• changes in regulatory commissions' policies and procedures;

• the timeliness of regulatory commissions' actions concerning rate relief;

• changes in the capital markets and access to sufficient capital on satisfactory terms;

• new legislation;

• changes in accounting valuations and estimates;

• changes in accounting treatment for regulated companies, including adoption of International Financial Reporting Standards, if required;

• electric power interruptions;

• increases in suppliers' prices and the availability of supplies including water and power;

• fluctuations in interest rates;

• changes in environmental compliance and water quality requirements;

• acquisitions and the ability to successfully integrate acquired companies;

• the ability to successfully implement business plans;

• civil disturbances or terrorist threats or acts, or apprehension about the possible future occurrences of acts of this type;

• the involvement of the United States in war or other hostilities;

• our ability to attract and retain qualified employees;

• labor relations matters as we negotiate with the unions;

• implementation of new information technology systems;

• restrictive covenants in or changes to the credit ratings on current or future debt that could increase financing costs or affect the ability to borrow, make payments on debt, or pay dividends;

• general economic conditions, including changes in customer growth patterns and our ability to collect billed revenue from customers;

• changes in customer water use patterns and the effects of conservation;

• the impact of weather on water sales and operating results;

• the ability to satisfy requirements related to the Sarbanes-Oxley Act and other regulations on internal controls; and

• the risks set forth in "Risk Factors" included elsewhere in this quarterly report.

In light of these risks, uncertainties and assumptions, investors are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this quarterly report or as of the date of any document incorporated by reference in this report, as applicable. When considering forward-looking statements, investors should keep in mind the cautionary statements in this quarterly report and the documents incorporated by reference. We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.
CRITICAL ACCOUNTING POLICIES
We maintain our accounting records in accordance with accounting principles generally accepted in the United States of America (GAAP) and as directed by the regulatory commissions to which we are subject. The process of preparing financial statements in accordance with GAAP requires the use of estimates and assumptions on the part of management. The estimates and assumptions used by management are based on historical experience and our understanding of current facts and circumstances. Management believes that the following accounting policies are critical because they involve a higher degree of complexity and judgment, and can have a material impact on our results of operations and financial condition. These policies and their key characteristics are discussed in detail in the 2008 Form 10-K. They include:
• revenue recognition;

• expense balancing and memorandum accounts;

• modified cost balancing accounts;

• regulatory utility accounting;

• income taxes;

• pension benefits;

• workers' compensation, general liability and other claims; and

• contingencies

For the period ended June 30, 2009, there were no changes in the methodology for computing critical accounting estimates, no additional accounting estimates met the standards for critical accounting policies, and there were no material changes to the important assumptions underlying the critical accounting estimates.

              Rate increases                              $  19,199
              Decrease in usage by existing customers       (11,941 )
              Usage by new customers                          3,390
              Net revenue decrease due to WRAM and MCBA        (352 )
              Other                                             791

              Net operating revenue increase              $  11,087

The components of the rate increases are listed in the following table:

                   General Rate Case (GRC) Increases   $ 14,131
                   Purchased Water Offset Increases       4,406
                   Balancing Account Adjustments            248
                   Step Rate Increases                      414

                   Total Increase in Rates             $ 19,199

Total Operating Expenses
Total operating expenses were $100.7 million for the second quarter of 2009, versus $91.1 million for the same period in 2008, an 11% increase.
Water production expense consists of purchased water, purchased power, and pump taxes. It represents the largest component of total operating expenses, accounting for approximately 41% of total operating expenses in the second quarter of 2009. Water production expenses increased 3% compared to the same period last year due to increased cost of purchased water and purchased power, although usage was down.
Sources of water as a percent of total water production are listed in the following table:

                                       Three Months Ended June 30
                                         2009                2008
                 Well production             49 %                 50 %
                 Purchased                   47 %                 46 %
                 Surface                      4 %                  4 %

Our wholly-owned operating subsidiaries, Washington Water, New Mexico Water and Hawaii Water obtain all of their water supply from wells. The components of water production costs are shown in the table below:

                                        Three Months Ended June 30
                                       2009          2008       Change
                  Purchased water   $   31,654     $ 30,785     $   869
                  Purchased power        7,584        6,965         619
                  Pump taxes             2,464        2,599        (135 )

                  Total             $   41,702     $ 40,349     $ 1,353

Purchased water costs increased due to price increases from water wholesalers. Total water production, measured in acre feet, decreased by 11% during the second quarter of 2009 as compared with the second quarter of 2008 due to lower customer usage primarily attributed to cooler weather.
Administrative and general expense and other operations expense increased 27% to $33.7 million. The primary increase was due to increased pension and postretirement benefit costs, other benefit costs, and outside legal services. Effective January 1, 2009, wage increases became effective and there was an increase in the number of employees. At June 30, 2009, there were 956 employees and at June 30, 2008, there were 922 employees.
Maintenance expenses decreased by 13% to $4.3 million in the second quarter of 2009 compared to $4.9 million in the second quarter of 2008, due to decrease in main and service repairs. Depreciation and amortization expense increased $1.0 million, or 11%, because of 2008 capital additions.
Federal and state income taxes charged to operating expenses and other income and expenses increased $1.1 million, from a provision of $6.7 million in the second quarter of 2008 to $7.8 million in the second quarter of 2009, due to an increase in pretax income. We expect the effective tax rate to be between 38% and 40% for fiscal year 2009.
Other Income and Expense
Non-regulated revenue, net of related expenses, and gain on sale of non-utility property reflected net income of $1.5 million for the second quarter of 2009, compared to a gain of $0.4 million in the same period last year, which is an increase of $1.1 million. The change from the prior year is due to a favorable change to the cash surrender value of the life insurance contracts associated with our benefit plans.
Interest Expense
Total interest expense, net of interest capitalized, increased $0.6 million to $5.3 million for the second quarter of 2009 compared to the same period last year. This increase was attributable to the additional interest on the first mortgage bonds issued in April less increased capitalized interest on construction activity.

              Rate increases                              $  30,785
              Decrease in usage by existing customers       (17,151 )
              Increase in usage by new customers              5,818
              Net revenue increase due to WRAM and MCBA       4,631
              Other                                             695

              Net changes in operating revenue            $  24,778

The components of the rate increases are listed in the following table:

                   General Rate Case (GRC) Increase   $ 23,115
                   Purchased Water Offset Increase       6,455
                   Step Rate Increase                      798
                   Balancing Account Adjustments           417

                   Total increase in rates            $ 30,785

Total Operating Expenses
Total operating expenses were $181.1 million for the six months ended June 30, 2009, versus $159.2 million for the same period in 2008, a 14% increase. Water production expense consists of purchased water, purchased power and pump taxes. Water production expense represents the largest component of total operating expenses, accounting for approximately 39% of total operating expenses. Water production expenses increased $4.9 million in the six months ended June 30, 2009, or 7% compared to the same period last year due to increased cost of purchased water and purchased power.

Sources of water production as a percent of total water production are listed on the following table:

                                        Six Months Ended June 30
                                         2009               2008
                  Well production            47 %                46 %
                  Purchased                  49 %                50 %
                  Surface                     4 %                 4 %

                  Total                     100 %               100 %



Our wholly-owned operating subsidiaries, Washington Water, New Mexico Water and
Hawaii Water, obtain all of their water supply from wells. The components of
water production costs are shown in the table below:

                                         Six Months Ended June 30
                                       2009         2008       Change
                   Purchased water   $ 54,594     $ 51,496     $ 3,098
                   Purchased power     12,127       10,419       1,708
                   Pump taxes           3,849        3,792          57

                   Total             $ 70,570     $ 65,707     $ 4,863

Purchased water cost increased due to higher prices from wholesalers. Included in purchased water are credits received from certain wholesale suppliers and the sale of unused water rights. There were no significant credits during the six months ended June 30, 2009 and June 30, 2008. The increase in purchased power and pump taxes is due to the acquisitions in Hawaii last year.
Administration and general and other operations expenses were $65.0 million, increasing $12.9 million, or 25%, for the six months ended June 30, 2009. The primary increase was due to the increased pension and postretirement benefit costs, other benefit costs, and outside legal services. Payroll charged to operating expense increased $1.8 million for the six months ended June 30, 2009. Wages for union employees increased 3.1%, effective January 1, 2009. Overall payroll costs (expensed and capitalized) increased 6.9% for the six months ended June 30, 2009, due to increases in the number of employees and higher wage rates. At June 30, 2009, there were 956 employees and at June 30, 2008, there were 922 employees.
Maintenance expense was down for the six months ended June 30, 2009, decreasing $0.1 million, or 1%. Depreciation and amortization expense increased $2.0 million, or 11%, because of increased capital expenditures in 2008. Federal and state income taxes increased $2.6 million, or 38%, for the six months ended June 30, 2009, due to the change in taxable income. We expect the effective tax rate to be between 38% and 40% for 2009. Other Income and Expense
Other income, net of related expenses was $2.0 million for the six months ended June 30, 2009, compared to $0.3 million for the first six-months of 2008. The change from the prior year is due to an increase in non-utility service revenues and a gain on the sale of non-utility property. In addition, other expense was reduced by a gain in cash surrender value of life insurance contracts associated with our benefit plans of $1.8 million in the six months ended June 30, 2009. In the prior year we recorded a loss (reduction) in cash surrender value of life insurance contracts associated with our benefit plans of $1 million for the six-month period ended June 30, 2008. The cash surrender value is determined in part by the market of certain underlining funds, the value of which reflects changes in the stock market. Due to a significant increase in the stock market in the first six months of 2009, there was a corresponding impact to the cash surrender value of the life insurance contracts. Interest Expense
Net interest expense increased $0.4 million to $9.7 million for the period ended June 30, 2009 compared to the six-month period ended June 30, 2008. This increase was attributable to the additional interest on the first mortgage bonds issued in April 2009 less increased capitalized interest on construction activity.

REGULATORY MATTERS
Rates and Regulations
The state regulatory commissions have plenary powers setting rates and operating standards. As such, state commission decisions significantly impact our revenues, earnings, and cash flows. The amounts discussed herein are generally annual amounts, unless specifically stated, and the financial impact to recorded revenue is expected to occur over a 12-month period from the effective date of the decision. In California, water utilities are required to make several different types of filings. Most filings result in rate changes that remain in place until the next General Rate Case (GRC). As explained below, surcharges and surcredits to recover balancing and memorandum accounts as well as interim rate true-ups are temporary rate changes, which have specific time frames for recovery.
GRCs, step rate increase filings, and offset filings change rates to amounts that will remain in effect until the next GRC. The CPUC follows a rate case plan, which requires Cal Water to file a GRC for each of its 24 regulated operating districts every three years. In a GRC proceeding, the CPUC not only considers the utility's rate setting requests, but may also consider other issues that affect the utility's rates and operations. Effective in 2004, Cal Water's GRC schedule was shifted from a calendar year to a fiscal year with test years commencing on July 1st of each year. The CPUC is generally required to issue its GRC decision prior to the first day of the test year or authorize interim rates. As such, Cal Water's GRC decisions, prior to 2005, were generally issued in the fourth quarter. Effective with the 2009 GRC, the processing time is scheduled for eighteen months with rates effective on January 1, 2011. Between GRC filings utilities may file escalation rate increases, which allow the utility to recover cost increases, primarily from inflation and incremental investment, during the second and third years of the rate case cycle. However, escalation rate increases are subject to a weather-normalized earnings test. Under the earnings test, the CPUC may reduce the escalation rate increase to prevent the utility from earning in excess of the authorized rate of return for that district.
In addition, utilities are entitled to file offset filings. Offset filings may be filed to adjust revenues for construction projects authorized in GRCs when the plant is placed in service or for rate changes charged to the Company for purchased water, purchased power, and pump taxes (referred to as "offsettable expenses"). Such rate changes approved in offset filings remain in effect until a GRC is approved. Additional information on the Company's regulatory process is described in its annual report on Form 10-K dated March 2, 2009. Remaining Unrecorded Balances from Previously Authorized Balancing Accounts Recoveries/Refunds
The total of unrecorded, under-collected memorandum and balancing accounts was approximately $0.9 million as of June 30, 2009. 2009 Regulatory Activity to Date
Cost of Capital Application
On May 1, 2008, Cal Water filed an application in compliance with the Rate Case Plan to establish an allowable cost of capital for 2009, 2010, and 2011. The cost of capital evaluation includes such issues as the authorized return on equity, the cost of debt, and the equitable capital structure for Cal Water. This application, A.08-05-002, was considered along with similar applications from two other multi-district California water utilities. On May 7, 2009, the CPUC issued D.09-05-019 ruling on these issues and adopting a cost of capital for Cal Water for 2009. The CPUC authorized Cal Water a 10.20% return on equity, the same provision as had been last adopted by the CPUC for Cal Water in 2007 and 2008. The decision also allowed a capital structure of 53% equity and 47% debt. Finally, the decision also allowed a temporary interest rate balancing account to insulate the utilities and their ratepayers from volatile debt financing costs due to market uncertainty. The total effect of the decision was a rate decrease, of $1.8 million effective June 2009 through July 2010. As of July 31, 2009, the CPUC had not yet ruled on a proposed all-party settlement in the proceeding that would establish a mechanism for adjusting return on equity in 2010 and 2011. Cal Water cannot predict whether or when the CPUC may issue a decision regarding these issues.

2009 California General Rate Case Filing On July 2, 2009, Cal Water filed its required application for a general review of rates for all operating districts and general operations. The application,
A.09-07-001, requests an annual increase in rates of $70.6 million on January 1, 2011, $24.8 million on January 1, 2012, and $24.8 million on January 1, 2013. The filing marks the beginning of an eighteen month review process. As a result, and based on past experience, Cal Water cannot predict at this time the ultimate rate change the Commission will order. The Commission is generally required under state law to allow Cal Water interim rates and an effective date of January 1, 2011 if a decision is not rendered in the proceeding by that date. Request for MTBE regulatory treatment
On July 10, 2009, Cal Water filed an application requesting the CPUC adopt ratemaking treatment of proceeds from its partial settlement of MTBE contamination litigation. Cal Water has requested that all of the proceeds be reinvested in infrastructure to treat or replace MTBE-contaminated facilities. In addition, Cal Water has requested that 50% of the reinvestment be included in rate base upon which Cal Water could earn its authorized fair and reasonable rate of return. The remaining 50% of the settlement proceeds would be included in rate base as contributions in aid of construction which does not earn a return. Cal Water has also requested specific regulatory treatment of future settlement or litigation proceeds that may occur in the consolidated MTBE cases. The CPUC has also opened a "rulemaking" proceeding, R.09-03-014, to consider, among other things, whether it should adopt a standard policy for ratemaking treatment of litigation proceeds. This rulemaking is scheduled to be concluded in the second quarter of 2010. The CPUC has previously authorized a wide range of regulatory treatments of contamination litigation proceeds. Due to the open policy proceeding and the considerable variability in the CPUC's past treatment of contamination litigation proceeds, Cal Water cannot predict the outcome or timing of a decision in this proceeding at this time. Washington 2009 General Rate Case Filing On May 12, 2009, Washington Water Service Company filed a general rate increase for its regulated operations with the Washington Utilities and Transportation Commission (WUTC). Washington Water requested increases of $1.9 million on an annual basis. On July 30, 2009, the WUTC agreed to a revised revenue requirement of $1.2 million in additional annual revenue and revised rates. Other 2009 Regulatory filings
In January and February 2009, Cal Water filed advice letters to offset increased purchased water and pump tax rates in eight of its regulated districts totaling $11.7 million in annual revenue. Under CPUC advice letter processing rules, Cal Water charges the rates to its customers upon filing of the expense offset advice letter. These rates were approved in late February 2009. However, expense offsets are dollar-for-dollar increases in revenue to match increased expenses and interact with the WRAM and MCBA mechanisms so that net operating income is not affected by an offset increase.
In January 2009 the City of Hawthorne approved Cal Water's requested rate increase for its leased water system. The increase will take effect in phases, with a $0.8 million annual increase in February 2009, a $1.0 million annual increase in July 2009, and a $1.2 million annual increase in January 2010. In January 2009 Cal Water filed an application to the CPUC for approvals and consents related to its secured debt offering, which was completed on April 17, 2009. The application included, among other things, requests for (i) a waiver of . . .