General

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") and its subsidiaries (Fort Bliss Water Services Company ("FBWS"), Terrapin Utility Services, Inc. ("TUS"), Old Dominion Utility Services, Inc. ("ODUS"), Palmetto State Utility Services, Inc. ("PSUS") and Old North Utility Services, Inc. ("ONUS")). AWR was incorporated as a California corporation in 1998 as a holding company. AWR has three reportable segments: water, electric and contracted services. Within the segments, AWR has three principal business units: water and electric service utility operations conducted through GSWC, a water-service utility operation conducted through CCWC, and a contracted services unit conducted through ASUS and its subsidiaries. FBWS, TUS, ODUS, PSUS and ONUS may be referred to herein collectively as the "Military Utility Privatization Subsidiaries".

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, and in 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 ("BVES") division.

GSWC served 255,028 water customers and 23,055 electric customers at September 30, 2009, or a total of 278,083 customers, compared with 254,689 water customers and 23,091 electric customers, or a total of 277,780 customers at September 30, 2008. GSWC's utility operations exhibit seasonal trends. 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 91% of total water revenues for the three months ended September 30, 2009 and 2008 and approximately 88% for the nine months ended September 30, 2009 and 2008.

CCWC is an Arizona public utility company serving 13,397 customers at September 30, 2009, compared with 13,437 customers at September 30, 2008. 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.

ASUS, through its wholly-owned subsidiaries, has contracted with the U.S. government to provide water and/or wastewater services, including both the operation and maintenance and the renewal and replacement of the water and/or wastewater systems pursuant to 50-year fixed price contracts, which are subject to periodic prospective price redeterminations and modifications for changes in circumstances. All of the contracts with the U.S. government may be terminated, in whole or in part, prior to the end of the 50-year term for convenience of the U.S. government or as a result of default or nonperformance by the subsidiary performing the contract. In either event, each Military Utility Privatization Subsidiary is entitled to recover the remaining amount of its capital investment pursuant to the terms of a termination settlement with the U.S. government at the time of termination as provided for in the contract. The contract price for each of these contracts is subject to redetermination two years after commencement of operations and every three years thereafter under the terms of the contract. Prices are subject to equitable adjustment based upon changes in circumstances, changes in laws and/or regulations, and changes in wages and fringe benefits to the extent provided in each of the contracts. AWR guarantees performance on all of ASUS' military contracts. Pursuant to the terms of these contracts, the Military Utility Privatization Subsidiaries operate, as of the effective date of their respective contracts, the following water and wastewater systems:

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

† TUS - water and wastewater systems at Andrews Air Force Base in Maryland effective February 1, 2006;

† ODUS - wastewater systems at Fort Lee in Virginia effective February 23, 2006 and the water and wastewater systems at Fort Eustis, Fort Monroe and Fort Story in Virginia effective April 3, 2006;

† PSUS - water and wastewater systems at Fort Jackson in South Carolina effective February 16, 2008; and

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

ASUS and GSWC have also been pursuing opportunities 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 and Natomas have entered into various agreements for the purchase of certain water and water rights that may allow GSWC the ability to serve portions of Sutter County in the future.

Overview

Registrant's revenues, operating income and cash flows are earned primarily through delivering potable water to homes and businesses through approximately 2,900 miles of water distribution pipelines and the delivery of electricity in the Big Bear area of San Bernardino County. Rates charged to customers of GSWC and CCWC are determined by the CPUC and ACC, respectively. These rates are intended to allow recovery of operating costs and a reasonable rate of return on capital. Factors affecting financial performance of our regulated utilities include the process and timing of setting rates charged to customers; the ability to recover, and the process for recovering in rates, the costs of distributing water and electricity and our overhead costs; weather; the impact of increased water quality standards and environmental regulations on the cost of operations and capital expenditures; pressures on water supply caused by population growth, more stringent water quality standards, deterioration in water quality and a variety of other causes; capital expenditures needed to upgrade water systems; and risks associated with litigation relating to water quality and water supply, including suits initiated by Registrant to protect its water supply.

Operating revenues and income from contracted services at ASUS and its subsidiaries are earned primarily from the operation and maintenance and renewal and replacement of the water and/or wastewater systems for the U.S. government at various military bases. All of the operations and maintenance and renewal and replacement contracts with the U.S. government are 50-year firm, fixed-price contracts with prospective price redeterminations. ASUS also may generate revenues from the construction of infrastructure improvements at these bases pursuant to the terms of these 50-year contracts or pursuant to contract modifications. Additional revenues generated by contract operations are primarily dependent on these additional construction activities. As a result, ASUS is subject to risks that are different than those of Registrant's regulated water and electric utilities. ASUS plans to continue seeking contracts for the operation and maintenance and renewal and replacement of water and/or wastewater services at military bases. Factors affecting the financial performance of our Military Utility Privatization Subsidiaries include delays in receiving payments from the U.S. government and the timing of implementation by the U.S. government of redeterminations and/or equitable adjustments of prices under contracts with the U.S. government.

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, investments in Registrant's contract business and other cash requirements. Registrant expects to fund a portion of these needs through common stock offerings, as well as from long- and short- term borrowings. In May 2009, AWR completed a public offering of 1,150,000 shares of its Common Shares, including 150,000 shares issued upon exercise of an option granted to the underwriters to cover over-allotments, at a price to the public of $31 per share. The net proceeds from the offering were $34.0 million, after deductions for underwriting commissions and discounts, and direct legal and accounting fees. The Company used the proceeds of the offering to repay short-term debt. In addition, a senior note was issued by GSWC on March 10, 2009, to CoBank, ACB ("CoBank"). Under the terms of this senior note, CoBank purchased a 6.7% Senior Note due March 10, 2019 in the aggregate principal amount of $40.0 million from GSWC. The proceeds from the sale of the note to CoBank have been used to pay down short-term borrowings, pending their use to fund capital expenditures.

Net income for the three months ended September 30, 2009 was $9.7 million compared to $4.6 million in the same period of 2008, an increase of 113.0%. Diluted earnings per share for the three months ended September 30, 2009 were $0.52 compared to $0.26 in the same period of 2008, an increase of $0.26 per share. Increasing diluted earnings per share were the following items, all of which are more fully discussed later: (i) a $3.7 million pretax unrealized loss on purchased power contracts, or $0.13 per share, for the three months ended September 30, 2008 with no corresponding loss in 2009; (ii) an increase in the dollar water margin of $4.7 million, or $0.15 per share; and (iii) the improved financial performance of the Military Utility Privatization Subsidiaries resulting in an increase in ASUS' pretax operating income of $3.9 million, or $0.12 per share (including a $1.1 million contract modification approved in September 2009 in connection with a request for equitable adjustment filed by PSUS in 2008). These increases to diluted earnings per share were partially offset by: (i) an increase in operating expenses, other than supply costs, at the Company's water and electric utilities of $2.2 million, or $0.07 per share;
(ii) an increase in interest expense, net of interest income of $553,000, or $0.02 per share; (iii) the recording of a loss on settlement for removal of wells at CCWC of $760,000, or $0.02 per share; and (iv) a decrease of $0.03 per share due to an increase in the weighted average number of common shares outstanding resulting from the issuance of 1.1 million shares of AWR's Common Shares in a public offering completed in May 2009.

Net income for the nine months ended September 30, 2009 was $26.1 million compared to $19.1 million in the same period of 2008, an increase of 36.5%.
Diluted earnings per share for the nine months ended September 30, 2009 were $1.45 compared to $1.10 in the same period of 2008, an increase of $0.35 per share. Increasing diluted earnings per share were the following items, all of which are more fully discussed later: (i) an increase in the water dollar water margin of $11.2 million, or $0.37 per share, during the nine months ended September 30, 2009 compared to the same period of 2008; (ii) a settlement agreement reached with Mirant Energy Trading, LLC and the recording of the $1.0 million proceeds received, or $0.03 per share, as a reduction in legal expenses;
(iii) the improved financial performance of the Military Utility Privatization Subsidiaries resulting in an increase in ASUS's pretax operating income of $7.1 million, or $0.23 per share (including the $1.1 million modification mentioned above); and (iv) a decrease in the effective tax rate ("ETR") and a tax benefit of $918,000 recorded in the first quarter of 2009 resulting from new California apportionment laws as well as refining certain related estimates, which favorably impacted earnings by $0.07 per share. These increases to diluted earnings per share were partially offset by: (i) a $766,000 pretax unrealized gain on purchased power contracts in 2008, or $0.03 per share, for the nine months ended September 30, 2008 with no corresponding gain in 2009; (ii) an increase in operating expenses, other than supply costs, at the Company's water and electric utilities of $6.3 million, or $0.21 per share (excluding the Mirant settlement discussed above), (iii) the recording of a $760,000 loss on settlement for the removal of wells at CCWC, or $0.02 per share; (iv) an increase in interest expenses net of interest income of $1.5 million, or $0.05 per share; and (v) a decrease of $0.04 per share due to an increase in the weighted average number of common shares outstanding resulting from the issuance of 1.1 million shares of AWR's Common Shares in a public offering completed in May 2009.

Unrealized gains and losses on previous purchased power contracts impacted GSWC's earnings since the contracts qualified as derivative instruments under the accounting guidance for derivatives. Historical purchased power contracts that impacted earnings terminated at December 31, 2008. GSWC entered into a new purchased power contract effective January 1, 2009 which is also subject to derivative accounting treatment. In May 2009, the CPUC issued a final decision approving the new purchased power contract and authorizing GSWC to establish the memorandum account to track unrealized gains and losses on the new contract throughout the term of the contract. Accordingly, at September 30, 2009 there was a $7.0 million cumulative unrealized loss which has been included in the memorandum account, therefore not impacting GSWC's earnings. There were $3.7 million of pretax unrealized losses and $766,000 of pretax unrealized gains on purchased power contracts included in earnings for the three and nine months ended September 30, 2008, respectively. Diluted earnings for the three and nine months ended September 30, 2008 were $0.26 per share and $1.10 per share, respectively. Eliminating the effects of the unrealized derivative loss and gains, adjusted diluted earnings per share for the three and nine months ended September 30, 2008 would have increased by $0.13 and decreased by $0.03 per share, respectively, to $0.39 and $1.07 per share, respectively.

Summary Results by Segment

AWR has three reportable segments: water, electric and contracts operation. Within the segments, AWR has three principal business units: water and electric service utility operations conducted through GSWC, a water-service utility operation conducted through CCWC, and a contracted services unit through ASUS and its subsidiaries.

Third Quarter Results



The tables below set forth summaries of the results by segment (amounts in
thousands):



                                Operating Revenues                             Pretax Operating Income
                    3 Months      3 Months                            3 Months       3 Months
                     Ended         Ended          $         %          Ended          Ended          $        %
                   9/30/2009     9/30/2008      CHANGE    CHANGE     9/30/2009      9/30/2008     CHANGE    CHANGE

Water              $   78,297   $     69,365   $  8,932     12.9 %  $     20,678   $     18,584   $ 2,094     11.3 %
Electric                6,563          6,743       (180 )   -2.7 %          (669 )       (4,011 )   3,342    -83.3 %
Contracted
services               16,641          9,153      7,488     81.8 %         2,456         (1,418 )   3,874   -273.2 %
AWR parent                  -              -          -        -             (10 )          (12 )       2    -16.7 %
Totals from
operations         $  101,501   $     85,261   $ 16,240     19.0 %  $     22,455   $     13,143   $ 9,312     70.9 %

Water - For the three months ended September 30, 2009, pretax operating income for water increased by $2.1 million, or 11.3%, primarily due to a $4.7 million increase in the water dollar margin as compared to the same period in 2008, partially offset by an increase in operating expenses, including higher pension costs. The dollar water margin increased due to higher water rates approved by the CPUC subsequent to September 30, 2008. These higher water rates increased water revenue by $2.9 million, partially offset by lower actual consumption. In addition, as a result of implementing the Water Revenue Adjustment Mechanism ("WRAM") accounts in Regions II and III in late November 2008 and in Region I in September 2009, GSWC recorded $8.6 million of additional revenues for the three months ended September 30, 2009. The revenue requirement and volumetric revenues are adopted as part of a General Rate Case ("GRC") every three years.
We expect to file Region I's next GRC in January 2010, with rates effective January 2011 and 2012, and a GRC for all three water regions in July of 2011 with rates effective January 2013. As part of future GRCs, the CPUC is expected to adopt new volumetric revenues based on historical usage patterns and the revenue requirement adopted in these GRCs.

Although the recording of the WRAM added $8.6 million of water revenues, this favorable impact to earnings was reduced by $1.6 million of water supply over-collection costs tracked in the Modified Cost Balancing Account ("MCBA"), also implemented in late November 2008 for Regions II and III and in September 2009 for Region I. The over-collection in the MCBA account is due to:
(i) lower consumption in the third quarter of 2009 as compared to the consumption level adopted by the CPUC, and (ii) a lower percentage of purchased water in the supply mix during 2009 when compared to the supply mix included in customer rates, partially offset by increases in rates charged by GSWC's suppliers. The implementation of the WRAM and MCBA help mitigate fluctuations in the Company's earnings caused by changes in the volume of water sold and supply costs.

Electric - For the three months ended September 30, 2009 as compared to the same period in 2008, pretax operating income from electric operations increased by $3.3 million due in large part to a $3.7 million pretax unrealized loss on purchased power contracts recorded in 2008. This unrealized loss on purchased power contracts decreased operating income by approximately $3.7 million during the third quarter of 2008, or $0.13 per share, with no corresponding loss in 2009. As previously discussed, the purchased power contract that resulted in unrealized gains and losses to BVES' earnings terminated at December 31, 2008. Excluding the effects of the unrealized loss in 2008, BVES pretax operating loss increased by approximately $400,000 from $270,000 for the three months ended September 30, 2008 to $669,000 for the same period of 2009. This was primarily due to an increase in administrative and general expenses resulting from higher outside legal and consulting costs associated with the general rate case.

Contracted Services - For the three months ended September 30, 2009, pretax operating income for contracted services increased by $3.9 million, or $0.12 per share. This was primarily due to an interim increase in operations and maintenance revenues at FBWS, an increase in construction revenues at FBWS and ODUS, and lower overall operating expenses. In addition, on September 30, 2009, the U.S. government approved $1.1 million in revenues for a Request for Equitable Adjustment ("REA") filed by PSUS for emergency construction costs mostly incurred in 2008. As a result of the approved REA, ASUS recorded $1.1 million in additional construction revenues and operating income for the three months ended September 30, 2009. ONUS also had an increase of $273,000 in pretax operating income for the three months ended September 30, 2009 due to lower operating expenses.

The timely receipt of price redeterminations continues to be critical in order for ASUS to recover increasing costs for operating and maintaining the water and wastewater systems at the military bases. In addition, higher allocations of expenses from the General Office and ASUS headquarters to the Military Utility Privatization Subsidiaries were not contemplated at the time the contracts with the U.S. government were negotiated and will be addressed in future price redeterminations. Under the terms of these contracts, the contract price is subject to price redetermination two years after commencement of operations and every three years thereafter.

Redeterminations have been submitted and are under review by the U.S. government for operations of ODUS and TUS in Virginia and Maryland, respectively. The price redeterminations for ODUS and TUS are expected to be completed in late 2009 and in 2010, respectively. Pending redetermination of prices, ASUS has received interim inflation adjustments during 2008 to the management fees for operating and maintaining the water and wastewater systems for military bases in Virginia, and the wastewater system at Fort Lee also in Virginia effective on the second anniversary of the date when ASUS began operating these bases (February 23, 2008 for Fort Lee and April 3, 2008 for the other three bases).

In March 2009, ONUS filed an REA related to a joint inventory report for Fort Bragg in North Carolina. The report indicated the quantity of the ONUS infrastructure to be about 40% greater than what was assumed under the original 50-year contract. The REA is expected to be resolved during the fourth quarter of 2009. First price redetermination filings for Fort Jackson and Fort Bragg are also expected to be filed by PSUS and ONUS, respectively, during the fourth quarter of 2009.

FBWS has experienced delays in the redetermination of prices at Fort Bliss following completion of the first two years of operation in October 2006. At Fort Bliss, management fees for operation and maintenance of the water and wastewater systems are based on cost levels prevailing in 2003 when the contract with the U.S. government was bid. Further, the contract pricing was also based on assumptions about the size and age of the infrastructure to be operated and maintained over the 50-year contract. An REA has been filed as a claim with the U.S. government to adequately reflect the amount of assets included in the infrastructure at Fort Bliss, which is substantially more than originally estimated by the U.S. government as part of its solicitation for this contract. In December 2008, the U.S. government approved an interim adjustment for FBWS which increased the monthly water and wastewater fees by 50% and 59%, respectively, related to operating and maintaining the Fort Bliss systems. The increase was retroactive to October 1, 2008 and expired on September 30, 2009. FBWS is negotiating with the government to extend the interim increases while continuing negotiations to finalize the adjustment necessary due to the increased infrastructure. FBWS also intends to file its first price redetermination request for Fort Bliss during the fourth quarter of 2009 followed by the second redetermination request shortly thereafter.

These price redeterminations and equitable adjustments, which include adjustments to reflect changes in operating conditions and infrastructure levels from that assumed at the time of the execution of the contracts, as well as inflation in costs, are expected to provide added revenues prospectively to help offset increased costs and provide Registrant the opportunity to generate positive operating income at its Military Utility Privatization Subsidiaries. As of September 30, 2009, ASUS has $1.1 million of goodwill, which may be at risk for potential impairment if requested price redeterminations and equitable adjustments that have not yet been approved, are not received.

In September 2009, the U.S. government issued contract modifications to subsidiaries of ASUS. The modifications provided funding for $7.3 million in new construction projects at FBWS, ODUS, TUS and ONUS. The majority of this work will be performed during calendar year 2010. Earnings and cash flows from amendments and modifications for additional construction projects to the original 50-year contracts with the U.S. government may or may not continue in future periods.

Year-to-Date Results



The tables below set forth summaries of the results by segment (amounts in
thousands):



                               Operating Revenues                             Pretax Operating Income
                    9 Months     9 Months                           9 Months       9 Months
                     Ended        Ended         $         %          Ended          Ended          $         %
                   9/30/2009    9/30/2008     CHANGE    CHANGE     9/30/2009      9/30/2008      CHANGE    CHANGE

Water              $  209,248   $  186,824   $ 22,424     12.0 %  $     55,060   $     48,808   $  6,252     12.8 %
Electric               21,083       21,754       (671 )   -3.1 %        (1,141 )        1,073     (2,214 ) -206.3 %
Contracted
services               44,332       25,938     18,394     70.9 %         4,539         (2,567 )    7,106   -276.8 %
AWR parent                  -            -          -        -             (71 )         (128 )       57    -44.5 %
Totals from
operations         $  274,663   $  234,516   $ 40,147     17.1 %  $     58,387   $     47,186   $ 11,201     23.7 %

Water - Pretax operating income for water increased by $6.3 million, or 12.8%, primarily due to an $11.2 million increase in the dollar water margin as compared to the same period in 2008, partially offset by an increase in operating expenses including higher pension costs. The dollar water margin increased due to higher water rates approved by the CPUC subsequent to September 30, 2008. These higher water rates increased water revenue by approximately $6.9 million, partially offset by lower actual consumption. In addition, as a result of implementing the WRAM accounts in all its water regions, GSWC recorded $15.2 million of additional revenues for the nine months ended September 30, 2009.

Although the recording of the WRAM added $15.2 million of water revenues, this favorable impact to earnings was reduced by $3.4 million of water supply over-collection costs tracked in the MCBA account, also implemented in all of GSWC's water regions. The over-collection in the MCBA account is due to:
(i) lower consumption for the nine months ended September 30, 2009 as compared to the consumption level approved by the CPUC, and (ii) a lower percentage of purchased water in the supply mix during 2009 when compared to the supply mix . . .