Regulatory Matters:

9 Months Ended

Sep. 30, 2012

Regulatory Matters:

Regulatory Matters:

Note 2 — Regulatory Matters:

In accordance with accounting principles for rate-regulated enterprises, Registrant records regulatory assets, which represent probable future recovery of costs from customers through the ratemaking process, and regulatory liabilities, which represent probable future refunds that are to be credited to customers through the ratemaking process. At September 30, 2012, Registrant had approximately $77.7 million of regulatory assets, net of regulatory liabilities not accruing carrying costs. Of this amount, $52.1 million relates to the underfunded positions of the pension and other post-retirement obligations, $16.2 million relates to deferred income taxes representing accelerated tax benefits flowed through to customers, which will be included in rates concurrently with recognition of the associated future tax expense, and $2.7 million relates to a memorandum account authorized by the CPUC to track unrealized gains and losses on GSWC’s purchase power contract over the life of the contract. The remainder relates to other items that do not provide for or incur carrying costs. Regulatory assets, less regulatory liabilities, included in the consolidated balance sheets are as follows:

(dollars in thousands)	September 30,2012			December 31, 2011
GSWC
Electric supply cost balancing account	$	5,937		$	8,347
Water Revenue Adjustment Mechanism, net of Modified Cost Balancing Account	43,638			39,112
Base Revenue Requirement Adjustment Mechanism	6,171			4,053
Costs deferred for future recovery on Aerojet case	16,310			17,173
Pensions and other post-retirement obligations	55,780			56,960
Derivative unrealized loss (Note 4)	2,719			7,611
Flow-through taxes, net (Note 6)	16,169			17,032
Electric transmission line abandonment costs	2,257			2,428
Asset retirement obligations	2,869			2,793
Low income rate assistance balancing accounts	8,305			6,194
General rate case memorandum accounts	6,610			12,922
Santa Maria adjudication memorandum accounts	3,561			3,662
Bay Point balancing accounts	5,242			5,752
Other regulatory assets, net	9,756			8,409
Various refunds to customers	(8,604		)	(12,491		)
Total	$	176,720		$	179,957

Regulatory matters are discussed in detail in the consolidated financial statements and the notes thereto included in the Form 10-K for the year ended December 31, 2011 filed with the SEC.  The discussion below focuses on significant matters and changes since December 31, 2011.

Alternative-Revenue Programs:

GSWC records the difference between what it bills its water customers and that which is authorized by the CPUC using the Water Revenue Adjustment Mechanism (“WRAM”). GSWC also records the difference between adopted and actual expense levels for purchased water, purchased power and pump taxes, as established by the CPUC, using the Modified Cost Balancing Accounts (“MCBA”). GSWC has implemented surcharges to recover its WRAM balances, net of the MCBA.  For the three months ended September 30, 2012 and 2011, surcharges of $6.7 million and $5.2 million, respectively, were billed to customers to decrease previously incurred under-collections in the WRAM, net of MCBA accounts, and approximately $14.3 million and $10.8 million for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, GSWC has a net aggregated regulatory asset of $43.6 million which is comprised of a $64.2 million under-collection in the WRAM accounts and $20.6 million over-collection in the MCBA accounts.

Based on CPUC guidelines, recovery periods relating to GSWC’s WRAM/MCBA balances range between 12 and 36 months, with the majority being 24 months.  As required by the accounting guidance for alternative revenue programs, GSWC is required to collect its WRAM, net of its MCBA, within 24 months following the year in which they are recorded.  In September 2010, GSWC, along with other California water utilities, filed an application with the CPUC to modify the recovery period of its WRAM and MCBA to 18 months or less.  In April 2012, the CPUC issued a final decision which, among other things, sets the recovery period for under-collection balances that are up to 15% of adopted annual revenues at 18 months or less.  For under-collection balances greater than 15%, the recovery period is 19 to 36 months. GSWC does not currently have any balances over 15% of adopted annual revenues.

In addition to adopting a new amortization schedule, the final decision sets a cap on total net WRAM/MCBA surcharges in any given calendar year of 10% of the last authorized revenue requirement. For GSWC, the cap will be applied to its 2013 WRAM balances to be filed for recovery in early 2014.  The cap requirement set forth in the final decision will not impact GSWC’s 2012 and prior year WRAM/MCBA balances.

In June 2012, the CPUC approved surcharges for recovery of BVES’ 2011 Base Revenue Requirement Adjustment Mechanism (“BRRAM”) balance. The CPUC approved a 36-month surcharge, with the amounts collected through December 2013 to be applied to the 2011 BRRAM under-collection.  Surcharges collected during the remainder of the 36-month period would be for recovery of a $1.6 million increase in the BVES revenue requirement representing the difference between the allocated general office costs authorized by the CPUC in its November 2010 decision on the Region II, Region III and general office rate case, and what is currently in BVES’ rates for allocated general office costs.  As authorized by the CPUC, the $1.6 million was included in the BRRAM for recovery through the surcharge; however, these costs are not considered an alternative revenue program.

CPUC Pending Rehearing Matter:

In July 2011, the CPUC issued an order granting the Division of Ratepayer Advocates (“DRA”) request to rehear certain issues from the Region II, Region III and general office rate case approved in November 2010.  Among the issues in the rehearing are the La Serena plant improvement project included in rate base totaling approximately $3.5 million and GSWC’s methodology for deferring rate case costs.  Final resolution of these matters is expected in 2013. The regulatory issues associated with these matters are further discussed below.

La Serena Plant Improvement Project:

In November 2010, as part of GSWC’s Region II, Region III and general office rate case decision, the CPUC disallowed a portion of the La Serena plant improvement project costs from utility customer rates.  As a result of the CPUC’s decision in 2010, GSWC recorded a charge of $2.2 million, which included the disallowance of these capital costs and the related revenues earned on those capital costs that will be refunded to customers.

In December 2010, DRA filed a motion for rehearing on this matter, contending that the CPUC erred in assigning a portion of the La Serena plant improvement costs to GSWC utility customers and requested that all of the capital costs related to the La Serena plant improvement project be disallowed. In July 2011, the CPUC granted DRA’s request for rehearing.  Hearings on these matters are expected in the fourth quarter of 2012. A proposed decision is expected in June 2013. In addition to granting a rehearing, the CPUC also directed the Division of Water and Audits (“DWA”) to undertake an audit of the La Serena project costs and to provide a confidential report to the CPUC with recommendations on whether an investigation should be conducted to determine whether any laws were broken related to the La Serena project.  Management does not believe it has violated any laws in regards to the La Serena project.  DWA issued its independent audit report, which found cost overruns for the La Serena plant improvement project to be lower than the amount of costs for rate recovery previously disallowed by the CPUC.

In October 2012, DRA issued a report on this matter recommending further disallowances of costs and refund of revenues earned on those costs. DRA’s recommendation is inconsistent with the independent audit report issued by DWA.  In addition, GSWC believes DRA’s recommendations are without merit and inconsistent with previous CPUC decisions on this matter.  However, if DRA prevails, GSWC may be required to write-off additional capital costs and provide refunds to customers of the revenues earned on those costs.  Based on DRA’s recommendation, additional disallowed costs and revenues earned on those costs through September 30, 2012 totaled approximately $2.5 million. GSWC intends to vigorously defend its position. However, at this time, management cannot predict the outcome of the rehearing, DWA’s and DRA’s recommendations, or determine the estimated additional loss or range of loss, if any.

Deferred rate case costs:

The rehearing is also re-addressing deferred rate case costs, which are direct costs consisting primarily of outside consulting services which have been incurred in connection with the preparation and processing of a general rate case. Historically, GSWC has deferred these costs as a regulatory asset which are then recovered in rates and amortized over the term of a rate case cycle once the new rates go into effect.  In the rehearing proceeding, DRA is again challenging GSWC’s historical practice of deferring these costs with subsequent recovery upon the effective date of the new rates. Instead, DRA believes that rate case costs should be projected for future periods and recovered prospectively.  Management believes that DRA’s rationale and recommendations are inconsistent with previous CPUC decisions on this matter and also with GSWC’s historical practice of deferring and recovering rate case expenses associated with the current general rate case, and continues to believe that the costs are probable for recovery.  However, if DRA prevails, GSWC may be required to write-off deferred rate case costs related to its current pending rate case, which total approximately $1.9 million as of September 30, 2012.  At this time, GSWC is unable to predict the outcome of this matter.

BVES Regulatory Matters:

BVES General Rate Case

In February 2012, GSWC filed its BVES general rate case (“GRC”) for rates in years 2013 through 2016.  In August 2012, DRA issued its report on the GRC.  Included in DRA’s recommendations is a $2.0 million retroactive ratemaking proposal to increase BVES’ accumulated depreciation balance to reflect adopted depreciation expense for the years 2009 through 2012 rather than actual depreciation expense as recorded in compliance with Generally Accepted Accounting Principles.  DRA also recommends that one-half of deferred rate case costs be borne by shareholders, rather than entirely by customers as has been authorized by the CPUC in prior rate cases.  As of September 30, 2012, GSWC has a $2.2 million regulatory asset representing deferred rate case costs for the current BVES general rate case, which are considered probable of recovery. Hearings on the GRC, including these matters, were held in September 2012.  If DRA prevails, GSWC may be required to record a charge to adjust accumulated depreciation and to write-off half of its deferred rate case costs. GSWC believes DRA’s recommendations are without merit and intends to vigorously defend its positions.  However, at this time, GSWC is unable to predict the final outcome of these matters which are expected to be resolved in the pending rate case.

Renewables Portfolio Standard

GSWC’s BVES division has been regularly filing compliance reports with the CPUC regarding its purchases of energy from renewable energy resources to meet California’s renewables portfolio standards (“RPS”).  Previous filings under prior RPS laws had indicated that BVES had not achieved annual target purchase levels of renewable energy resources and thus, on its face, might be subject to a potential penalty.  However, a new RPS law went into effect in December 2011 which changed, among other things, the prior RPS requirement based upon annual procurement targets to multi-year procurement targets.  Under the new RPS law, BVES must procure sufficient RPS-eligible resources to meet: (i) any RPS procurement requirement deficit for any year prior to 2011, and (ii) RPS procurement requirements for the 2011 — 2013 compliance period by no later than December 31, 2013.  BVES’ first RPS reports under the new law were submitted to the CPUC in March 2012 and August 2012, and did not reflect any RPS procurement deficiencies nor any potential or actual penalties.  Accordingly, no provision for loss has been recorded in the financial statements as of September 30, 2012.

In September 2009, GSWC negotiated a ten-year contract with the Los Angeles County Sanitation District (“LACSD”) to purchase renewable energy created from landfill gas. In February 2011, LACSD notified GSWC that it intended to shut down the landfill gas generator. In August 2011, GSWC and LACSD negotiated a settlement to resolve a dispute between the parties regarding certain terms of the contract.  Under the terms of the settlement, GSWC agreed to waive its right to a 14 month termination notice and LACSD agreed to sell renewable energy credits (“RECs”) to GSWC.

In November 2011, GSWC filed for CPUC approval for the purchase of these RECs.   In July 2012, the CPUC approved the purchase.  BVES intends to apply these RECs towards either its pre-2011 renewable energy requirements or its 2011-2013 requirements. The REC’s were purchased for approximately $325,000 during the third quarter of 2012 as an asset and will be included as part of BVES’ electric supply cost balancing account when the RECs are applied towards the RPS requirements.

In June 2011, GSWC’s BVES filed an application with the CPUC to recover $1.2 million in legal and outside service costs incurred during the period September 1, 2007 through March 31, 2011 in connection with seeking to procure renewable energy resources.  In March 2012, the CPUC approved the application.  Accordingly, a regulatory asset of $1.3 million, including accrued interest, was recorded in March 2012.  A 12-month surcharge was implemented in May 2012 for recovery of these costs.

Other Regulatory Matters:

Cost of Capital Proceeding for Water Regions:

In July 2012, the CPUC issued a final decision on GSWC’s water cost of capital proceeding filed in May 2011. The decision approves the settlement agreement entered into between GSWC, along with three other California water utilities, and DRA in November 2011.  The approved settlement authorizes a Return on Equity (“ROE”) of 9.99% and a rate-making capital structure for GSWC of 55% equity and 45% debt. The weighted cost of capital (return on rate base), with an updated embedded debt cost and the settlement ROE, is 8.64%. The new rate of return authorized by the CPUC’s final decision was implemented into water rates retroactive to January 1, 2012.  Among other things, the final decision required GSWC to refund to customers approximately $408,000, representing the settled amount included in the interest rate balancing account.  During the three months ended September 30, 2012, GSWC refunded the majority of this to customers through a one-time surcredit.

The CPUC decision also authorized GSWC to continue the Water Cost of Capital Mechanism (“WCCM”).  The WCCM adjusts ROE and rate of return on rate base between the three-year cost of capital proceedings only if there is a positive or negative change of more than 100 basis points in the average of Moody’s Aa utility bond rate as measured over the period October 1 through September 30.  If the average Moody’s rate for this period changes by over 100 basis points from the benchmark, the ROE will be adjusted by one half of the difference. For the period October 1, 2011 through September 30, 2012, Moody’s rate declined by 112 basis points from the benchmark. As a result, in October 2012, GSWC filed an advice letter to lower its water ROE by 56 basis points, from 9.99% to 9.43%, which will be incorporated in the new 2013 water rates.

Changes in Tax Law

The Small Business Jobs Act of 2010 and the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“Tax Relief Acts”) extended 50% bonus depreciation for qualifying property through 2012 and created 100% bonus depreciation for qualifying property placed in service between September 9, 2010 and December 31, 2011.

In June 2011, the CPUC adopted a resolution that requires water utilities to file advice letters implementing a one-way memorandum account to track the revenue effects associated with the Tax Relief Acts. This may result in a reduction in revenue requirements in future rate case proceedings. The effective date of the memorandum account established by the resolution was April 14, 2011.  More specifically, the memorandum account established by the resolution tracks on a CPUC-jurisdictional, revenue-requirement basis: (a) decreases in each impacted utility’s revenue requirement resulting from increases in its deferred tax reserve; and (b) other direct changes in the revenue requirement resulting from taking advantage of the Tax Relief Acts. This resolution also authorizes impacted utilities to use savings from this new tax law to invest in certain additional, needed utility infrastructure, not otherwise funded in rates, within a time frame shorter than would be practicable through the formal application or advice letter processes. The establishment of a memorandum account does not change rates, nor guarantee that rates will be changed in the future. This mechanism simply allows the CPUC to determine at a future date whether rates should be changed. GSWC has evaluated the potential impact of this resolution and does not expect it to have a material impact on its consolidated financial statements. However, at this time, GSWC cannot predict the outcome of this resolution or determine its potential impact, if any, on future rates.

CPUC Subpoena

On December 15, 2011, the CPUC approved a settlement agreement reached between GSWC and DWA to resolve an investigation of certain work orders and charges paid to a specific contractor used previously for numerous construction projects over a period of 14 years.  The settlement provides for refunds to customers totaling $9.5 million to be made over a period of 12-36 months, as well as a reduction in rate-base and other rate adjustments totaling $3.0 million.  As a result of the settlement, management does not expect future increases in the reserve related to this specific contractor.  Refunds totaling $1.1 million and $2.2 million were made to customers during the three and nine months ended September 30, 2012, respectively.

As part of the settlement agreement, GSWC agreed to be subject to three separate independent audits of its procurement practices over a period of ten years from the date the settlement was approved by the CPUC.  The audits will cover GSWC’s procurement practices from 1994 forward and could result in further disallowances of costs.  The cost of the audits will be borne by shareholders and may not be recovered by GSWC in rates to customers. At this time, management cannot predict the outcome of these audits or determine the estimated loss or range of loss, if any, resulting from these audits.