• 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 annual 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 March 31, 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                                      $ 11,586
           Net revenue increase due to WRAM and MCBA              4,983
           Decrease in usage by existing customers and other     (5,306 )
           Usage by new customers                                 2,429

           Net operating revenue increase                      $ 13,692

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

                   General Rate Case (GRC) Increases   $  8,985
                   Purchased Water Offset Increases       2,049
                   Balancing Account Adjustments            168
                   Step Rate Increases                      384

                   Total Increase in Rates             $ 11,586

Total Operating Expenses
Total operating expenses were $80.3 million for the first quarter of 2009, versus $68.1 million for the same period in 2008, an 18% 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 36% of total operating expenses in the first quarter of 2009. Water production expenses increased 14% compared to the same period last year due to increased cost of all components of water production, although usage was down.
Sources of water as a percent of total water production are listed in the following table:

                                      Three Months Ended March 31
                                      2009                  2008
                Well production              42 %                  44 %
                Purchased                    54 %                  52 %
                Surface                       4 %                   4 %

                Total                       100 %                 100 %

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 March 31
                                       2009           2008       Change
                  Purchased water   $   22,940      $ 20,711     $ 2,229
                  Purchased power        4,543         3,454       1,089
                  Pump taxes             1,385         1,193         192

                  Total             $   28,868      $ 25,358     $ 3,510

Purchased water costs increased primarily due to price increases from water wholesalers. Total water production measured in acre feet decreased by 6% during the first quarter of 2009 as compared with the first quarter of 2008 due to higher precipitation, as compared to the same period in 2008.
Administrative and general expense and other operations expense increased 23% to $31.3 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 March 31, 2009, there were 925 employees and at March 31, 2008, there were 907 employees.
Maintenance expenses increased by 13% to $4.6 million in the first quarter of 2009 compared to $4.1 million in the first quarter of 2008, due to increase in main 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 $1.0 million, from a provision of $0.1 million in the first quarter of 2008 to $1.2 million in the first 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 income of $0.5 million for the first quarter of 2009, compared to a loss of $0.1 million in the same period last year, which is an increase of $0.6 million. The change from the prior year is due to the gain on sale of non-utility property.
Interest Expense
Total interest expense, net of interest capitalized, decreased $0.2 million to $4.4 million for the first quarter of 2009 compared to the same period last year. This decrease was attributable to the increased capitalized interest resulting from capital expenditure 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 the catch-up 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, but are now expected to be issued in the second quarter of each year until 2011, when the updated rate case plan takes effect. A decision on the eight GRCs filed in July of 2006 was delayed beyond July 1, 2007. As required by state law, the CPUC authorized interim rates incorporating the last twelve-months change in CPI. A final decision on the 2006 GRC was made on December 20, 2007 with final rates billed effective on January 1, 2008. A provision in the final decision allows recovery of the revenue lost due to the delay over a twelve-month period beginning in the first quarter of 2008.
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.
Surcharges and surcredits, which are usually effective for a twelve-month period, are authorized by the CPUC to recover the memorandum and balancing accounts under- and over- collections usually due to changes in offsettable expenses. However, significant under-collection may be authorized over multiple years. Typically, an expense difference occurs during the time period from when an offsettable expense rate changes and we are allowed to adjust its water rates. Expense changes for this regulatory lag period, which may exceed two months, are booked into memorandum and balancing accounts for later recovery. These accounts are subject to reasonableness reviews. Future recovery of balancing account balances will be addressed in general rate cases or by advice letter filings if the account balance is greater than 2% of revenues. As of December 31, 2008 and March 31, 2009, the amount in the balancing accounts was $1.5 million and $1.2 million, respectively.
We do not record an asset (or liability) for the recovery (or refund) of expense balancing or memorandum accounts in our consolidated financial statements as revenue (refunds), nor as a receivable (or payable), until the CPUC and other regulators have authorized recovery and the customer is billed. Therefore, a timing difference may occur between when costs are recorded as an expense and the associated revenues are received (or refunds are made) and booked. Remaining Unrecorded Balances from Previously Authorized Balancing Accounts Recoveries/Refunds
The total of unrecorded, under-collected memorandum and balancing accounts was approximately $1.2 million as of March 31, 2009. Included in this amount, Cal Water has amounts from districts that are pending further action when balances become large enough to warrant action of either recovery or refund. Rate Case Plan
In December 2005, the CPUC issued the California Water Action Plan. The plan focuses on four key principles, among other things, including safe, high quality water; highly reliable water supplies; efficient use of water; and reasonable rates and viable utilities. In accordance with the Water Action Plan's objective to streamline regulatory decision-making the CPUC issued R.06-12-016 in December 2006, to address streamlining of its water rate case plan. The CPUC issued D.07-05-062 on May 24, 2007 adopting a new rate case plan. As a result, Cal Water will be filing a company-wide general rate case every three years beginning in July 2009. Rates would be effective approximately 18 months from the filing date or January 1, 2011 in the first cycle. As an interim measure, the CPUC allowed Cal Water to incorporate general operations costs including company benefits in rates for all districts in July 2008 after a decision in its 2007 general rate case. In addition, for the sixteen districts that have a delayed effective date, the CPUC will authorize interim rates from the authorized effective date under the old rate case plan. These interim rates will be subject to adjustment based on a final determination in the 2009 general rate case filing. In addition to general rate case processing, the RCP set a schedule for separate cost of capital applications. Under the RCP, Cal Water must file its cost of capital application every three years. The first application under this procedure was made on May 1, 2008. Cal Water's 2008 cost of capital application was consolidated with applications of two other multi-district Class A water utilities into a combined proceeding.

2009 Regulatory Activity to Date
In January and February 2009, Cal Water filed advice letters to offset increased purchased water and pump tax rates in seven of its regulated districts totaling $9.9 million in annual revenue. Under CPUC advice letter processing rules, Cal Water charges the rates in expense offset advice letters to its customers upon filing. 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 revenue 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 a CPUC policy, which would allow debt offerings by Cal Water of up to $100 million in principal amount be conducted through a single underwriter and
(ii) clarification that complying with the terms of the indenture for the outstanding unsecured notes by granting the holders a first mortgage security interest upon the issuance of additional first mortgage debt does not use any of the Cal Water's previously used financing authorization. This application was approved by the Commission in March 2009. On March 30, 2009, the CPUC issued decision 09-03-038 granting Cal Water (i) a competitive bidding rule exemption for the issuance of $100 million of first mortgage bonds to the extent that no one purchaser from Cal Water is permitted to acquire more than $20 million in debt in a calendar year, (ii) authority to exchange $260 million of its senior notes for first mortgage bonds without obtaining additional financing authority, and (iii) a competitive bidding rule exemption for an exchange of $260 million of senior notes for first mortgage bonds. Throughout the calendar year, Cal Water plans to file advice letters to offset expected increases in purchased water and pump tax charges in some districts. Cal Water cannot predict the exact timing or dollar amount of the changes. 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 revenue is not affected by an offset increase. In May 2009, as allowed in the Commission's 2007 Rate Case Plan, Cal Water intends to file advice letters for interim rate increases for eight districts effective in July 2009. Under the Commission's prior rate case plan, these districts would have had rates effective in July 2009. The interim rate changes will be adjusted once the Commission has issued a determination in Cal Water's 2009 GRC, expected in the fourth quarter of 2010. In May 2009, Cal Water intends to file for step rate increases effective in July for sixteen districts. The CPUC's current practice on approving step rate increases is based partly on inflation through March 2009. Inputs to the weather-adjusted earnings test include recorded information through March 2009. Therefore, Cal Water does not know the amount of its request at this time. In July 2009, Cal Water is required to file a GRC covering all 24 regulated districts and general expenses. Cal Water expects the CPUC to issue a decision in the proceeding in the fourth quarter of 2010 with rates effective in January 2011. Cal Water cannot predict the magnitude of any potential rate changes at this time.
LIQUIDITY
Cash flows from Operations
Cash flows from operations were $11.5 million for the first quarter of 2009. Cash flows from operations is primarily generated by changes in our operating assets and liabilities. Cash generated by operations varies during the year which is dependent upon customer billings and timing of estimated tax payments. During the first quarter of 2009, we made contributions to our pension and retiree health care plan of $11.6 million compared to $176 paid during the first quarter of 2008. As approved in the 2007 General Rate Case, we will be increasing the funding level of our pension and retiree health care plan compared with prior years.
The water business is seasonal. Revenue is lower in the cool, wet winter months when less water is used compared to the warm, dry summer months when water use is highest. This seasonality results in the possible need for short-term borrowings under the bank lines of credit in the event cash is not available during the winter period. The increase in cash flows during the summer allows short-term borrowings to be paid down. Customer water usage can be lower than normal in years when more than normal

precipitation falls in our service areas or temperatures are lower than normal, especially in the summer months. The reduction in water usage reduces cash flows from operations and increases the need for short-term bank borrowings. In addition, short-term borrowings are used to finance capital expenditures until long-term financing is arranged.
Investing Activities
During the first quarter of 2009, we had company-funded capital expenditures of $23.5 million. For 2009, our capital budget is approximately $100 to $120 million.
Financing Activities
During the first quarter of 2009, there were no debt or equity offerings; however, we began to utilize our bank lines of credit as anticipated. In April 2009, Cal Water issued $100 million of First Mortgage Bonds at the rate of 5.875 due in 2019, which are fully and unconditionally guaranteed by the Company. Proceeds were used to pay down Cal Water's short-term borrowings and will be added to Cal Water's general funds to be used for capital expenditures and other corporate items. Dividend payments were higher than the prior year due to an increased dividend rate paid in the current year. Short-Term and Long-Term Debt
Short-term liquidity is provided by bank lines of credit funds extended to us and certain of our subsidiaries and by internally generated funds. Long-term financing is accomplished through the use of both debt and equity. As of March 31, 2009, there were short-term borrowings of $52 million outstanding on the line of credit. There were short-term bank borrowings of $40 million at December 31, 2008.
There were no significant additions to long-term debt in the first quarter of 2009, and we made principal payments on our first mortgage bonds and other long-term debt payments of $483 during the first quarter of 2009. As noted above, subsequent to March 31, 2009, we issued $100 million of First Mortgage Bonds. In connection with this issuance, Cal Water's outstanding senior notes in the aggregate principal amount of $259 million were exchanged for first mortgage bonds with the same interest rate and maturities the previously outstanding senior notes for which they were exchanged.
Long-term financing, which includes senior notes, other debt securities, and common stock, has typically been used to replace short-term borrowings and fund capital expenditures. Internally generated funds, after making dividend payments, provide positive cash flow, but have not been at a level to meet the needs of our capital expenditure requirements. Management expects this trend to continue given our capital expenditures plan for the next 5 years. Some capital expenditures are funded by payments received from developers for contributions in aid of construction or advances for construction. Funds received for contributions in aid of construction are non-refundable, whereas funds classified as advances in construction are refundable. Management believes long-term financing is available to meet our cash flow needs through issuances in both debt and equity instruments.
Credit Ratings
Cal Water's first mortgage bonds are rated by Standard & Poor's (S&P). Since 2004, the credit rating agency has maintained their rating of A+ and characterized us as stable. On April 8, 2009, Standard & Poor's issued a rating of AA- on the 5.875% $100 million First Mortgage Bonds issued in April. If rating were downgraded in the future, it may result in a higher interest rate on future debt.
Dividends, Book Value and Shareholders
The first quarter common stock dividend of $0.2950 per share was paid on February 20, 2009, compared to a quarterly dividend in the first quarter of 2008 of $0.2925. This was Cal Water's 257th consecutive quarterly dividend. Annualized, the 2009 dividend rate is $1.18 per common share, compared to $1.17 in 2008. For the full year 2008, the payout ratio was 62% of net income. On a long-term basis, our goal is to achieve a dividend payout ratio of 60% of net income accomplished through future earnings growth.
At its April 29, 2009 meeting, the Board declared the second quarter dividend of $0.2950 per share payable on May 15, 2009, to stockholders of record on May 4, 2009. This will be our 258th consecutive quarterly dividend.

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