• 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 and the water revenue adjustment mechanism;

• 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 September 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                                                      $ 12,544
   Usage by new customers                                                 3,258
   Net change due to actual versus adopted results, usage, and other     (8,338 )

   Net operating revenue increase                                      $  7,464

The net change due to actual versus adopted results, usage, and other in the above table refers to the revenue impact year over year of the change in revenue recognized by the Water Revenue Adjustment Mechanism (WRAM) and Modified Cost Balancing Account (MCBA). The WRAM is impacted by changes in consumption patterns from our historical trends as well as an increase in conservation efforts. The MCBA, which records the differences in production costs from the adopted costs, is recorded as an element of revenue as it represents pass through costs which are billed to customers. The MCBA is impacted by changes in total production quantities, the production mix of the source of water, the price paid for purchased water and power, and the amount of pump taxes paid. The components of the rate increases are listed in the following table:

                   Purchased water offset increases    $  5,844
                   Step-rate increases                    2,878
                   General Rate Case (GRC) increases      2,726
                   Balancing account adjustments            271
                   Other                                    825

                   Total rate increases                $ 12,544

Total Operating Expenses
Total operating expenses were $115.1 million for the third quarter of 2009, versus $104.9 million for the same period in 2008, a 10% 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 43% of total operating expenses in the third quarter of 2009. Water production expenses increased 5% compared to the same period last year due to increased cost of purchased water and purchased power, although usage was down. Our wholly-owned operating subsidiaries, Washington Water, New Mexico Water and Hawaii Water obtain all of their water supply from wells.

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

                                     Three Months Ended September 30
                                        2009                 2008
                Well production              51 %                  51 %
                Purchased                    46 %                  45 %
                Surface                       3 %                   4 %

                Total                       100 %                 100 %

The components of water production costs are shown in the table below:

                                      Three Months Ended September 30
                                    2009              2008         Change
               Purchased water   $    35,326       $    33,858     $ 1,468
               Purchased power        10,089             9,285         804
               Pump taxes              3,483             3,312         171

               Total             $    48,898       $    46,455     $ 2,443

Purchased water costs increased due to price increases from water wholesalers. Total water production, measured in acre feet, decreased by 7% during the third quarter of 2009 as compared with the third quarter of 2008, due to lower customer usage primarily attributed to cooler weather and voluntary conservation.
Administrative and general expense and other operations expense increased 21% to $33.7 million. The primary increase was due to increased pension costs, other employee benefit costs, increased payroll expense from new employees, and increased legal expenses. On January 1, 2009, wage increases became effective and there was an increase in the number of employees. At September 30, 2009, there were 976 employees and at September 30, 2008, there were 936 employees. Maintenance expenses increased by 15% to $4.4 million in the third quarter of 2009 compared to $3.8 million in the third quarter of 2008, due to an increase 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 $0.9 million, from a provision of $13.2 million in the third quarter of 2008 to $14.1 million in the third quarter of 2009, due to a change in the effective tax rate recognized in the third quarter due to revised estimated permanent differences. We expect the effective tax rate to be between 40% and 40.7% for fiscal year 2009.
Other Income and Expense
Non-regulated revenue, net of related expenses, reflected net income of $1.0 million for the third quarter of 2009 compared to a loss of $0.4 million in the same period last year, which is an increase of $1.4 million. The change from the prior year is due to a favorable change of the cash surrender value of the life insurance contracts associated with certain benefit plans. Interest Expense
Total interest expense, net of interest capitalized, increased $1.4 million to $5.5 million for the third 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 2009.

  Rate increases                                                      $  43,330
  Increase in usage by new customers                                      9,076
  Net change due to actual verses adopted results, usage, and other     (20,163 )

  Net changes in operating revenue                                    $  32,243

The net change due to actual versus adopted results, usage, and other in the above table refers to the revenue impact year over year of the change in revenue recognized by the WRAM and MCBA. The WRAM is impacted by changes in consumption patterns from our historical trends as well as an increase in conservation efforts. The MCBA, which records the differences in production costs from the adopted costs, is recorded as an element of revenue as it is a pass through cost. The MCBA is impacted by changes in total production quantities, the production mix of the source of water, the price paid for purchased water and power, and the amount of pump taxes paid.
The components of the rate increases are listed in the following table:

                   General Rate Case (GRC) increase   $ 25,841
                   Purchased water offset increase      12,300
                   Step rate increase                    3,677
                   Balancing account adjustments           687
                   Other                                   825

                   Total rate increases               $ 43,330

Total Operating Expenses
Total operating expenses were $296.1 million for the nine-months ended September 30, 2009, versus $264.1 million for the same period in 2008, a 12% 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 40% of total operating expenses. Water production expenses increased $7.3 million in the nine-months ended September 30, 2009, or 7%, compared to the same period last year due to increased cost of purchased water and purchased power. Our wholly-owned operating subsidiaries, Washington Water, New Mexico Water and Hawaii Water, obtain all of their water supply from wells.

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

                                     Nine-months ended September 30
                                        2009                 2008
                Well production              49 %                  49 %
                Purchased                    48 %                  47 %
                Surface                       3 %                   4 %

                Total                       100 %                 100 %

The components of water production costs are shown in the table below:

                                      Nine-months ended September 30
                                      2009            2008        Change
                Purchased water   $     89,920      $  85,354     $ 4,566
                Purchased power         22,216         19,704       2,512
                Pump taxes               7,332          7,104         228

                Total             $    119,468      $ 112,162     $ 7,306

Purchased water cost increased due to higher prices from wholesalers. Included in purchased water are leases of unused water rights of $1.8 million and $1.6 million during the nine-months ended September 30, 2009 and September 30, 2008, respectively. The increase in purchased power is primarily due to the acquisitions in Hawaii last year.
Administration and general and other operations expenses were $98.8 million, increasing $18.7 million, or 23%, for the nine-months ended September 30, 2009. The increase was primarily due to increased pension and postretirement benefit costs, other benefit costs, new employees, and outside legal services. Payroll charged to operating expense increased $1.6 million for the nine-months ended September 30, 2009. Wages for union employees increased 3.0%, effective January 1, 2009. Overall payroll costs (expensed and capitalized) increased 6.7% for the nine-months ended September 30, 2009, due to increases in the number of employees and higher wage rates. At September 30, 2009, there were 976 employees and at September 30, 2008, there were 936 employees.
Maintenance expense increased for the nine-months ended September 30, 2009, increasing $0.5 million, or 4%, due to an increase in main and service repairs. Depreciation and amortization expense increased $3.0 million, or 11%, because of increased capital expenditures in 2008.
Federal and state income taxes increased $1.3 million, or 7%, for the nine-months ended September 30, 2009, due to a change in the effective tax rate due to revised estimated permanent differences and change in taxable income. We expect the effective tax rate to be between 40% and 40.7% for 2009. Other Income and Expense
Other income, net of related expenses, was $3.0 million for the nine-months ended September 30, 2009, compared to a loss of $0.1 million for the first nine-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 $3.6 million in the nine-months ended September 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 $2.2 million for the nine-month period ended September 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 nine months of 2009, there was a corresponding increase to the cash surrender value of the life insurance contracts.
Interest Expense
Net interest expense increased $1.8 million to $15.2 million for the period ended September 30, 2009, compared to the nine-month period ended September 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 $1.1 million as of September 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 in annual revenues effective in June 2009. On July 30, 2009, the CPUC issued its D.09-07-051, which adopted an all-party settlement for a cost of capital adjustment mechanism. Under the settlement, the authorized return on equity may be adjusted prospectively based on annual changes in a bond index. The mechanism has a threshold trigger of 100 basis points change in the index before any adjustment is made to Cal Water's authorized return. Cal Water does not anticipate the mechanism will trigger in 2009.

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 . . .