042006 would have actually increased by $0.09 per share as discussed below. There were no retroactive revenues recorded incompared to the same period of 2005.• A 2.7% decrease inlast year, resulting primarily from higher water revenues due to increased customer rates and consumption impacted revenues negativelydue to warmer weather conditions, offset partially by approximately $1.1 million (or approximately $0.03 per share impact)higher operating expenses, as further discussed below.• A higher effective tax rate reduced earnings by $0.07 per share resulting from differences between book and taxable income that are treated as flow-through adjustments in accordance with regulatory requirements.Registrant relies upon rate approval by state regulatory agencies in California and Arizona, in order to recover operating expenses and provide for a return on invested and borrowed capital used to fund utility plant. Without such adequate rate relief granted in a timely manner, revenues and earnings can be negatively impacted.2005,2006, revenues from water utility operations decreasedincreased by 3.1%7.3% to $60.5$65.0 million, compared to $62.5$60.5 million for the three months ended September 30, 2004. The decrease primarily reflects: (i) a favorable CPUC decision resulting2005. An increase of 1.5% in the recording of approximately $2.0 million in August 2004 related to additional revenues associated with the Region II rate increase approved by the CPUC in August 2004 that were retroactive to February 14, 2004, pursuant to new legislation effective January 1, 2004; there were no corresponding retroactive revenues recorded in 2005, and (ii) decreases inbilled water consumption of approximately 2.7% due toresulting from changes in weather conditions. These decreases were partially offsetconditions increased revenues by approximately $524,000. In addition, higher water revenues reflecting rate increases in water ratessince the third quarter of 2005 covering almost all water customers contributed $3.6 million in increased revenues for the third quarter of GSWC’s water33customers. 2006. Differences in temperature and rainfall in Registrant’s service areas impact sales of water to customers, causing fluctuations in Registrant’s revenues and earnings between comparable periods.2005,2006, revenues from electric operations increaseddecreased by 5.4%1.5% to $6.5$6.4 million compared to $6.2$6.5 million for the three months ended September 30, 2004.2005. The decrease primarilyreflects primarilyin kilowatt-hour (“KWh”) usage, due to changes in weather conditions. During the third quarter of 2006, the Big Bear area experienced a rate increase effective on April 15, 2005 relatedheat wave. Temperatures ran above normal and residential customers used more power for fans and central air, as well as the commercial customers which required more power for air cooling and freezers compared to the 8.4 MW natural gas-fueled generation facility. This newthird quarter of 2005is expectedapprovals by state regulatory agencies in California and Arizona, in order to increase annualrecover operating expenses and provide for a fair return on invested and borrowed capital used to fund utility plant. Without adequate rate relief granted in a timely manner, revenues by approximately $2.7 million. and earnings can be negatively impacted.2005, the rate increase was partially offset2006, other operating revenues increased by a 3% decrease in kilowatt-hour consumption.For131.6% to $2.3 million compared to $1.0 million for the three months ended September 30, 2005 other operating revenues increased by 231.5% to $988,000 compared to $298,000 for the three months ended September 30, 2004 due primarily to approximately $543,000$954,000 of additional revenues associated with the operation ofgenerated by ASUS from operating the water and wastewater systems pursuant to new contracts at Fort Bliss, located near El Paso, Texasmilitary bases. In addition, revenues increased due to a decision issued by the CPUC on April 13, 2006 enabling GSWC to record water rights lease revenues from the City of Folsom subsequent to January 2004, as income. Prior to this decision, the apportionment of any lease revenues that commenced on October 1, 2004.GSWC collected in 2004 and 2005 had been included in a regulatory liability account and no amounts were recognized as revenues until uncertainties about this matter were resolved. For the third quarter 2006, Registrant recorded additional water lease revenues of $311,000.2005,2006, purchased water costs increaseddecreased by 2.9%4.5% to $15.8$15.1 million compared to $15.3$15.8 million for the three months ended September 30, 20042005. The decrease is due primarily to supplier rate increases. In addition, 49.8%a favorable change in the supply mix caused by less purchased water needed to replace contaminated groundwater supply or wells temporarily out of service in 2005. For the Company’sthree months ended September 30, 2006, 46.3% of Registrant’s supply mix was purchased water for the third quarter of 2005 as compared to 48.9%49.8% purchased water for the three months ended September 30, 2005. During the same period last year, there were additional purchases of 2004. These increases were partially offset by a decline in customer demandwater needed to replace contaminated groundwater supply lost due to wells being removed from service resulting from lower consumption.water quality issues and mechanical problems, particularly in GSWC’s Foothill district. The cost of purchased water in this district decreased by approximately $616,000 for the three months ended September 30, 2006 when compared to the three months ended September 30, 2005 as a result of certain wells being returned to operation in 2006.2005,2006, the cost of power purchased for pumping increased by 9.5%10.7% to $3.3$3.6 million compared to $3.0$3.3 million for the three months ended September 30, 20042005 due to rate increases from suppliers, offsetan increase in KWh usage by a decrease in water consumption.Registrant caused by higher pumping volume due to the favorable supply mix change discussed above.2005,2006, groundwater production assessments increased by 9.2%7.0% to $2.5 million as compared to $2.3 million for the three months ended September 30, 20042005 due to increases in well production resulting from the supply mix change and increased consumption. There were also increases in assessment rates levied against groundwater production, effective July 2005.2006. Average pump tax rates increased in GSWC’s Regions II and III by approximately 5%2% and 22%4%, respectively. The increases were offset by a decrease in well production due to decreased consumption.time of filing of the applications.time. However, without additional regulatory mechanisms, it is impossiblenot possible to adequatelywholly protect earnings from adverse changes in supply costs related to unforeseen contamination or other loss of water supply.2005,2006, cost of power purchased for resale to customers in GSWC’s Bear Valley Electric division decreased by 1.0% as13.5% to $2.7 million compared to $3.1 million for the three months ended September 30, 20042005, reflecting lower costs of energy in the third quarter of 2006 as compared to the same period of 2005 in the spot market. The third quarter of 2005 was characterized by high energy costs due primarily to athe effects of hurricanes and uncertainty in the energy markets. The same period in 2006, with no significant hurricane activity, saw spot market costs decline from 2005 levels. This decrease in kilowatt-hour usage.to the cost of power purchased for resale was offset partially by higher customer demand during the third quarter of 2006.gain and loss (gain) on purchased power contracts represents gainslosses and lossesgains recorded for GSWC’s purchased power agreements with Pinnacle West Capital Corporation (“PWCC”), which qualify as derivative instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. The $4,018,000$2.8 million pretax unrealized loss on purchased power contracts for the three months ended September 30, 2006 is due to a decrease in the current forward market prices since June 30, 2006. There was a $4.0 million pretax unrealized gain on purchased power contracts for the three months ended September 30, 2005 is due to an increase in current forward market prices since June 30, 2005. As of September 30, 2005, GSWC has recorded a cumulative unrealized gain of $5.5 million on its balance34sheet. Unrealized gains and losses at the Bear Valley Electric division of GSWC will continue to impact earnings during the life of the contract with PWCC, which terminates in 2008.$502,000$270,000 during the three months ended September 30, 20052006 in the provision for supply cost balancing accounts as compared to the three months ended September 30, 20042005 was primarily reflects: (i)due to the recording in 2006 of a decrease of $375,000 in amortization primarily$1.4 million under-collection related to pre-November 2001the 2006 year-to-date supply cost memorandum account resulting from the elimination of the earnings test. This change was authorized by the CPUC in April 2006. This decrease was offset by: (i) an increase of $654,000 in the third quarter of 2006 related to the amortization of the water supply cost balancing accounts approved by the CPUC in August and the electric balancing account,September of 2005, and (ii) a decreasenet increase of $107,000$504,000 in the electric supply cost balancing account due to aresulting from the lower amount being written off over the $77 per MWh recovery cap authorized by the CPUC.offset cost of power.2005,2006, other operating expenses increased slightly by 0.7%37.7% to $4.9$6.7 million compared to $4.8$4.9 million for the three months ended September 30, 20042005 due primarily to: (i) higher labor costs in 2005 which increased by approximately $113,000 at GSWC; (ii) higher operating expenses of $143,000$519,000 at ASUSODUS and TUS due to the commencement of the operations of the water and wastewater system at Fort Bliss; (iii) higher chemicalsystems pursuant to new military contracts in Maryland and water treatment costs which increased by approximately $127,000, and (iv) a net increase of approximately $90,000Virginia in various other operating expenses. These increases were offset by early 2006; (ii) a $459,000 downward adjustment in July of 2005 reflecting the approval from the CPUC of recovery of previously incurred operating expenses in the Aerojet memorandum account.matter, previously discussed; (iii) higher chemicals and water treatment costs of $266,000 at GSWC; (iv) higher labor costs as a result of higher wages which increased by approximately $164,000 at GSWC; (v) an increase of $226,000 in bad debt expense at GSWC relating to miscellaneous accounts receivable balances, and (vi) a net increase of $193,000 in various other miscellaneous operating expenses.2005,2006, administrative and general expenses decreasedincreased by 4.9%22.0% to $10.1$12.6 million compared to $10.6$10.3 million for the three months ended September 30, 2004. The decrease was2005 due to: (i) loweradministrative and general expenses of $446,000 at ODUS and TUS due to the commencement of the operations of the water and wastewater systems pursuant to new military contracts in Maryland and Virginia; (ii) an increase of approximately $683,000 in various employee benefit costs including stock-based compensation expense of $102,000 due to the adoption of SFAS No. 123(R) effective January 1, 2006; (iii) an increase of $994,000 in outside services relating primarily to tax and legal services at GSWC, and (iv) higher labor costs as a result of higher wages which increased by approximately $646,000 in connection with new business development and other matters, and (ii) net decreases in various other miscellaneous expenses totaling $440,000. These decreases were offset by an approximate $300,000 increase in pensions and benefits caused by actuarial assumption changes in the discount rate and mortality tables, and increases of approximately $268,000 in various other benefit costs.$118,000 at GSWC. Registrant believes that prudent administrative expenses approved in advance by state regulators to be incurred in the operation and management of its regulated subsidiaries will be recovered through water and electric rates. Amounts included in each general rate case are estimated for future years. Overages from those estimates are not covered in rates.2005,2006, depreciation and amortization expense decreasedincreased by 15.8%40.1% to $4.7$6.6 million compared to $5.6$4.7 million for the three months ended September 30, 2004. This2005 reflecting, among other things, the effects of closing approximately $100 million of additions to utility plant during 2005, depreciation on which began in January 2006. In addition, there was a decrease in depreciation expense resultedin 2005 resulting from the favorable CPUC decision on the Aerojet matter, discussed previously, which ordered GSWC in July of 2005 to restore approximately $1$1.0 million to the appropriate plant accounts and decrease depreciation expense. In addition, Region II’s general rate case was approved in August 2004 by the CPUC, which increased the depreciation composite rates, retroactive to February 14, 2004 to match with the timing of revenue recovery. This resulted in an increase in depreciation expense of approximately $344,000 for the three months ended September 30, 2004. There was no corresponding increasesuch adjustment in 2005. These decreases were partially offset by, among other things, the effects of recording approximately $71 million in additions to utility plant during 2004, depreciation on which began in January 2005.2006. Registrant anticipates that depreciation expense will continue to increase due to Registrant’s on-going construction program at its regulated subsidiaries. Registrant believes that depreciation expense related to property additions approved by the appropriate regulatory agency will be recovered through water and electric rates.2005,2006, maintenance expensesexpense increased by 18.8%16.9% to $3.1$3.4 million compared to $2.9 million for the three months ended September 30, 2005 due principally to an increase in required maintenance on GSWC’s wells and water supply sources. There were also increases in well treatment and emergency repair costs. Furthermore, there was an increase of $61,000 at ODUS and TUS due to the commencement of the operations of the water and wastewater systems pursuant to new military contracts in Maryland and Virginia.2004 due principally to2005 reflecting additional property taxes resulting from higher assessed values, and increases in scheduled maintenance and emergency repairs at GSWC’s Regions II and III. Maintenance expense increases for regulated activities are included in each general rate case and are covered in rates, unless disallowed as not reasonable or prudent. Each of the Military Utility Privatization Subsidiaries bears the risk of increases in maintenance and all other costs above those authorized in the contract for operation of the water and wastewater systems for the U.S. Army or Air Force, unless it is entitled to an equitable adjustment for such matters as an increase inpayroll taxes based on increased labor rates, changes in circumstances or differing site conditions from those anticipated at the time of execution of the contract.35costs.taxesRegistrant recorded a net pre-tax gain of $124,000 on operating incomethe sale of non-utility property. There was no similar gain in the same period of 2005.85.5%$5.5 million during the three months ended September 30, 2006 as compared to $10.6the same period in 2005 reflecting primarily the approval from the CPUC in July of 2005 for the recovery of previously incurred and expensed interest costs totaling $5.1 million in the Aerojet memorandum account, discussed previously. In addition, the increase also reflects increases in long-term debt interest expense of $585,000 due to $40.0 million of additional private placement notes issued at GSWC in October 2005. Partially offsetting this increase was a decrease in short-term cash borrowings. Average bank loan balances outstanding under an AWR credit facility for the third quarter of 2006 were approximately $26.5 million, as compared to an average of $50.8 million during the same period of 2005. However, the decrease in short-term bank loan balances was also partially offset by higher interest rates.$5.7$10.5 million for the three months ended September 30, 20042005 due in part,primarily to an increasea decrease in pretax operating income of 65.7%54.3%. In addition, theThe effective tax rate (“ETR”) applicable tofor the three months ended September 30, 20052006 increased slightly to 46.2%46.3% as compared to a 41.3%46.1% ETR applicable to the three months ended September 30, 2004.2005. The variance between the ETR and the statutory tax rate is primarily the result of differences between book and taxable income that are treated as flow-through adjustments in accordance with regulatory requirements. Flow-through adjustments increase or decrease tax expense in one period, with an offsetting increase or decrease occurring in another period. DuringDuring the second quarter of 2005, the recognition of the federal benefiteffect of state taxes was adjusted to conform to the flow-through method reflected in the tax calculation for ratemaking purposes, which partially defers the recognition of the benefiteffect to the subsequent tax year. This resulted in additionalincreased income taxes of $801,000tax expense by $33,000 for the three months ended September 30, 2005.2006.For the three months ended September 30, 2005, other taxes increased by 14.0% to $2.5 million compared to $2.2 million for the three months ended September 30, 2004 reflecting additional property taxes of $273,000 resulting from higher assessed values, and increases in payroll taxes of approximately $27,000 based on increased labor costs.Other Income (Loss)For the three months ended September 30, 2005, other net income (loss) was a loss of $64,000 as compared to a loss of $84,000 for the three months ended September 30, 2004. This was largely due to an increase in charitable contributions of $29,000 in connection with the Katrina Relief Fund, offset by increases in other investment income.Interest ChargesFor the three months ended September 30, 2005, interest expense decreased by $5.5 million reflecting the approval from the CPUC of previously incurred and expensed interest costs totaling $5.7 million in the Aerojet memorandum account, discussed previously. This was offset by increases in short-term borrowings and higher interest rates on short-term borrowings of approximately $232,000.36–— Nine Months Ended September 30, 20052006 and 20042005 (dollars in thousands)thousand)
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CHANGE
CHANGE2005 increased 36.9%2006, to $17.7 million, which is equivalent to $1.03 per common share on both a basic and fully diluted basis, compared to $21.7 million equivalent toor $1.29 per common share on a basic and fully diluted basis, compared to $15.9 million or $1.04 per sharerespectively, for the nine months ended September 30, 2004.2005. Impacting the comparability in the results of the two periods are the following significant items:•· A favorable decision issued by the CPUCThere was an unrealized loss on purchased power contracts in 2004 that resulted in a $5.7 million pre-tax2006 due to decreasing energy prices versus an unrealized gain on the sale of water rights during the second quarter of 2004 offsetpurchased power contracts in 2005. The cumulative unrealized loss on purchased power contracts decreased pretax income by an impairment loss of $482,000 associated with related assets removed from rate base pursuant to this decision. This $5.2approximately $5.9 million, net gain added approximately $0.20or $0.21 per share, tofor the nine months ended September 30, 2004.• A significant increase in the2006, as compared to a cumulative unrealized gain on purchased power contracts due to increasing energy prices. This unrealized gain added approximatelythat increased pretax income by $7.5 million, to pretax income, or $0.26 per share increase to the nine months ended September 30, 2005, as compared to the unrealized gain of $0.3 million, or $0.01 per share,income, for the same period of 2004.in 2005.37•· As discussed in the quarterly results, the increase in the2005 nine months recorded results reflects a favorable decision issued by the CPUC on July 21, 2005 regarding the Aerojet memorandum accountmatter which added about $4.3pre-taxpretax income was to reduceresulted in reduced interest charges, depreciation expense and other operating expenses as discussed below.•· A significant decrease indecision issued by the provisionCPUC on April 13, 2006 regarding the treatment of GSWC’s water rights lease revenues added about $3.2 million to pretax income for supply cost balancing account. In May 2004, GSWC recorded a cumulative $2.7 million regulatory liability with a corresponding charge booked to the provision for supply cost balancing account as a result of the advice letters filed for the memorandum supply cost accounts for Regions I and II that had net over-collection balances covering 2001, 2002, 2003 and parts of 2004. During the nine months ended September 30, 2005, there was no similar charge for over-collection.2006 or approximately $0.11 per share. In addition, an approximate $1.3 million under-collection in Region III’s 2004 memorandum supply cost account which was approved bythis decision, the CPUC authorized GSWC to reinvest all lease revenues since January 2004, inclusive of the balances in Junethe regulatory liability accounts established by GSWC for this matter, in water system infrastructure. These investments will be included in the rate base upon which GSWC earns a rate of return. In accordance with California law, GSWC will have 8 years in which to reinvest the proceeds. As a result, GSWC transferred about $2.3 million of water rights lease revenues received from the City of Folsom in 2004 and 2005 from the regulatory liability account into other operating revenues. GSWC also recorded pretax income of $909,000 reflecting water rights lease revenues for the first, second and was recorded duringthird quarters of 2006.20052006. This was partially offset by higher expenses as a reduction to the provision.described below.•· Water rateAn increase in ASUS’s pretax operating income of $1.4 million, or $0.05 per share, as compared to the same period of 2005 by operating and maintaining the water and wastewater systems for the U.S. Government. The increases contributed approximately $6.1 million to revenues, almost allincluded revenue recognized for certain special projects and reimbursement of which was offsetvarious operating costs incurred during the period of transition of the operation and maintenance of the water and wastewater systems at military bases in Maryland and Virginia formerly owned and operated by a 6.9% decrease in billed water consumption. The decrease in consumption negatively impacted earnings by approximately $0.15 per share.the U.S. Government.•· A higher$2.4 million increase in other interest income, excluding the impact of the Aerojet decision in July 2005 mentioned above, or $0.09 per share, resulting primarily from interest accrued on the uncollected balance of the Aerojet litigation memorandum account authorized by the CPUC, interest income related to a $3.0 million Internal Revenue Service refund received in May 2006, and interest income from the U.S. Government for costs incurred on capital upgrade projects at Andrews Air Force Basereducedincreased earnings by $0.07$0.09 per share resulting fromprimarily from: (i) a $400,000 tax benefit relating to a $3.0 million IRS refund received in May 2006; and (ii) differences between book and taxable income, thatwhich are treated as flow-through adjustments in accordance with regulatory requirements.2005,2006, revenues from water operations remained relatively flatincreased by 6.8% to $166.2 million, compared to $155.6 million for the nine months ended September 30, 2004. Water2005. Higher water revenues reflect rate increases in 2004 andsince the second quarter of 2005 covering almost all of GSWC’s water customers, which contributed $6.1$8.8 million in increased revenues, offset by a decreaserevenues. In addition, an increase of 6.9%about 2.0% in billed water consumption resulting from changes in weather conditions.conditions also increased revenues by approximately $1.8 million. Differences in temperature and rainfall in Registrant’s service areas impact sales of water to customers, causing fluctuations in Registrant’s revenues and earnings between comparable periods.2005,2006, revenues from electric operations increased by 4.3%8.5% to $20.1$21.8 million compared to $19.3$20.1 million for the nine months ended September 30, 2004.2005. The increase reflects primarily a rate7.4% increase relatedin KWh usage, due to changes in weather conditions which caused the commencementusage of operations of ansnow-making machines to increase in 2006. The cooler 2006 winter weather as compared to same period last year allowed the ski resorts (industrial customers) to remain open well into May, operating their lifts and some snow-making in the evening hours. New rates authorized by the CPUC for the 8.4 MWmegawatt (“MW”) natural gas-fueled generation facility.facility also contributed to the increase. The new rates went into effect on April 15, 2005. The rate increase for this facility is expected to2005 and generate approximately $2.7 million in additional annual revenues, and is subject to refund. refund pending the CPUC’s final cost review.increase was offset by a slight decreasenew Bear Valley Electric rates have been recognized in kilowatt-hour consumption.2006 revenues and management believes it is probable that the final CPUC cost review will not result in refunds to the customer.2005,2006, other operating revenues increased by 196.9%210.1% to $8.4 million compared to $2.7 million compared to $899,000 for the nine months ended September 30, 20042005 due primarily to approximately $1.6a decision issued by the CPUC on April 13, 2006 enabling GSWC to record $3.2 million of water rights lease revenues from the City of Folsom from January 2004 to September 2006. Prior to this decision, the apportionment of any lease revenues that GSWC collected in 2004 and 2005, totaling $2.3 million, had been included in a regulatory liability account and no amounts were recognized as revenues until regulatory uncertainties about this matter were resolved. Registrant also recorded additional revenue of $909,000, reflecting the first, second and third quarters of the 2006 water rights lease revenues. In addition, an increase of $2.8 million in revenues as compared to the first nine months of 2005 reflects: (i) the recording of FBWS revenue of approximately $768,000 during the nine months ended September 30, 2006 based on the percentage of completion method of accounting for contract revenue recognition for several projects at Fort Bliss; and (ii) additional revenues associated with the operation oftotaling $2.0 million generated from operating the water and wastewater systems at Andrews Air Force Base which began operation on February 1, 2005, at Fort Bliss, located near El Paso, Texas that commencedEustis, Fort Monroe and Fort Story all of which began operation on October 1, 2004 pursuant to the terms of a 50-year contract between FBWSApril 3, 2006, and the U.S. Government.wastewater systems at Fort Lee which began operation on February 23, 2006.382005 and 2004, 47.2% of the Company’s supply mix was2006, purchased water. Purchased water costs decreased by 3.5%4.0% to $35.7$34.3 million compared to $37.0$35.7 million for the nine months ended September 30, 20042005. The decrease is due primarily to a declinechange in the supply mix caused by less purchased water needed to replace groundwater supply lost in 2005. For the nine months ended September 30, 2006, 44.8% of Registrant’s supply mix was purchased water as compared to 47.2% purchased water for the nine months ended September 30, 2005. During the same period last year, there were additional purchases of water needed to replace groundwater supply, due to wells being removed from service. The wells were removed from service in 2005 as a result of water quality issues and mechanical problems, particularly in GSWC’s Foothill district. The cost of purchased water in this district decreased by approximately $1.7 million as a result of the wells being returned to operation in 2006. This decrease was partially offset by an increase in customer demand resulting from lower consumption. These decreases were offsethigher consumption and increased water rates by increases in supplier rates.purchased water suppliers.2005,2006, the cost of power purchased for pumping decreasedincreased by 2.5%10.1% to $6.9$7.6 million compared to $7.1$6.9 million for the nine months ended September 30, 20042005 due primarily to a decreasean increase in kilowatt hourKWh usage by Registrant caused by lowerhigher customer demand.water demand and an increase in pumping volume due to the supply mix change discussed above.2005,2006, groundwater production assessments increased by 15.1%11.8% to $6.8 million as compared to $6.1 million for the nine months ended September 30, 20042005 due primarily to increases in well production to meet higher customer demand. There were also increases in assessment rates levied against groundwater production, in Regions II and III, effective July 20042005 and 2005.2006. Average pump tax rates increased in Regions II and III in July 20042006 by approximately 11%2% and 15%4%, respectively, and increased by 5% and 22%, respectively,20% in July 2005. In addition, GSWC received $728,000 for leasing temporary surplus water rights during the nine months ended September 30, 2004 which was recorded as a reduction to groundwater production assessments as compared to $221,000 received for the nine months ended September 30, 2005. These increases were partially offset by a decrease in well production due to a decline in customer demand.2005, respectively.2005,2006, cost of power purchased for resale to customers in GSWC’s Bear Valley Electric division decreasedincreased by 5.3%5.5% to $9.9$10.5 million compared to $10.5$9.9 million for the nine months ended September 30, 2004. The decrease was due2005, primarily to two related events with Mirant Americas Energy Marketing (“Mirant Marketing”). The first event was the recording of additional one time costs forreflecting higher customer demand during the nine months ended September 2004 that did not recur in the nine months ended September 2005. The additional one time costs booked in the first nine months of 2004 was due to a refund to Mirant Marketing of $644,000 ordered by the Federal Energy Regulatory Commission (“FERC”) in March of 2004 for the one-time sale of excess energy in the spot market. While this increased the cost of power purchased for resale, GSWC also booked the refund payment to Mirant Marketing in its supply cost balancing account; therefore, there was no net impact on earnings in 2004. The second event was the result of a FERC order in November of 2004 in which FERC ordered Mirant Marketing to reimburse $247,000 of the amount GSWC had refunded to Mirant Marketing. GSWC received the reimbursement of $247,000 from Mirant Marketing in May of 2005. GSWC recorded the Mirant Marketing reimbursement in its supply cost balancing account which also resulted in no net impact on earnings in 2005. These decreases were partially offset by: (i) an increase of approximately $193,000 in charges from Southern California Edison due to rate increases, and (ii) increases in power costs paid to APX of approximately $65,000.30, 2006.gain and loss (gain) on purchased power contracts represents gainslosses and lossesgains recorded for GSWC’s purchased power agreements with PWCC, which qualify as derivative instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. The $7,492,000$5.9 million pretax unrealized loss on purchased power contracts for the nine months ended September 30, 2006 is due to a decrease in the current forward2005 is due to an increase in the current forward market prices since December 31, 2004. As of September 30, 2005, GSWC has recorded a cumulative unrealized gain of $5.5 million on its balance sheet.2005. Unrealized gains and losses at Bear Valley Electric will continue to impact earnings during the life of the contract with PWCC, which terminates in 2008.39A decrease of $1.1 million during the nine months ended September 30, 2006 in the provision for supply cost balancing accounts as compared to the nine months ended September 30, 2005 was primarily due to: (i) the recording of a $247,000 refund received in May 2005 from Mirant with no corresponding amount booked in the same period of 2006; (ii) the recording of a $2.7 million under-collection in the second and third quarter of 2006 related to the 2006 year-to-date supply cost memorandum account resulting from the elimination of the earnings test by the CPUC in April 2006, and (iii) the recording in April 2006 of an additional $181,000 under-collection for 2005’s supply cost memorandum account due to the elimination by the CPUC of the earnings test. These decreases were offset by: (i) the approval by the CPUC and recording in September 2005 of $1.3 million under-collection related to Region III’s 2004 supply cost memorandum account, and (ii) an increase of $884,000 in the amortization of water supply cost balancing accounts approved by the CPUC in June, August and September of 2005.2004, Registrant recorded a $5.7 million pre-tax gain on the sale of water rights reflecting a favorable CPUC decision in 2004. The $5.7 million represented settlement proceeds received in May 2004 from the City of Santa Monica relating to the sale and the assignment of rights regarding the Charnock Groundwater Basin.A decrease of $3.82006, interest expense increased $6.7 million during the nine months ended September 30, 2006 as compared to the same period in 2005reflecting primarily the approval from the CPUC in 2005 for the recovery of previously incurred and expensed interest costs totaling $5.1 million in the provisionAerojet memorandum account, discussed previously. In addition, the increase also reflects increases in long-term debt interest expense of $1.8 million primarily due to the placement of $40.0 million of notes in October 2005 coupled with increases in short-term bank loan interest rates. Partially offsetting this increase was a decrease in short-term cash borrowings. Average bank loan balances outstanding under an AWR credit facility for supply cost balancing accounts as compared to the nine months ended September 30, 2004 primarily reflects: (i) the recording in May 20042006 were approximately $28.2 million, as compared to an average of a cumulative $2.7$48.6 million regulatory liability with a corresponding charge booked to the provision for supply cost balancing account as a result of the advice letters filed for the memorandum supply cost accounts for Regions I and II that had net over-collection balances covering 2001, 2002, 2003 and parts of 2004; there was no similar charge during the same period of 2005; (ii) approval by the CPUC in June 2005 to recover an approximate $1.3 million under-collection in Region III’s 2004 memorandum supply cost account; (iii) a decrease of $883,000 in amortization primarily related to pre-November 2001 water supply cost balancing accounts and the electric balancing account, and (iv) a decrease of $283,000 in the electric supply cost amounts in excess of the $77 per MWh recovery cap authorized by the CPUC. These decreases were offset by: (i) a net change in the current period of $622,000 in the over-collections of the memorandum supply cost accounts, and (ii) the net refunds to Mirant Marketing previously discussed in cost of power purchased for resale in GSWC’s Bear Valley Electric service area.2005.2005, other operating expenses2006, interest income increased by 4.1%230% to $15.1$2.6 million compared to $14.5 million$801,000 for the nine months ended September 30, 2004 2005 due primarily to: (i) higher labor costs as a result of higher wages which increased by approximately $908,000 at GSWC; (ii) higher operating expenses of $439,000 at ASUS due tointerest accrued on the commencement of operationsuncollected balance of the waterAerojet litigation memorandum account authorized by the CPUC of $1.1 million; (ii) interest income of $381,000 related to a $3.0 million Internal Revenue Service refund received in May 2006; (iii) interest income totaling $345,000 earned from the U.S. Government for costs incurred on capital upgrade projects at Andrews Air Force Base, and wastewater system at Fort Bliss, and (iii) higher chemicals and water treatment costs of $152,000 at GSWC.(iv) interest earned on short-term cash surplus. These increases were partially offset by: (i) an impairment lossby the recognition in July 2005 of $482,000 that was recorded atapproximately $607,000 in interest income earned on the end$8.0 million Aerojet long-term note receivable. The recording of the second quarter of 2004 related tointerest income had been deferred pending the Charnock Groundwater Basin assets being removed from rate-base pursuant to afinal CPUC order in 2004, and (ii) by a $459,000 adjustment in the third quarter of 2005 reflecting the approval from the CPUC of recovery of previously incurred operating expenses indecision on the Aerojet memorandum account.matter. Registrant has since been recording the interest income on the $8.0 million Aerojet long-term note receivable on a monthly basis.2005, administrative and general expenses increased2006, income tax expense decreased by 1.7%34.3% to $31.7$12.1 million compared to $31.2$18.4 million for the nine months ended September 30, 20042005 due, to: (i) an approximate $900,000 increase in pensions and benefits duepart, to changes in actuarial assumptions with respect to the discount rate and mortality tables, and increases of approximately $834,000 in various other benefit costs, (ii) an approximate $347,000 increase in GSWC’s general office labor costs due to higher wages, and (iii) an approximate $351,000 increase at FBWS due to the commencement of operations of the water and wastewater system at Fort Bliss. These increases were partially offset by: (i) a $1.4 million decrease in outside services in connection with new business developmentpretax income of 25.7%. In addition, the decrease was as a result of flow-through adjustments and other matters, and (ii) a net decrease of approximately $536,000 in various other miscellaneous expenses.For the nine months ended September 30, 2005, depreciation and amortization expense increased by 1.2% to $16.0 million compared to $15.8 millionrefund claim, as discussed further, below. The ETR for the nine months ended September 30, 2004 reflecting, among other things, the effects of recording2006 decreased by approximately $71 million in additions5.3 percentage points to utility plant during 2004, depreciation on which began in January 2005. This increase was offset by a decrease in depreciation expense resulting from the favorable CPUC decision on the Aerojet matter, discussed previously, which ordered GSWC to restore approximately $1 million to the appropriate plant accounts40and decrease depreciation expense. Registrant anticipates that depreciation expense will continue to increase due to Registrant’s on-going construction program at its regulated subsidiaries. Registrant believes that depreciation expense related to property additions approved by the appropriate regulatory agency will be recovered through water and electric rates.For the nine months ended September 30, 2005, maintenance expense increased by 7.2% to $8.1 million40.5% as compared to $7.5 million for the nine months ended September 30, 2004 due principally to increases in scheduled maintenance and emergency repairs at GSWC’s Region III and an increase of $169,000 in maintenance expenses for FBWS due to the Fort Bliss operations which began in October 2004. Each of the Military Utility Privatization Subsidiaries bears the risk of increases in maintenance and all other costs above those authorized in the contract for operation of the water and wastewater systems for the U.S. Army and Air Force, unless it is entitled to an equitable adjustment for such matters as an increase in labor rates, changes in circumstances or differing site conditions from those anticipated at the time of execution of the contract.For the nine months ended September 30, 2005, taxes on operating income increased by 58.5% to $18.6 million compared to $11.7 million for the nine months ended September 30, 2004 due, in part, to an increase in pretax operating income of 48.7%. In addition, thea 45.8% ETR applicable to the nine months ended September 30, 2005 increased to 45.9% as compared to a 43.1% ETR applicable to the nine months ended September 30, 2004.2005. The variance between the ETR and the statutory tax rate is primarily the result of differences between book and taxable income that are treated as flow-through adjustments in accordance with regulatory requirements. Flow-through adjustments increase or decrease tax expense in one period, with an offsetting increase or decrease occurring in another period. During the nine months ended September 30,second quarter of 2005, the recognition of the federal benefiteffect of state taxes was adjusted to conform to the flow-through method reflected in the tax calculation for ratemaking purposes, which partially defers the recognition of the benefiteffect to the subsequent tax year. This resulted in additionalreduced income taxes of $1,190,000.For the nine months ended September 30, 2005, other taxes increasedtax expense by 7.2% to $7.0 million compared to $6.6 million$171,000 for the nine months ended September 30, 2004 reflecting2006. During the third quarter of 2005, AWR filed an increaseamended tax return for 2001 with the Internal Revenue Service (“IRS”) which was subject to IRS and Congressional Joint Committee of approximately $351,000 in additional property taxes resulting from higher assessed values,Taxation (“JCT”) review. During the second quarter of 2006, the IRS and increases in payroll taxes of approximately $112,000 based on increased labor costs.Other Income (Loss)For the nine months ended September 30, 2005, other net income (loss) wasJCT reviews were completed and AWR received a loss of $165,000 as compared to income of $371,000 for the nine months ended September 30, 2004. This was largely due to a reduction in GSWC’s estimate of customer refunds associated with lease revenues from the City of Folsom adjusted in September 2004.Interest ChargesFor the nine months ended September 30, 2005, interest charges decreased by 36.6% to $8.4 million compared to $13.3 million for the nine months ended September 30, 2004 reflecting the approval from the CPUC of previously incurred and expensed carrying costs totaling $5.7 millionrefund in the Aerojet memorandum account, discussed previously. This was offset by increasesamount of its original claim of $3.0 million, with interest. Consequently, in short-term borrowings and higher interest rates on short-term borrowings of approximately $645,000. In addition, during the firstsecond quarter of 2004 GSWC2006, AWR recorded a tax benefit of $400,000, of which $351,000 was attributable to GSWC. The refund-claim benefit contributed to 1.3 of the recovery of carrying costs of approximately $168,000 with respect5.3 percentage point ETR reduction referred to, the costs incurred in connection with the CPUC’s investigation of water quality matters relating to public utilities regulated by the CPUC which was authorized by the CPUC in March 2004. There was no corresponding recovery in 2005.41above.Operation”Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2004. There2005. Except for the adoption of SFAS No. 123(R), “Share-Based Payment”, there have been no material changes to the critical accounting policies since December 31, 2004.policies. Effective January 1, 2006, Registrant began accounting for employee and directors stock-based compensation costs in accordance with SFAS No. 123(R) which requires the recognition of compensation expense in the financial statements based on fair values of the stock awards. Registrant elected to adopt the modified prospective transition method as provided by SFAS No. 123(R) and, accordingly, financial statement amounts for the prior periods presented in the Form 10-Q have not been restated to reflect the fair value method of expensing share-based compensation. Registrant utilized the Black-Scholes option pricing model to estimate the fair value of employee stock based compensation at the date of grant, which requires the input of highly subjective assumptions, including expected volatility and expected life. Further, as required under SFAS No. 123(R), Registrant now estimates forfeitures for options granted, which are not expected to vest. The cumulative effect of adopting the change in estimating forfeitures is not material to Registrant’s financial statements for the nine months ended September 30, 2006. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of Registrants share-based compensation. The adoption of SFAS No. 123(R) did not have a material affect on Registrant’s consolidated financial position, results of operations and cash flows for the three and nine months ended September 30, 2006.common sharesCommon Shares primarily through dividends from its subsidiaries, principally GSWC.$45.2$45.6 million for the nine months ended September 30, 20052006 as compared to $48.1$45.2 million for the nine monthssame period ended September 30, 2004.2005. The decreaseslight increase of $2.9$0.4 million was primarily attributable to the receipt in the first quarter of 2004 of $8.7 millionhigher net income after adjustments for non-cash items, which increased cash flows from Aerojet in connection with the settlement of the litigation which accounted for the change in other accounts receivable. This decrease was offset primarily by the receipt of $5.0 million in federal tax refunds during the nine months ended September 30, 2005 not received during the nine months ended September 30, 2004. A change in cash provided by operating activities is also affectedby $7.5 million. This increase was offset by the timing of cash receipts and disbursements related to other working capital items.items, in particular the decrease in cash flows from operating activities of $5.1 million in income taxes receivable/payable resulting from the receipt of a $3.0 million federal tax refund received in May 2006 as compared to a $5.0 million federal tax refund in April 2005 as well as differences in the timing of remitting taxes which resulted in additional taxes paid during the nine months ended September 30, 2006 as compared to same period in 2005.was $52.0decreased slightly to $51.1 million for the nine months ended September 30, 20052006 as compared to $57.5$52.0 million for the same period ended September 30, 2005.2004 due to higher capital expenditures incurred during the third quarter of 2004.Net cash provided by financing activities was $8.2 million for the nine months ended September 30, 20052006 as compared to net cash provided by financing activities of $3.3$8.2 million for the nine months ended September 30, 2004.same period in 2005. The increasedecrease in net cash provided by financing activities was due primarily to an increase in short-term borrowings against the revolving credit line andcaused by a $2.0decrease of about $3.6 million increase in receipt of advances for and contributions in aid of construction. In addition, the change also reflects approximately $35construction and a $12.0 million ofnet decrease in notes payable to banks. These decreases were offset by a $5.2 million increase in proceeds from stock option exercises and the issuance of Common Shares under the Registrant’s Common Share Purchase and Dividend Reinvestment Plan and 401(k) Plan. Cash flows from financing activities also increased by $1.1 million from the tax benefits associated with the exercise of stock options.shares which was then useddividends for 75 consecutive years. On October 27, 2006, AWR declared a regular quarterly dividend of $0.235 per Common Share. The dividend, totaling approximately $4.0 million, will be paid on December 1, 2006 to common shareholders of record at the close of business on November 10, 2006. During the nine months ended September 30, 2006 and 2005, AWR paid quarterly dividends to shareholders, totaling approximately $11.4 million or $0.675 per share and $11.3 million or $0.675 per share, respectively. AWR’s ability to pay down $28 millioncash dividends on its Common Shares outstanding depends primarily upon cash flows from GSWC. AWR presently intends to continue paying quarterly cash dividends in the future, on March 1, June 1, September 1 and December 1, subject to earnings and financial condition, regulatory requirements and such other factors as the Board of short-term borrowings in September of 2004.Directors may deem relevant.2005,2006, an aggregate of $55$25.0 million in cash borrowingborrowings were included in current liabilities and approximately $11.2 million of letters of credit were outstanding under this facility. In August 2006, AWR filed a Registration Statement with the Securities and Exchange Commission for the sale from time to time of debt and equity securities. As of September 30, 2006, approximately $156.5 million was available for issuance under this Registration Statement.42program, potential general market interest rate increases and the April, 2004 downgradeprogram. In December of 2005, S&P revised AWR’s credit rating by Standard & Poor’s Ratings Service (S&P) from A+A- negative to A- with a negative outlook. stable. S&P debt ratings range from AAA (highest rating possible) to D (obligation is in default). Securities ratings are not recommendations to buy, sell or hold a security and are subject to change or withdrawal at any time by the rating agency. Registrant believes that costs associated with capital used to fund construction at its regulated subsidiaries will continue to be recovered in water and electric rates charged to customers.$47.2$47.7 million for the nine months ended September 30, 20052006 as compared to $50.6$47.2 million for the nine months ended September 30, 2004.same period in 2005. The decreaseslight increase of $3.4$0.5 million in cash provided by operations was primarily attributable to the receipt in the first quarter of 2004 of $8.7 millionhigher net income after adjustments for non-cash items, which increased cash flows from Aerojet in connection with a settlement agreement.operating activities by approximately $6.5 million. This increase was offset by: (i)by higher general rate case costs, lower tax refunds received in 2006 as compared to the payment of approximately $1.4 million to Southern California Edison in March of 2004 pursuant to a settlement agreement, with no corresponding paymentsame period in 2005 and (ii) an approximately $3.5 million increase in intercompany receivable/payable. There were also other changesas well as differences in the timing of remitting taxes, and the timing of cash receipts from customer accounts receivable and disbursements related to other working capital items.decreasedincreased slightly to $48.8$49.5 million for the nine months ended September 30, 20052006 as compared to $54.8$48.8 million for the same period of 2004 due to higher capital expenditures during the third quarter of 2004.in 2005.providedused by financing activities was $3.0$4.4 million for the nine months ended September 30, 20052006 as compared to net cash used inprovided by financing activities of $1.6$3.0 million for the nine months ended September 30, 2004, reflecting primarily an increasesame period in intercompany borrowings. There was also an $823,000 increase2005. The decrease reflects a $2.9 million decrease in the receipt of advances for and contributions in aid of construction, and a net decrease of $4.8 million in 2005. In addition, the change reflects $28 million received by GSWC from the issuance of common shares to AWR, offset by the repayment of $24.5 million of intercompany short-term borrowings in 2004.borrowings.contributions-in-aid-of-construction,contributions in aid of construction, advances for construction and install-and-convey advances to fund the majority of its construction expenditures. GSWC has a Registration Statement on file with the SEC for issuance from time to time, of up to $100$100.0 million of debt securities. As of September 30, 2005, $502006, $50.0 million remained for issuance under this Registration Statement.Statement, subject to regulatory approval from the CPUC for issuance of additional debt.(the “Note”) in the aggregate principal amount of $40,000,000$40.0 million from GSWC pursuant to the terms of a Note Purchase Agreement dated as of October 11, 2005 between GSWC and CoBank.GSWC. The proceeds were used to pay down GSWC’s intercompany short-term borrowings.GSWC currently has aIn December 2005, S&P changed its debt rating offor GSWC from A- with negative outlook by S&P.to A- stable. Securities ratings are not recommendations to buy, sell or hold a security and are subject to change or withdrawal at any time by the rating agency.43contributions-in-aid-of-construction,contributions in aid of construction, advances for construction and install-and-convey advances, to fund the majority of its construction expenditures.the Military Utility Privatization Subsidiaries.its subsidiaries.The following is an updateRegistrant has various contractual obligations which are recorded as liabilities in the consolidated financial statements. Other items, such as certain purchase commitments and operating leases are not recognized as liabilities in the consolidated financial statements, but are required to be disclosed.commitments.commitments since December 31, 2005. See “Managements’ Discussion and Analysis of Financial Condition and Results of Operation—Contractual Obligations and Other Commitments” section of the Registrant’s Form 10-K for the year-ended 2004December 31, 2005 for a detailed discussion of contractual obligations and other commitments.In June 2005, AWR amended and restated its syndicated revolving credit agreement which increased its borrowing limit under this agreement to $85 million and extended the maturity date to June 2010. Up to $20 million of this facility may be used for letters of credit. As of September 30, 2005, an aggregate of $55 million in cash borrowings are included in current liabilities and approximately $11.2 million of letters of credit were outstanding under this facility. The syndicated revolving credit facility contains restrictions on prepayments, disposition of property, mergers, liens indebtedness and guaranty obligations and, transactions with affiliates and contains a negative pledge, minimum interest coverage requirements, a maximum debt to capitalization ratio, and a minimum debt rating covenant. Pursuant to the Credit Agreement, AWR must maintain a minimum interest coverage ratio of 3.25 times interest expense, a maximum total funded debt ratio of 0.65 to 1.00 and a minimum debt rating of Baa3 or BBB-.On October 11, 2005, CoBank purchased a 5.87% Senior Note due December 20, 2028 in the aggregate principal amount of $40,000,000 from GSWC pursuant to the terms of a Note Purchase Agreement dated as of October 11, 2005 between GSWC and CoBank. The proceeds were used to pay down GSWC’s intercompany short-term borrowings. This Agreement contains restrictions on (i) incurring liens and entering into sale and leaseback transactions, with customary exceptions, (ii) dispositions of property with a book value of more than 15% of total capitalization (as defined) in any fiscal year, unless the proceeds are used within one year to purchase public utility property or redeem all or a portion of the amount borrowed from CoBank or other debt ranking pari passu with the debt owed to CoBank, (iii) merging or consolidating with any other person, unless GSWC is the survivor or the survivor is principally engaged in the business of a water or wastewater public utility and the financial covenants described below are satisfied on a pro forma basis at the end of the quarter immediately preceding the merger or consolidation, after giving effect to the transaction, (iv) incurring any indebtedness if, as a result an event of default would occur or the total indebtedness to EBITDA ratio ( as defined) of GSWC at the end of the quarter preceding the transaction would exceed 8 to 1 or the total indebtedness to capitalization ratio (as defined) would exceed .6667 to 1, or (v) declaring or paying any dividends in cash or property if at the time of the distribution or payment, an event of default would occur or, if after giving effect to the distribution, the total indebtedness to capital ratio (as defined) of GSWC would be more than .6667 to 1.Under the terms of its power purchase contracts, GSWC is required to post security, at the request of the seller, if GSWC is in default under the terms of the contract and the future value of the contract is greater than the future value of contracts of a similar term on the date of default. GSWC will be in default under the terms of these contracts if its debt is rated less than BBB- by S&P or Fitch, Inc. (“Fitch”) or less44than Baa3 by Moody’s. GSWC currently has a senior unsecured debt rating of A- with a negative outlook by S&P and A2 with a recent upgrade from negative to “stable outlook” by Moody’s. Fitch does not rate GSWC.S&P debt ratings range from AAA (highest rating possible) to D (obligation is in default). Moody’s debt ratings range from Aaa (best quality) to C (lowest quality). Securities ratings are not recommendations to buy, sell or hold a security and are subject to change or withdrawal at any time by the rating agency.Construction ProgramGSWC maintains an ongoing water distribution main replacement program throughout its customer service areas based on the priority of leaks detected, fire protection enhancement and an underlying replacement schedule. In addition, GSWC upgrades its electric and water supply facilities in accordance with industry standards, local requirements and CPUC requirements. As of September 30, 2005, GSWC has unconditional purchase obligations for capital projects of approximately $36.5 million. During the nine months ended September 30, 2005, GSWC spent $48.8 million for these purposes.During the nine months ended September 30, 2005, CCWC spent $2,843,000 primarily related to a new water treatment facility, the cost of which is included in rates authorized by the ACC in October 2005.AWR has no material capital commitments. ASUS actively seeks opportunities to own, lease or operate water and wastewater systems for governmental entities, which may involve significant capital commitments. Each of the Military Utility Privatization Subsidiaries has capital commitments that are to be funded by future revenues under the contracts with the U.S. Government.Regulationclassificationsclassification of accounts, valuation of properties, the purchase, disposition and mortgaging of properties necessary or useful in rendering public utility service, the issuance of securities, the granting of certificates of public convenience and necessity as to the extension of services and facilities and various other matters. CCWC and FBWS areis subject to regulation by the ACCACC.TCEQ, respectively.ACC, respectively, in general rate cases and are derived using rate base, cost of service and cost of capital, as projected for a future test year in California and using an historical test year, as adjusted, in Arizona. Rates charged to customers vary according to customer class and rate jurisdiction and are generally set at levels allowing for recovery of prudently incurred costs, including a fair return on rate base. Rate base generally consists of the original cost of utility plant in service, plus certain other assets, such as working capital and inventory, less accumulated depreciation on utility plant in service, deferred income tax liabilities and certain other deductions.TheOn January 12, 2006, the CPUC has approved GSWC’s advice letter requestingRegion III rate increases in Region I.case. The new rates wereauthorized rate increase for 2006 was made effective June 8, 2005January 19, 2006 and areis expected to generateprovide GSWC additional annual revenuesrevenue approximating $5.4 million in 2006 based on a return on equity of 9.8%. For the second and the third years of this three-year GRC, the CPUC approved an annual increase of approximately $1.9 million and $2.3 million.million, respectively, subject to certain earnings tests.2, 2004,14, 2005, GSWC filed advice letters with the CPUC for step increases for Region III in an amount of approximately $2.8$0.6 million and an attrition increasesincrease of approximately $2.4$5.2 million for Region III thatII, both of which were approved and became effective on January 1, 2005.On July 10, 2003, the CPUC approved the Certificate of Public Convenience and Necessity (“CPCN”) for construction of an 8.4 MW natural gas-fueled generation facility on a portion of its property in the City of Big Bear Lake. The capital cost of the generating facility was approximately $13 million. GSWC filed for increased rates in the third quarter of 2004, using a special filing called a “Major Additions Adjustment Clause” or “MAAC” filing. This request was approved by the CPUC and the new rates became effective on April 15, 2005, which should result in an estimated annual revenue increase of45approximately $2.7 million. The rate increase for the generation facility is all subject to refund pending final cost review.CCWC filed its rate case with the ACC in August 2004. In September 2005, the ACC approved a rate increase for CCWC. The rate increase was effective on October 1, 2005 and is expected to generate additional annual revenues of $1.1 million, an 18% increase over current revenues.2006.2005,2006, GSWC filed an application with the CPUC for rate increases in Region III. If approved as filed,II and to cover general office expenses at the Corporate Headquarters. In the filing, GSWC requested rate increases which are expected to generate approximately $15.6$14.9 million in annual revenues starting in 2006. In addition, rates are expected to increase by approximately $1.02007, with additional increases of $4.7 million in 20072008 and 2008, respectively.$6.9 million in 2009. A decision on this application is expected in the fourth quarter of 2005; however, at this time managementlate 2006. Management is unable to predict the ultimate outcome of this rate case.arewere required to seek review of under- and over- collections by filing an advice letter annually. In addition, the utility’s recovery of such expenses was reduced by the amount exceeding the authorized rate-of return (earnings test). On April 13, 2006, the CPUC issued a decision to remove these requirements. Pursuant to this order, GSWC recognized a cumulative under-collection of approximately $636,000 to the supply cost memorandum account provisions in the second quarter of 2006 for the under-collected balances not recognized at March 31, 2006 and began recording under- and over- collections on a monthly basis thereafter. 2004October 2006 for a $1.7 million increase in supply cost and 2005 with respectrecovery of $2.0 million of previously under-collected supply cost for GSWC’s Region I, for a total revenue increase of $3.7 million. Management believes that it is probable that the CPUC will permit GSWC to its cumulativerecover in rates the net over-collection for Regions Iunder-collections in supply costs.II forseveral other public water purveyors. The plaintiff’s lawsuit seeks an adjudication of the period from November 29, 2001 to December 31, 2004, whichSanta Maria Groundwater Basin. A settlement of the lawsuit has been recorded as a regulatory liability. In June 2005, thereached, subject to CPUC approved these advice letters, as filed, for the 2001, 2002 and 2003 years and as a result a $1.4 million over-collection was transferred to the supply cost balancing accounts. approval. The advice letters for 2004 totaling $4.2 million net over-collection weresettlement, among other things, if approved by the CPUC, would preserve GSWC’s historical pumping rights and secure supplemental water rights for use in Augustcase of 2005. The $4.2 million net over-collection includes approximately $3.5 million of the net proceeds received from potentially responsible partiesdrought or other reductions in the Charnock Groundwater Basin, which was recordednatural yield of the Santa Maria Basin. There are also a small number of nonsettling parties, and the case is going forward as a regulatory liability.to their claims. The amount was transferredstipulation, if approved, would preserve GSWC’s position with the settling parties independent of the outcome of the case as it moves forward with the nonsettling parties. GSWC can not predict the outcome of the case as to the supply cost balancing accountsnonsettling parties.August 2005. There was no impact to earnings as these over-collections haddefending its rights in the Santa Maria Basin, including legal and expert witness fees, which have been recorded as regulatory liabilities in prior years.also filed advice lettersfor recovery of these costs with the CPUC for review of the activity in the Region III memorandum supply cost account for the period from November 29, 2001 to December 31, 2004 totaling a cumulative $4.2 million under-collection. A regulatory asset with respect to this under-collection was not recorded pending receipt of a CPUC decision authorizingCPUC. Management believes that the recovery of these costs through rates is probable.under-collection. City of Folsom 5,000 acre-feet per year of water rights from the American River. GSWC included all associated revenues in a nonoperating income account. In June 2005,a decision issued on March 16, 2004, the CPUC approvedordered GSWC to refund 70 percent of the transfertotal amount of an approximate $1.3 million under-collection in Region III’s 2004 memorandum supply cost account into the water supply cost balancing account, income of which was recorded in the second quarter of 2005. The advice letters for the 2001-2003 years were approved in October 2005. As a result, GSWC will be allowedlease revenues received since 1994, plus interest, to recover an under-collection of $2.9 million recorded in the supply cost memorandum account between November 2001 and December 2003. This will result in an increase to pre-tax income of $2.9 million in the fourth quarter of 2005.July 21, 2005,April 13, 2006, the CPUC authorized GSWC to collectreinvest all lease revenues received from the balanceCity of Folsom since January, 2004, inclusive of the Aerojet litigation memorandum account of approximately $21.3 million, throughbalances in the regulatory liability accounts, in water system infrastructure and to include such investments in the rate base upon which GSWC earns a rate surcharge, which will continue for no longer than 20 years.of return. As a result, GSWC transferred about $2.3 million of water rights lease revenues received from the City of Folsom in 2004 and 2005 from the regulatory liability account into income and recorded an additional pretax income of $311,000 and $909,000 reflecting the three and nine months ended September 30, 2006, respectively, water rights lease revenues.decision,memorandum account to record costs incurred while working with the Water Replenishment District (“WRD”), WRD Technical Advisory Committee, Central and West Basin Municipal Water Districts, Metropolitan Water District, West Basin Water Association and Central Basin Water Association on water supply reliability and rate-related issues in Region II. GSWC among other things, was ordered to: (i) impose a surchargeincurred approximately $374,000 and $345,000 in the Arden-Cordova customer service areaOSMA in 2004 and 2005, respectively. GSWC sought and received authorization to amortize the balance totaling $21.3 million in the memorandum account and consequently, GSWC reflected an increasecumulative total of approximately $6.2 million$719,000 over a 12-month period through customer rates. Accordingly, GSWC recorded a regulatory asset for this amount in its regulatory assetsApril of 2006 with an offset and reduction to include previously expensed carrying costs and record a corresponding gain in its results of operationsoutside legal services during the thirdsecond quarter of 2005; (ii) restore2006. A surcharge went into effect in April of 2006 and accordingly, GSWC began amortizing the appropriate plant accounts byOSMA account. Revenues of approximately $1.0 million with a corresponding decrease in depreciation expense$200,000 and $304,000 were received from customers during the third quarter of 2005, duethree and nine months ended September 30, 2006, respectively, relating to the full reimbursement from Aerojet of capital expenditures, and (iii) keep the memorandum account open until it is fully amortized. However, no costs maythis surcharge. The surcharge will be added to the memorandum account, other than cumulative interest charges approved by the decision. Furthermore, it is management’s intention to offset any settlement proceeds from Aerojet’s proposed land development,46first against an $8 million note from Aerojet and then against the balance in the memorandum account at the time of receipt of the settlement payments.effect over a 12-month period.OurRegistrant’s subsidiaries are subject to increasingly stringent environmental regulations including the 1996 amendments to the Federal Safe Drinking Water Act; enhanced surface water treatment rules; regulation of disinfectant/disinfection by-products; and the long-term enhanced surface water treatment rules; ground water treatment rule; contaminant regulation of radon and arsenic; and unregulated contaminants monitoring rule.20042005 Annual Report on Form 10-K for the year ended December 31, 2005.Construction activitiesSince receiving the NOV, changes in GSWC procedures have prevented additional violations at the new treatment plantfacility. The AQMD could assess penalties associated with an NOV that can range from $10,000 up to $75,000 per day of violation. GSWC estimates that it was in violation approximately 180 days in 2004. GSWC has met with AQMD to ensure future compliance and resolve the NOV. As part of this, GSWC also promptly submitted an application to amend the permit as an amendment may have been necessary for continued operation of the subject air stripping equipment.Calipatria-Niland customer service area were completed inimposition of only a nominal monetary penalty. However, until further notice from the second quarterAQMD on the proposed SEP, GSWC cannot reasonably estimate the amount of 2005. As a result, management believes that all surface water plants in GSWC and CCWC are in compliance with the Enhanced Surface Water Treatment Rulepenalties which becomes effective on June 1, 2006. Except for this matter, theremight be assessed. 2004.Under the terms of contracts executed by the Military Utility Privatization Subsidiaries with the U.S. Army and U.S. Air Force, the U.S. Government continues to be responsible for environmental contamination caused by its fault or negligence and for environmental contamination that occurred prior to execution of the contract. In addition, each of the Military Utility Privatization Subsidiaries has the right to seek an equitable adjustment to its contract in the event that there are changes in environmental laws, a change in the quality of water used in providing water service or wastewater discharged by the U.S. Government or contamination of the air or soil not caused by the fault or negligence of the Military Utility Privatization Subsidiary. Following the end of a transition period, one of the Military Utility Privatization Subsidiaries will assume responsibility for operation and maintenance of the water and wastewater systems at Fort Eustis, Virginia. The U.S. Government has entered into a consent order with the Department of Health of the Commonwealth of Virginia relating to exceedances of the non-acute primary maximum contaminant level for total coliform bacteria, which appears to be due to biological growth in the distribution system. This Military Utility Privatization Subsidiary will be undertaking a number of improvements to the water system at Fort Eustis to address this problem. Until these improvements are completed, there may be additional exceedances of the non-acute primary maximum contaminant level for total coliform bacteria at Fort Eustis.2005.ourRegistrant’s water supplies variesvary from year to year depending upon a variety of factors, including:• Rainfall• Availabilityincluding rainfall, availability of Colorado River water and imported water from northern California,• The the amount of water stored in reservoirs and groundwater basins,• The the amount of water used by ourRegistrant’s customers and others,• Water water quality• Legal and legal limitations on useuse.47CCWC’sits ability to meet the requirements of the Arizona Department of Water Resources regarding its assured water supply account.contracts with our Military Utility Privatization Subsidiaries.Water shortages may affect us in a varietysubsidiaries of ways:• They adversely affect supply mix by causing us to rely on more expensive purchased water.• They adversely affect operating costs.• They may result in an increase in capital expenditures for building pipelines to connect to alternative sources of supply, new wells to replace those that are no longer in service or are otherwise inadequate to meet the needs of customers and reservoirs and other facilities to conserve or reclaim water.We may be able to recover increased operating and construction costs for our regulated systems through the ratemaking process. We may also be able to recover certain of these costs from third parties that may be responsible, or potentially responsible, for groundwater contamination. We may be able to recover increased operating and construction costs for the water systems operated by our Military Utility Privatization Subsidiaries through equitable adjustments to our contractsASUS with the U.S. Army and Air Force.Risk Factor SummaryThe following risk factors, which are described more fully in our 2004 Annual Report on Form 10-K, represent risks and uncertainties that could cause our actual results to differ materially from our historical experience and our present expectations or projections. There have been no significant changes in risk factors since December 31, 2004.• Our business is heavily regulated and, as a result, decisions by regulatory agencies and changes in laws and regulations can significantly affect our business;• Our liquidity and earnings could be adversely affected by changes in water supply costs;• Our business entails a significant risk of litigation, brought on a variety of legal theories, alleging that we have caused personal injury and property damage as a result of alleged delivery of contaminated water;• Our operating costs have increased and are expected to continue to increase as a result of groundwater contamination;• Environmental regulation has increased, and is expected to continue to increase our operating costs;• The adequacy of our water supplies depends upon a variety of factors beyond our control described more fully in the “Management’s Discussion and Analysis of Financial Condition and Results of Operation— Water Supply” section;• Our earnings are greatly affected by weather during different seasons;• Our liquidity, and in certain circumstances, earnings, could be adversely affected by increases in electricity and natural gas prices in California;• Our business requires significant capital expenditures; and48• The expansion of our contract operations exposes us to different risks than those associated with our utility operations.Government.StandardStandards Board. DifferencesSee Note 1 included in financial reporting between periods could occur unless and until the CPUC and the ACC approve such changes for conformity through regulatory proceedings. See Note 9 of Notes to Consolidated Financial Statements.Statements for disclosure on new accounting pronouncements.2004.2005. The quantitative and qualitative disclosures about market risk are discussed in Item 7A-Quantitative and Qualitative Disclosures About Market Risk, contained in Registrant’s 2004 Annual Report on Form 10-K.(“SEC”)(SEC) under the Exchange Act. Based upon that evaluation, the CEO and the CFO concluded that disclosure controls and procedures, as of the end of such fiscal quarter, were adequate and effective to ensure that information required to be disclosed by us in the reports 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 and forms and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.20052006, that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.492004,2005, no other legal proceedings are pending, which are believed to be material. There have been no material developments in any of these legal proceedings since the filing of this Form 10-K. Management believes that rate recovery, proper insurance coverage and reserves are in place to insure against property, general liability and workers’ compensation claims incurred in the ordinary course of business.Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
2005.2006.common sharesCommon Shares by AWR during the three months ended September 30, 2005:third quarter of 2006:
Number of
Shares
Purchased
per Share
Shares Purchased
as Part of Publicly
Announced Plans
or Programs(1)
of Shares That
May Yet Be
Purchased under
the Plans or
Programs
Shares Purchased
Paid per Share
Shares Purchased
as Part of Publicly
Announced Plans
or Programs(1)
of Shares That May
Yet Be Purchased
under the Plans or
Programscommon sharesCommon Shares were purchased pursuant to any publicly announced stock repurchase program.common sharesCommon Shares that may be purchased in the open market under the plans.(4) Of this amount, 15,500 and 8,500 Common Shares were acquired on the open market in August and September, respectively, for employees pursuant to the Company’s 401(k) plan. All of the Common Shares needed to meet the requirements of this plan were purchased in the open market. The remainder of the Common Shares was acquired on the open market for new participants in the Company’s Common Share Purchase and Dividend Reinvestment Plan.5020052006 fiscal year covered by this report to a vote of security holders through the solicitation of proxies or otherwise.November 7, 2005,October 27, 2006, the Board of Directors of Registrant declared a regular quarterly dividend of $0.225$0.235 per common share. The dividend will be paid December 1, 20052006 to shareholders of record as of the close of business on November 18, 2005. The Board also approved an amendment to the Company’s Supplemental Executive Retirement Plan to provide that annual bonus payments and dividend equivalent rights be included in compensation for purposes10, 2006. determining the amount of payments under the Plan. In addition, the Board authorized the Company, to make payments to Mr. Sprowls in an amount equal to what Mr. Sprowls would be entitled to receive under the Company’s Pension Plan and Supplemental Executive Retirement Plan if Mr. Sprowls retires prior to becoming vested in these plans.Oneffective November 7, 2005,2006 with a term expiring at the Compensation Committee also approved a new form of Amended and Restated Change-in-Control Agreement for eachannual meeting of the executive officersCompany in 2008 and as a director of Registrant which will amend and restate the current change-in-control agreements. The change in control agreements, as amended, provide each of the executive officers with certain benefits in the event of a change in control of AWR if the executive officer’s employment is terminated other than for cause or disability or the executive terminates employment for good reason. A change in control under these agreements will generally include (i) any sale, lease, exchange or other change in ownership (in one or a series of transactions) of all or substantially all of the assets of AWR, unless its business is continued by another entity in which holders of AWR’s voting securities immediately before the event own, either directly or indirectly, more than 55% of the continuing entity’s voting securities after the event, (ii) a reorganization or merger of AWR, unless the holders of AWR’s voting securities immediately before the event own, either directly or indirectly, more than 55% of the continuing entity’s voting securities and at least a majority of the members of the continuing entity’s board of directors were members of the incumbent Board of Directors at the time that such incumbent Board of Directors took action on such reorganization or merger, or (iii) an acquisition by any person or group acting in concert of more than 55% of the voting securities of AWR, unless the holders of AWR’s voting securities immediately before the event own, either directly or indirectly, more than 55% of the acquirer’s voting securities immediately after the acquisition, (iv) the consummation of a tender offer or exchange offer by any person or group which results in that person or group owning beneficially more than 25% of the voting securities of AWR, unless the tender offer is made by AWR or onetwo of its subsidiaries, orGolden State Water Company and Chaparral City Water Company, with a term expiring on the tender offer is approved by a majoritydate of the membersannual meeting of each of these subsidiaries in 2007. There is no arrangement or understanding pursuant to which Mr. King was elected a director. Mr. King was also named as a member of the Audit and Finance Committee of the Board of Directors of AWR who were in office at the beginning of the 12 month period preceding the tender offer, or (v) a change of one-half or more of the members of the Board of Directors, unless the election or nomination for election by shareholders of new directors within such period constituting a majority of the applicable Board was approved by a vote of at least 2/3rds of the directors still in office who were in office at the beginning of the 12 month period. An executive may terminate his or her employment for good reason if the executive is assigned duties inconsistent in any respect with the executive’s position, the executive is not reappointed to such position, except as a result of death, disability or termination for cause, or any other action which results in a diminution of such position following the change in control, the executive’s compensation is reduced or the executive is located at an office that increases the distance from the executive’s home by more than 35 miles.Company.change in control agreements,terms of the Company’s Amended 2003 Non-Employee Directors Stock Plan, Mr. King was automatically granted an option to purchase 3,000 of the Common Shares of the Company at an exercise price of $36.63 per share, effective on the date of his appointment as amended, each executivea director. Each option is exercisable upon the date of grant and will expire ten years after the date of grant, unless Mr. King’s services as a director are terminated for cause. Mr. King will be entitled to receive director and committee fees on the same basis as other directors, except that Mr. King’s retainer for service as a director for the remainder of 2006, will be reduced to $3,333.33. The Board also approved the execution of an amount equal to 2.99 timesIndemnification Agreement with Mr. King in the sum of (i) his or her annual salary at the highest rate in effect during the three calendar years preceding the termination of employment, (ii) the average of the payments made to the executive during the preceding 5 calendar years under any cash compensation plan, and (iii) the average of the amount of cash receivedsame form executed by the executive duringCompany with its other directors. preceding 5 calendar years with respectsize of its Board of Directors from six to dividend equivalents credited to the account of the executive. In addition, each executive officer will be entitled to a cash lump sum payment equal to the excess of (i) the single sum actuarial equivalent of what the executive’s accrued benefits would be under the terms of the Southern California Water Company Pension Plan, or any successor plan (the “Pension Plan”) at the time of the executive’s termination of employment, whether or not vested, if the executive were credited with 3 additional years of service and (ii) the single sum actuarial equivalent of the executive’s benefits under the Pension Plan at the time of termination of employment. Health and welfare benefits will also be extended for an additional three years for the Chief Executive Officer and Chief Financial Officer and for an additional two years for each of the other executive officers. The change in control agreements also provide for a gross-up payment if any executive officer is required to pay an excise tax under Section 4999 of the Internal Revenue Code.seven.20052006 to the procedures by which shareholders may nominate persons to the Board of Directors of AWR.Item 6. Exhibits
Restated Articles of Incorporation of Golden State Water Company, as amended (1)10.1 Supplemental Executive Retirement Plan, as amended (1)(2)10.2 Letter Agreement with Mr. Sprowls regarding retirement benefits (1)(2)10.3 Form of Amended and Restated Change in Control Agreement (1)(2)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 (3)32.2Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (3)herewith.herewith(2) Management contract or compensatory benefit plan.Furnished concurrently herewith.Compensatory benefit agreement51SIGNATURE
and its subsidiary
GOLDEN STATE WATER COMPANY9, 20058, 2006