10-K

QuickLinks -- Click here to rapidly navigate through this document

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)
ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the fiscal year ended December 31, 2003
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from                              to
Commission file number 0-8176

SOUTHWEST WATER COMPANY
(Exact name of registrant as specified in its charter)

Delaware	95-1840947
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

One Wilshire Building
624 South Grand Avenue, Suite 2900
Los Angeles, California 90017-3782
(Address of principal executive offices, including zip code)

(213) 929-1800
(Registrant's telephone, including area code)

Title of each class	Name of each exchange on which registered
Securities registered pursuant to Section 12(b) of the Act:	None
Securities registered pursuant to Section 12(g) of the Act:
(1) Common Stock, $.01 par value	NASDAQ
(2) Series A, Preferred Stock, $.01 par value	None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III in this Form 10-K or any amendment to this Form 10-K. o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes  ý    No o

        The aggregate market value of the voting common equity held by non-affiliates of the registrant was approximately $136.7 million based upon the average bid and asked price of such common equity as of June 30, 2003. The registrant is unable to estimate the aggregate market value of its preferred shares held by non-affiliates of the registrant because there is no public market for such shares. On March 12, 2004, there were 14,712,228 common shares outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the Proxy Statement to be filed with the Securities and Exchange Commission on or prior to April 8, 2004 and to be used in connection with the 2004 Annual Meeting of Stockholders to be held on May 13, 2004 are incorporated by reference in Part III of this Form 10-K.

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

TABLE OF CONTENTS

Part I
Item 1.	Business	1
Item 2.	Properties	22
Item 3.	Legal Proceedings	24
Item 4.	Submission of Matters to a Vote of Security-Holders	24
Item 4a.	Executive Officers	24
Part II
Item 5.	Market for Registrant's Common Equity and Related Stockholder Matters	27
Item 6.	Selected Financial Data	28
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	29
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	42
Item 8.	Financial Statements and Supplementary Data	43
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	76
Item 9A.	Controls and Procedures	76
Part III
Item 10.	Directors and Executive Officers of the Registrant	77
Item 11.	Executive Compensation	77
Item 12.	Security Ownership of Certain Beneficial Owners and Management	77
Item 13.	Certain Relationships and Related Transactions	77
Item 14.	Principal Accountant Fees and Services	77
Part IV
Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	78
EXHIBIT INDEX		85
SIGNATURES		89

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

FORWARD-LOOKING STATEMENTS

This Annual Report on 10-K contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. All statements contained in this Form 10-K that are not clearly historical in nature are forward-looking, and the words "anticipate," "believe," "belief," "expect," "estimate," "plan," "intend," "continue," "predict," "may," "should" and similar expressions are generally intended to identify forward-looking statements. Forward-looking statements are subject to risks and uncertainties, including those set forth under "Risk Factors" below, that could cause actual results to differ materially from our historical experience and our present expectations or projections. Factors that could affect forward-looking statements relating to the resolution of the reportable condition with respect to internal controls discussed in Item 9A of this Form 10-K include, among other things: the Company's ability to fully resolve the deficiencies during the six to nine month period from the date of filing of this Form 10-K; the Company's ability to identify and retain qualified and experienced financial personnel at the Services Group; the Company's ability to design and maintain policies and procedures which enable the Company to avoid any reoccurrence of the matters which gave rise to the reportable condition; and the Company's ability to implement policies and procedures including documentation that meets the internal control over financial reporting requirements of the rules adopted by the Securities and Exchange Commission pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. Caution should be taken not to place undue reliance on any such forward-looking statements since such statements speak only as of the date when made. Other than as required by applicable law, we undertake no obligation to publicly update or revise forward-looking statements.

PART I

ITEM 1.    DESCRIPTION OF BUSINESS.

OVERVIEW

        Southwest Water Company (Southwest Water, the "Company," "we," "us," or "our") was incorporated in California in December 1954. We reincorporated in Delaware in June 1988. We provide a broad range of services including water production and distribution, wastewater collection and treatment, public works services, utility billing and service, and infrastructure construction management. We provide our services to more than two million people in 36 states. Our business is operated by our subsidiaries and is segmented into two operating groups: our Services Group and our Utility Group.

        Our Services Group provides water and wastewater facility operations and maintenance services, equipment maintenance and repair, sewer pipeline cleaning, billing and collection services, and state-certified water and wastewater laboratory analysis on a contract basis. The facilities we operate are owned by cities, public agencies, municipal utility districts and private entities primarily in Texas, New Mexico, California, Colorado, Alabama, Mississippi, Georgia and New Jersey. Our Services Group also facilitates the design, construction, project management, and operating aspects of various water and wastewater projects. During the construction phase of such a project, our Services group may have an ownership interest in the project. This Group is headquartered in Sugar Land, Texas. Additionally, our Services Group provides utility billing services for multiple family housing units such as apartment buildings. These operations include installation of meters, billing, collection and customer services. While state and federal agencies issue regulations regarding standards of water quality, safety, environmental and other matters which affect our Services Group operations, the pricing of our services within the Services Group is not subject to regulation.

        Within our Utility Group, we own and manage the operations of rate-regulated public water and wastewater utilities in California, New Mexico and Texas. State and federal agencies issue regulations regarding standards of water quality, safety, environmental and other matters which affect these

1

operations. The rates that we can charge for water and wastewater usage are established and approved by government agencies.

OUR BUSINESS STRATEGY

        Our primary objectives are to provide an essential product or service, and to generate value for clients, customers, employees and stockholders. We apply two principal strategies in our efforts to continue growing our business and improving our financial performance:

We work to enhance organic revenue growth.

        Southwest Water Company is a leading full spectrum service provider in the water and wastewater industries. We have a broad footprint in high population-growth states. Our target market focus is on small to medium size cities. We offer our clients and customers services within our core competency of water and wastewater management. In addition we provide related peripheral services including:

•

Refurbishing of manholes and sewer lines,



•

Pipeline inspection,



•

Water meter replacement,



•

Water and waste water quality testing,



•

Construction management,



•

Utility billing and collection and



•

Public works management.

        Successful application of our organic revenue growth strategy was evidenced in June 2003 when one of our subsidiaries was granted a 10-year, $30-million contract to operate the public works department of the City of Pascagoula, Mississippi. Included in this contract is management of water production and distribution, sewage collection and treatment, and other public works services for the Gulf Coast city's 30,000 residents.

        Organic revenue growth in 2003 benefited from rate increases in our California and Texas utilities and increased customer connections in our New Mexico and Texas utilities.

We pursue selected acquisitions that fit our long-term growth goals in both the Utility and Services Groups.

        In recent years we have made several key acquisitions to expand our business.

•

In February 2000, our California utility purchased the City of West Covina's water distribution system and facilities adding approximately 7,000 connections to our customer base; (an increase of approximately 11%).



•

In April 2000, we acquired 80% of Master Tek International, Inc. (Master Tek), a company with expertise in billing and collection services and utility submetering. We subsequently acquired the remaining 20% of Master Tek in 2003.



•

In August 2001, we acquired Operations Technologies, Inc. (OpTech) which enhanced our contract operations in two ways. First, it extended our client base to the Southeast portion of the United States as OpTech serves clients in Georgia, and expanded our coverage of the Gulf Coast by adding operations in Alabama and Mississippi. Second, it expanded our range of contract services to include such public works functions as storm water drainage, system maintenance and street repair.

2

•

In November 2002 we acquired certain contract operations of AquaSource, Inc., which we operate under the name Aqua Services, LP (Aqua Services). The acquisition introduced us to new markets in three states and strengthened our presence in the Houston, Texas area.

KEY BUSINESS SEGMENTS

        Group revenues for the three years ended December 31, 2003 were as follows:

	Years ended December 31,
	2003		% of Revenue		2002		% of Revenue		2001		% of Revenue
	(in millions, except percentages)
Services Group	$	116	67	%	$	79	60	%	$	67	58	%
Utility Group		57	33	%		52	40	%		49	42	%
	$	173	100	%	$	131	100	%	$	116	100	%

SERVICES GROUP—DEVELOPMENT OF BUSINESS, SERVICES AND REGULATION

Contractual Relationships

        Our Services Group has three distinct types of contractual relationships:

•

Time-and-material contracts, primarily with municipal utility districts in Texas,



•

Operations and maintenance contracts for a fixed-fee and



•

Construction management contracts.

Municipal Utility District (MUD) Contracts

        A MUD is created under the rules of the Texas Commission on Environmental Quality (TCEQ), formerly the Texas Natural Resource Conservation Commission, to provide water supply, wastewater treatment and drainage services to areas where existing municipal services are not available. Our Services Group has MUD contracts in the suburbs of Houston, Austin and El Paso, Texas. Under a typical MUD contract, we bill a monthly base fee to provide a specified level of services. We typically provide water and wastewater facility operations and maintenance services, equipment maintenance and repair, billing and collection services, and state-certified water and wastewater laboratory analysis. We usually bill for any additional services provided beyond the basic contract on a time-and-materials basis as such services are rendered. Most contracts provide for an increase in the monthly base fee as the number of customer connections increases and do not generally include inflation adjustments. Changes in prices are negotiated on a contract-by-contract basis. Generally, MUD contracts are cancellable on 30 or 60-day notice by either party. Our experience indicates that, with high-quality service and strong focus on client satisfaction, MUD relationships can last for many years.

Operations and Maintenance (O&M) Contracts

        O&M contracts are agreements with cities and private entities that provide specific services such as facility operation and maintenance, meter reading, customer billing and collection, or management of the entire water or wastewater system. Under a standard O&M contract, our Services Group companies charge a fee that covers a specified level of services. Services are typically provided evenly throughout the contract period and are billed on a monthly basis. Our O&M contracts limit our liability in the event of a major system failure or catastrophic event. If we provide services beyond the scope of a contract, we bill for the additional services. For example, if a major system failure or catastrophic event occurred as the result of flooding, earthquake, electrical strike or vandalism, the facility owner usually asks us to provide additional services on a time-and-materials basis.

3

        Most O&M contracts provide for annual increases based upon measures of inflation, and we typically have the right to increase our fixed operations fee if the system experiences customer connection growth beyond a specified level. We may pay certain costs such as chemical or power expenses. Usually, however, the contracts provide reimbursement for these costs.

        In most cases, O&M contracts are cancellable only upon a specific breach of contract by either party. O&M contracts have terms ranging from month-to-month up to 20 years. We have a strong focus on customer service and client satisfaction and our experience has been that over 95% of our O&M contracts are renewed upon expiration.

Construction Management Projects

        In 1999, we agreed to design, build, finance and operate a $6.5 million reverse osmosis water treatment plant near El Paso, Texas, for the El Paso County Water Authority (EPCWA). Reverse osmosis technology is a process that removes microscopic particles such as minerals and salts from a solution to produce potable water. The project included drilling five wells and developing associated water lines and settling ponds. During construction of the treatment plant, we received monthly payments from the EPCWA. In addition, the EPCWA awarded us a 20-year, $22.0 million extension of the existing operating contract. The construction of the plant was substantially completed in December 2000 and the facility began operating in February 2001, treating an average of 2.6 million gallons of water per day.

        In September 2002, we agreed to design, build, finance and operate a $25.0 million reverse osmosis water treatment plant in the city of San Juan Capistrano, California, for the Capistrano Valley Water District (CVWD). The project includes the drilling of eight new wells and the installation of associated water lines. During construction of the treatment plant, we have received payments upon completion of construction milestones and will continue to receive such payments until final completion of construction. In addition, the CVWD awarded us a 20-year $20.0 million contract to operate the treatment plant after completion of construction. The construction of the plant started in December 2002. As of December 31, 2003 the plant is approximately 50% complete. We expect to complete the plant during or before the fourth quarter of 2004 at which time we will begin to operate the facility under the 20-year contract. Upon completion, the plant will have the capacity to produce approximately 5.0 million gallons of potable water per day.

        Our Services Group has contracted with our Texas utilities and our New Mexico utility to perform operating services, normal maintenance and construction work and, in addition, to manage capital projects for these utilities. These contracts were established utilizing terms and conditions equivalent to prevailing industry rates and for similar work performed by our Services Group for non-affiliated customers. In accordance with Statement of Financial Accounting Standards (SFAS) No. 71, Accounting for the Effects of Certain Types of Regulation, we recognize a profit margin from contract work performed and do not eliminate the intercompany profit on the contract work performed when the contract price is reasonable and it is probable that the costs and capital will be recoverable through the rate making process.

Growth and Backlog

        During the past three years, our Services Group has increased revenues and service area by adding new contracts, construction projects, pursuing renewal of existing contracts and by making acquisitions.

        Our Services Group's revenue backlog consists of new and existing contracts. We include new contracts in the backlog when we have a signed contract. Revenues included in the backlog may be realized over a multi-year period. The O&M contracts signed by our Services Group typically have durations of three to five years, and the uncompleted remaining portion of these contracts is reflected in the backlog. MUD and utility billing contracts are assumed to have a 36-month term, consistent with

4

our experience, and are included in the backlog computation using an assumed 36-month term. The acquisition of Aqua Services in November 2002 accounted for most of the increase in MUD and O&M contracts during 2002.

        As of December 31, 2003 and 2002, our Services Group backlog was approximately $315.0 million and $275.0 million, respectively.

Seasonality

        Our Services Group operations can be affected by severe weather and rainfall. In general, heavy rainfall or storm conditions may limit our ability to perform certain billable work such as pipeline maintenance, manhole rehabilitation and other outdoor services. Severe weather conditions may also result in additional labor and material costs to us that may not necessarily be recoverable from our various firm price city contracts. However, such severe weather conditions are infrequent, and any additional costs that we incur that cannot be billed under our contracts are not material to our results of operations.

        Revenues and earnings of our billing and collection business are generally not subject to seasonal fluctuations.

Competition

        Competition in the O&M portion of our business includes a number of significantly larger companies that provide O&M services on a national and international basis, as well as regional and local competitors. New contracts are awarded based on a combination of customer relationships, service levels, competitive pricing, references and technical expertise. While our Services Group intends to expand its market share within the southwestern and southern United States, there is substantial competition in these markets. Cities themselves are also major competitors, since we must overcome reluctance on the part of city officials to outsource their water and wastewater services. Although industry renewal rates tend to be high, the contract water and wastewater management business is very competitive, and we cannot assure you that our Services Group will be able to increase or sustain its market share.

UTILITY GROUP—DEVELOPMENT OF BUSINESS, SERVICES AND REGULATION

California

        Our regulated public water utility in California produces and supplies water for residential, business, industrial and public authority use and for fire protection service under the jurisdiction of the California Public Utilities Commission (CPUC). Our California utility service area contains a population of approximately 311,000 people in an area of approximately 43 square miles within Los Angeles and Orange counties.

        Our California utility or its predecessor entities have supplied water since approximately 1907. From the mid-1950s to the late 1960s, our operations expanded rapidly as most of our service area was converted from agricultural use to residential, business and industrial use.

5

        The following table indicates by classification the number of water connections that our California utility served as of the end of each of the past three years:

California Utility—Number of Water Connections by Classification

		Water Connections as of December 31,
		2003	2002	2001
Residential		70,822	70,657	70,495
Business and commercial		3,006	3,015	2,996
Other		1,199	1,174	1,174
	Totals	75,027	74,846	74,665

        During 2003, our California utility's annual revenues were approximately 74% from sales to residential connections, approximately 17% from sales to business and industrial connections, and approximately 9% from sales to other connections.

        Our California Utility provides water by either pumping water from wells we own or by purchasing water from the Metropolitan Water District of Southern California (MWD), a governmental agency, and other sources. The wells owned and operated by our California utility pump water from two of the major groundwater basins in the Southern California coastal watershed: the Main San Gabriel Basin (the Main Basin) and the Central Basin. Our rights to pump water from the Main and Central Basins are fully adjudicated under California law, and these adjudications establish our right to produce water at levels and at a cost prescribed each year by the Watermaster Boards (the Boards) that manage the Main and Central Basins. Our California utility is also allowed to produce water from the Main and Central Basins in excess of the amount prescribed by the Boards, but when such excess production occurs, an additional payment from our utility is required to provide for the replenishment of the water supply. As the water levels in the Main and Central Basins increase or decrease, the Boards may adjust the amount of water that we are allowed to pump.

        In the Environmental Matters section below, we discuss certain groundwater issues impacting the Main Basin. In 2001 we were required to shut down some of our wells due to these issues. This resulted in our California utility purchasing increasing amounts of water from the MWD and other sources in 2001. During 2002, our California utility shut down additional wells which necessitated the purchase of an additional amount of water. The percentage of water supply purchased form external sources is as follows:

Years ended December 31,	Percentage Purchased
2000	40	%
2001	46	%
2002	72	%
2003	67	%

        Under an agreement made in early 2002, we have been reimbursed for certain costs of purchasing water needed to replace lost production as a result of the Main Basin contamination issues. We expect such reimbursement to continue until completion of remediation.

        Our California utility owns 15 wells and 30 reservoirs. We believe that we are able to purchase or produce adequate water to serve our current customer base and manage reasonable growth from new customers.

6

New Mexico

        Our regulated public water utility in New Mexico provides water supply and sewage collection services for residential, commercial and irrigation use and for fire protection service under jurisdiction of the New Mexico Public Regulation Commission (NMPRC). Our New Mexico utility service area is located in the northwest part of the City of Albuquerque and in the northern portion of Bernalillo County, and contains a population of about 41,000 people in an area of approximately 34 square miles. Approximately 35% of the area has been developed.

        The following table indicates by classification the number of water connections served by our New Mexico utility as of the end of each of the most recent three years:

New Mexico Utility—Number of Water Connections by Classification

		Water Connections as of December 31,
		2003	2002	2001
Residential		12,108	10,554	9,253
Business and commercial		723	707	668
Other		118	104	85
	Totals	12,949	11,365	10,006

        Our New Mexico utility has grown from approximately 800 connections at the time of its acquisition in 1969 to almost 13,000 connections. Most of this growth has resulted from the extension of water services and sewage collection services into new residential subdivisions and new commercial development. During 2003, we added 1,584 new water connections and 1,564 new wastewater connections in New Mexico. Because of the continuing real estate development in our service area, we expect continued connection growth in 2004. During 2003 and 2002, our revenues in New Mexico were approximately 63% and 61%, respectively, from sales to residential connections and approximately 37% and 39%, respectively, from sales to commercial and industrial connections.

        Our New Mexico utility owns six wells and five reservoirs, and we believe that we have adequate water capacity to serve our current customer base as well as reasonable growth from new customers. The wells that we own and operate in New Mexico produce water from the Rio Grande Underground Basin.

        As customer growth continues in our New Mexico service area, we may have to increase our water supply capacity through additional well construction. Our New Mexico utility has established an emergency supply of water available through an interconnection with another water purveyor, for use in the case of a temporary interruption in our New Mexico water supply.

Texas

        Our regulated public water utilities in Texas provide water supply and sewage collection and treatment services to approximately 6,100 connections for residential, commercial, irrigation and fire protection under the jurisdiction of the Texas Commission on Environmental Quality (TCEQ). Our service areas in Texas are located near the City of Austin, and contain a population of approximately 20,000 people in an area of approximately eight square miles, of which an estimated 50% has been developed. These service areas are experiencing continued real estate development, and we expect the number of connections to continue growing in 2004.

7

Texas Utilities—Number of Water Connections by Classification

		Water Connections as of December 31,
		2003	2002	2001
Residential		5,925	5,602	5,171
Business and commercial		156	152	145
	Totals	6,081	5,754	5,316

        Our Texas utilities own or have rights to 17 wells and 11 reservoirs in addition to distribution, collection and treatment facilities. Water is pumped from the Edwards aquifer. We believe that we have adequate capacity to serve our existing customer base in Texas as well as reasonable growth from new customers.

        As customer growth continues in our Texas service areas, we may have to increase the water supply capacity of our Texas utilities through a combination of outside water purchases and the construction of additional wells. One of our Texas utilities has long-term agreements to purchase water from the cities of Austin and Pflugerville in Texas.

Growth

        In recent years, the growth of our California utility has been limited to extensions into new subdivisions along the periphery of its service area. There is little undeveloped land available for new business, industrial construction or residential growth in the California service area. As a result, we do not anticipate significant increase in the number of connections in our current service area.

        Although our utility service areas in California are mature, our California utility operations are capital intensive. Significant capital expenditures are necessary for the renovation and replacement of our facilities in California. Capital is generated from utility operations and periodic debt financing. Our California utility also receives contributions in aid of construction from developers, governmental agencies, municipalities or individuals to assist in the cost of facility replacement. For the years ended December 31, 2003, 2002 and 2001, capital expenditures in California approximated $7.8 million, $10.0 million and $4.7 million, respectively. Of these amounts, our California utility received capital contributions and advances from developers of approximately $3.6 million, $2.5 million and $0.3 million in 2003, 2002 and 2001, respectively. Additions for 2003 included approximately $2.5 million of payments received as part of a settlement agreement relating to Main Basin groundwater contamination (see Environmental Matters below).

        Because our New Mexico utility service area continues to experience customer growth, our operations are capital intensive. Capital is generated from New Mexico operations, periodic debt financing, bank lines of credit extended to our New Mexico utility and to Southwest Water, contributions in aid of construction received from developers, and from advances received from developers, which must be repaid under rules of the NMPRC. For the years ended December 31, 2003, 2002 and 2001, capital expenditures approximated $9.6 million, $7.5 million and $3.7 million, respectively. Of these amounts, our New Mexico utility received capital contributions from developers of approximately $8.6 million, $6.7 million and $3.1 million in 2003, 2002 and 2001, respectively.

        Because our Texas utility service areas are also in locations of customer growth, these operations are capital intensive as well. Capital is generated from Texas operations, a bank term loan and Living Unit Equivalent (LUEs) connection fees received from developers. For the years ended December 31, 2003 and 2002, capital expenditures were approximately $11.1 million, $13.7 million and $5.0 million, respectively. Of these amounts, our Texas utilities received contributions and LUEs from developers of approximately $0.6 million in 2003, $4.8 million and $1.0 million in 2003, 2002 and 2001, respectively.

8

Seasonality

        Our Utility Group water revenues are seasonal because rainfall and weather conditions affect water consumption. The second and third quarters of each year typically account for the highest volume of water consumption when weather tends to be hot and dry. The results of operations for one quarter do not indicate results to be expected in another quarter. Drought conditions may result in consumer conservation efforts or water shortages, which can reduce consumption. Drought conditions may also result in increased water costs to us, which could adversely affect our profitability. Conversely, unusually wet conditions may result in decreased customer demand, lower revenues and lower profit in our utility operations. Utility Group wastewater revenues are generally not affected by seasonality.

Environmental Matters

        One of the water sources for our California water utility has been affected by the presence of certain groundwater contaminants. These contaminants consist mainly of chemicals disposed of by various industrial companies in the 1940s and 1950s. In 2001 and 2002, this contamination necessitated the shutdown of a number of our wells, and we purchased replacement water at a cost substantially higher than the cost of water pumped from our own wells.

        The incremental and unreimbursed costs of purchasing replacement water and related energy costs in 1999, 2000 and 2001 related to this contamination were approximately $84,000, $756,000 and $809,000, respectively. Prior to May 2002, these costs were recorded as operating expenses and reduced our operating income.

        In May 2002, a settlement agreement was reached between some of the parties allegedly responsible for the contamination (Cooperating Respondents) and a number of affected water companies, including our California water utility. As a result of this agreement, we recorded income in 2002 of approximately $1.7 million, for reimbursement of certain water and energy costs, incurred from the contamination. This settlement was an unusual event and we recorded the $1.7 million in Other income (expense), in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 30, Reporting the Results of Operations.

        Since our groundwater contamination related costs incurred prior to the agreement were not included in our water rate calculations, the reimbursement offset costs that our utility had previously incurred, resulting in no effect on ratepayers.

        As a result of this contamination, we have received payments during the last three years, and we expect to continue to receive payments until completion of remediation. These payments represent the incremental cost of purchasing water over the cost that would have been incurred by us to pump water from our wells had they not been shut down as a result of contamination and excluded costs covered in the $1.7 million settlement discussed above. The settlement agreement provided for ongoing reimbursement of our excess water costs and we bill and collect this reimbursement monthly. These monthly reimbursements are recorded as a reduction to operating expenses. The reimbursements were approximately $4.0 million, $4.4 million during 2003 and 2002.

        The settlement agreement also provides for contributions by the Cooperating Respondents for construction of new wells and interconnections with nearby water sources. These contributions were approximately $2.5 million and approximately $4.4 million for 2003 and 2002, respectively, and were recorded as contributions in aid of construction.

Water Quality Regulations

        The water supplies available to our utilities in California, New Mexico and Texas are subject to regulation by the United States Environmental Protection Agency (EPA) under the 1996 Federal Safe Drinking Water Act (US Act). The US Act establishes uniform minimum national water quality

9

standards, as well as specification of the types of treatment processes to be used for public drinking water. The EPA, as mandated under the US Act, issues regulations that require, among other things, disinfection of drinking water, specification of maximum contaminant levels (MCLs) and filtration of surface water supplies.

        Our California water supplies are also subject to regulation by the Office of Drinking Water of the California Department of Health Services (DOHS) under the California Safe Drinking Water Act (Cal Act). The Cal Act and the rules of the DOHS are similar to the US Act and the mandates of the EPA, except that in many instances the requirements of the DOHS are more stringent than those of the EPA.

        In addition to the EPA and the DOHS water quality regulations, our California water utility is also subject to water quality standards that may be set by the CPUC. The California Supreme Court has ruled that the CPUC has the authority to set standards that are more stringent than those set by the EPA and the DOHS.

        In June 1998, we detected the substance N-nitrosodimethylamine (NDMA) in one of our California utility's wells at a level in excess of the EPA reference dosage for health risks. Upon detection, the well was immediately removed from service. In 1999, our California utility completed construction of a treatment facility that is intended to reduce NDMA in this well to non-detectable levels. In February 2001, we received final regulatory approval of the facility and in May 2001, our California utility began producing water from this well.

        In January 2002, the DOHS set a more stringent recommended standard for the substance perchlorate, which was subsequently detected in this California well at levels in excess of the revised standard. We immediately removed this well from service. In 2000, in another of our California utility's well fields, we detected amounts of contaminants in excess of the EPA reference dosage for health risks. All wells in that well field were immediately removed from service. The water production from these wells was replaced with purchased water, the excess costs of which were substantially funded by the Cooperating Respondents.

        The water supplied by our New Mexico utility is subject to regulation by the EPA and by the State of New Mexico Environmental Improvement Division (EID). The water supplied by our Texas utilities is subject to regulation by the EPA and by the TCEQ.

        In February 2002, the EPA set a more stringent arsenic standard in drinking water from 50 parts per billion to 10 parts per billion, which must be fully met by 2006. At the present time, our water sources in California and Texas are in compliance with the new standards. The DOHS is holding discussions that could result in a more stringent arsenic standard effective in June 2004. We cannot predict the impact that such changes in the arsenic standard would have on our California and Texas water utility operations. If the arsenic standard remains at 10 parts per billion, we do not expect it to have a material adverse impact on our financial position or results of operations in California and Texas.

        Although our New Mexico utility meets the current arsenic standard of 50 parts per billion, it does not meet the newly adopted arsenic standard of 10 parts per billion. To meet this new standard by the required 2006 implementation date, we are considering options that include the construction of an arsenic removal treatment plant. We anticipate that significant capital expenditures at our New Mexico facility may be required to comply with the new arsenic standard and that the cost of water will increase as a result of treatment requirements. However, we cannot determine the impact at this time. We believe that there may be funds available from state or federal agencies that could defray all or a part of the capital expenditures that we believe will be necessary to meet the new arsenic standards. If this new standard has an impact on our New Mexico operations, we will likely make a request to the NMPRC for recovery of these costs. We cannot assure you that funds will be made available to our

10

New Mexico utility or that costs incurred or capital spent will ultimately be recoverable from the ratepayers.

        Costs associated with testing of our water supplies in California have increased and are expected to further increase as regulatory agencies adopt additional monitoring requirements. We believe that costs associated with the additional monitoring and testing of our water supply in California will be recoverable from ratepayers through future rate increases. However, we cannot assure you that water sources currently available to our California utility will meet future EPA or DOHS requirements, that recovery of additional costs will be allowed, or that new or revised monitoring requirements will not necessitate additional capital expenditures by our California utility in the future. We believe that future incremental costs of complying with governmental regulations, including capital expenditures, will be recoverable through increased rates. However, we cannot assure you that recovery of such costs will be allowed.

        Both the EPA and the DOHS have put into effect regulations and other pronouncements that require periodic testing and sampling of water to ensure that only permissible levels of organic and volatile and semi-volatile organic compounds (VOCs), herbicides, pesticides, radionuclides, and inorganic substances are present in water supplied to the public. Our California water quality personnel regularly sample and monitor the quality of water being distributed throughout the system. Our California utility conducts sampling, testing and inspections at the intervals, locations and frequencies required by EPA and DOHS regulations. Chlorination is currently performed to provide chlorine residuals required by the DOHS as a safeguard against bacteriological contamination. In addition to water sampling and testing performed by our personnel, independent engineers retained by the Boards conduct sampling and testing for certain pollutants such as VOCs. Water samples from throughout our California water system are tested regularly by independent, state-certified laboratories for bacterial contamination, chemical contaminant content and for the presence of pollutants and contaminants for which MCLs have been put into effect. The results of the sampling and testing are made available to DOHS and all water purveyors that produce water from the Basins. The cost of such sampling and testing is covered by assessments to the producers.

        Samples of water from throughout our water systems in California, New Mexico and Texas, as well as treated wastewater, are regularly tested by independent, state-certified laboratories, and the test results are sent to the respective state regulatory agencies. Chlorination is performed as a safeguard against bacteriological contamination. Each of the companies in our Utility Group provides its customers with an annual water quality report that, among other matters, informs them of the sources and quality of the water being provided.

        We believe that water supplied by our California utility meets all current requirements of the US Act, the Cal Act and the regulations put into effect under the related legislation and CPUC standards. We also believe that water supplied by our New Mexico utility and our Texas utilities complies with all current requirements of the EPA and the respective state regulatory agencies. However, we cannot assure you that water sources currently available to our water utilities will meet future EPA or state regulatory requirements, or that such future requirements will not necessitate future capital expenditures by our water utilities.

Rate Establishment

        The CPUC, the NMPRC and the TCEQ regulate the rates and operations of our regulated utility subsidiaries in California, New Mexico and Texas, respectively. The rates established by these agencies are intended to provide utilities an opportunity to recover costs and earn a reasonable return on capital.

        Under current CPUC practices, California customer water rates may be changed through general rate cases or by offsets for certain rate base and expense items. Since September 30, 2002, the

11

California Public Utilities Code has required that CPUC-regulated water utilities file general rate cases every three years. General rate cases require formal proceedings with the CPUC in which overall rate structure, expenses and rate base are examined by CPUC staff. Historically, rate proceedings have required approximately 12 months from the time an application is filed to the CPUC's authorization of new rates. Our California utility made a general rate case filing on April 2, 2002 and was granted an average 17% increase in rates effective May 28, 2003.

        In addition to a general rate increase, the CPUC typically provides for step increases in the second and third years. The step increases are intended to compensate for projected expense increases. Prior to their approval, step increases are subject to verification that proforma earnings levels have not exceeded the rate of return authorized in the general rate proceeding.

        Under prior CPUC procedures, offsets were approved through an abbreviated proceeding that required approximately two months from the time a request was filed to the authorization of new rates. Under current CPUC guidelines, offset changes, particularly increases, have more restrictions and will no longer be considered outside of general rate cases unless they occur within the three-year general rate cycle.

        The CPUC allows water utilities to pass unforseen expenses through to rate payers through balancing accounts. In the water industry those costs have been determined to consist of costs for purchased water, purchased power and pump taxes. Prior to November 29, 2001, the CPUC allowed balancing accounts in the income statements of water utilities, with a corresponding liability or asset on the balance sheet. However, the CPUC has changed this policy by eliminating the use of balancing accounts after November 29, 2001. Our California water utility has recorded a balancing account receivable of approximately $2.3 million, representing the difference between actual water production costs incurred and California Public Utilities Commission (CPUC)-adopted water production costs. In December 2002, the CPUC issued a decision that we anticipate will allow our water utility in California to recover the $2.3 million balancing account. Currently, when actual water production costs exceed CPUC-adopted levels the costs are expensed as incurred. Costs are tracked in a memorandum account for potential future recovery.

        One of our Texas utilities filed for a general rate increase in June 2001, and new rates became effective in January 2002. Our other utilities are not currently seeking any rate increase; however, regulatory changes concerning water quality, future construction expenditures and increased operating expenses may result in future requests for rate increases.

        Historically, our utilities have been permitted to increase rates as necessary to achieve a reasonable rate of return, and we believe that this practice will continue in the future. However, the inability to increase rates in the event that certain costs increase could adversely affect the results of operations of our Utility Group.

Competition

        Our regulated utility subsidiaries in California, New Mexico and Texas each operate under a Certificate of Public Convenience and Necessity granted by the CPUC, NMPRC and TCEQ, respectively. These companies are also regulated by other state and local governmental authorities having jurisdiction over water and wastewater service and other aspects of our water utility businesses. Our Utility Group water businesses are dependent upon maintaining these certificates and upon various governmental and court decisions affecting our water rights and service areas.

        California, Texas and New Mexico state laws provide that no public or private agency can install facilities within the service area of a public utility in order to compete with it, except upon payment of just compensation for all damages incurred by the public utility. Under the state laws of California and New Mexico, municipalities and certain other public agencies have the right to acquire private water

12

utility plants and systems within their territorial limits by condemnation but must pay fair value for the condemned system. We are not aware of any impending proceeding for the condemnation of any portion of their facilities.

CREDIT CONCENTRATION

        We have no individual customers who accounted for 10% or more of our consolidated revenues in 2003, or whose loss would have a material adverse effect on our consolidated or operating segment revenues.

INTELLECTUAL PROPERTY

        The primary focus of the water and wastewater management industry is customer service, and the industry does not rely heavily on technological or proprietary manufacturing processes. We do not conduct significant research and development activities, although we have several patents pending for certain metering equipment. Except for certain logos, trademarks and artwork used in marketing, we have no other patents, licenses or trademarks.

SIGNIFICANT ACQUISITIONS

        In November 2002, we acquired certain contract operations of Aqua Source Inc., a provider of contract water and wastewater services in Texas, Colorado and South Dakota. The purchase price consisted of approximately $10.3 million in cash. Upon closing of the transaction on November 22, 2002, we began operating the majority of this business under the name Aqua Services, LP (Aqua Services) while the remaining part was incorporated into one of our existing subsidiaries, ECO Resources, Inc. (ECO).

        In August 2001, we purchased 90% of the outstanding shares of OpTech, a provider of contract water and wastewater and public works services in the southeastern United States, for a purchase price of $8.2 million. The purchase price consisted of cash payments of $3.5 million in August 2001 and $0.4 million in January 2002, promissory notes in the aggregate amount of $3.0 million and shares our common stock with a market value of $1.3 million at August 31, 2001. We also entered into an employment agreement and a non-compete agreement with the owner of the remaining 10% of OpTech. Under the terms of our purchase agreement, we have the right to acquire the remaining 10% of OpTech after a period of five years based upon a formula relating to the profitability of OpTech. After two years, the minority owner has the option to sell the remaining 10% of OpTech to us using the same formula, subject to a minimum of $1.0 million.

        In April 2000, we acquired 80% of the outstanding common stock of Master Tek. The Company entered into a separate employment agreement, a consulting agreement and a non-compete agreement with the minority owner. Under the terms of the purchase agreement, the minority owner had the right to require the Company to purchase his initial 20% minority interest in 5% increments at a price based on a formula but not less than $1.0 million per year over a four-year period commencing in April 2002. In April 2002, the Company paid $1.0 million to the minority owner for an additional 5% interest in Master Tek in accordance with the purchase agreement. In February 2003, the minority owner exercised his right to require us to purchase an additional 5% interest in Master Tek, which increased the Company's ownership to 90% in April 2003.

        After the April 2000 purchase of Master Tek, the minority owner and the Company had several disagreements, which ultimately led us to initiate legal action against the minority owner. During 2003, we placed payments due to the minority owner in escrow.

        In December 2003, we came to a final resolution of the litigation against the minority owner. The agreement called for a payout of approximately $2.7 million to the minority owner as final payoff of the remaining $1.5 million note payable due the minority owner, and in exchange for the remaining 10% interest in Master Tek stock. All other future obligations to the minority owner were terminated. The final agreement provided for indemnifications from the minority owner to cover certain unasserted claims. The settlement payout of approximately $2.7 million was made in January 2004.

13

        In February 2000, our California utility purchased the city of West Covina's water distribution system and facilities for a price of approximately $8.5 million. The sale closed February 25, 2000, and we assumed ownership and operation of the water system on that date. The transaction added approximately 7,000 connections to our California utility customer base, an increase of about 11%.

        In 1996, we acquired a 49% interest in Windermere Utility Company (Windermere), a regulated water and wastewater utility located in the Austin, Texas area. In October 2000, we reached an agreement with the majority stockholder and purchased an additional 31% interest from the majority stockholder, increasing our ownership in Windermere to 80%. As part of this transaction, we also purchased 100% of Hornsby Bend Utility Company (Hornsby), a nearby water and wastewater utility. The purchase price for these two transactions consisted of Southwest Water common stock with a market value of $4.0 million at October 1, 2000. The purchase agreement provides that we have the right to acquire the remaining 20% ownership in Windermere for a purchase price of $6.0 million payable in our common stock at any time when the market value of our common stock increases to $13.61 per share (after adjustment for stock splits and dividends through January 2004). The minority owner of Windermere has the right to sell the remaining 20% after October 1, 2005, for $6.0 million payable in our common stock, subject to a limitation on the maximum and minimum number of issuable shares. We also entered into a consulting agreement with the minority owner.

EMPLOYEES

        At December 31, 2003, we employed approximately 1,400 people. Approximately 1,200 people were employed in our Services Group and 200 were employed in our Utility Group. Approximately 1% of our employees are represented by an employee-union. We believe relations with our employees are positive.

DIVIDEND HISTORY

        During the past twenty years, Southwest Water has paid a quarterly cash dividend. For specific information relative to dividends paid during 2003 and 2002, see Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters. In addition, we have also declared stock splits, paid in the form of stock dividends, annually over the last five years.

RISK FACTORS

        The following factors could cause our actual results to differ materially from our historical results and/or forward-looking statements:

Risks Related to our Common Stock

•

Our outstanding indebtedness may adversely affect our financial condition and the value of our common stock.

We have significant levels of long term debt including, first mortgage bond indentures, term loans, convertible debentures and revolving credit facilities. If we were unable to make scheduled principal or interest payments on our debt, we could face actions by our creditors including penalties, litigation, increased interest charges, acceleration of maturity schedules, and cross default issues. Such actions by our creditors could have a material adverse effect on our results of operations.

We are obligated to maintain specified debt covenants under certain of our loan and debt agreements. If we were unable to maintain compliance with these covenants we could face penalties, increased interest charges, litigation, acceleration of maturity schedules, and cross default

14

issues. Such actions by our creditors could have a material adverse effect on our results of operations.

•

We are a holding company that depends on cash flow from our subsidiaries to meet our obligations.

As a holding company, we conduct all of our operations exclusively through our subsidiaries and our only significant assets are our investment in those subsidiaries. This means that we are dependent on distributions of funds from our subsidiaries to meet our debt service and other obligations. Our subsidiaries are separate and distinct legal entities and have no obligation to pay any amounts due on our debt. Furthermore, our right to receive cash or other assets of one of our subsidiaries upon the liquidation or reorganization of that subsidiary is generally subject to the prior claims of creditors, including trade creditors, of that subsidiary. Even if we were recognized as a creditor of that subsidiary, our claims would still be subject to any security interest of that subsidiary's other creditors. Therefore, our debt would be structurally subordinated to creditors, including trade creditors, of our subsidiaries. If we were unable to collect funds from our wholly owned subsidiaries in a timely manner we could be unable to meet our obligations, which could have a material adverse effect on our results of operations.

•

The market price of our shares of common stock could be volatile.

Our share price could become volatile due in part to the high volatility in the securities markets generally as well as developments from quarter to quarter which impact our financial results. Factors other than our financial results that may affect our share price include, but are not limited to:

(i) market expectations of the performance and capital spending plans of our customers; (ii) the level of business activity or perceived growth in the market for water services in general; (iii) investor perception of, as well as the actual performance of, other utilities or water services companies; (iv) a change in interest rates; (v) announcements by our customers or announcements concerning financial difficulties for customers for whom we have provided financing or with whom we have entered into material contracts; (vi) announcements by our key competitors concerning the award of large agreements or contracts for water services; (vii) potential litigation involving ourselves or the industries in which we operate; and (viii) announcements concerning the bankruptcy or other similar reorganization proceedings involving, or any investigations into the accounting practices of, other water services companies.

Risks Related to Our Business

Risk factors that affect our Services Group operations

•

We operate in a competitive market with low operating margins.

Our Services Group competes with several larger companies whose size, financial resources, customer base and technical expertise may restrict our ability to compete successfully for certain operations and maintenance contracts.

Due to the nature of our contract operations business, and to the very competitive nature of the market, we operate in a low margin environment. We must accurately estimate the cost and profitability of each project while, at the same time, maintaining prices at a level low enough to compete with other large companies. Our inability to do so could adversely impact our future revenue growth and profitability.

15

•

Our revenue growth depends on our ability to enter into new, and maintain our existing, operating contracts with cities, agencies and municipal utility districts.

Our revenue growth depends upon our ability to generate new as well as renew operating contracts with smaller cities, other agencies and municipal utility districts. Because we are selling in a political environment, we are subject to changing trends and municipal preferences. Recent terrorist acts have affected some political viewpoints relative to outsourcing of water or wastewater utility services. In the United States, municipalities own and municipal employees operate the majority of water and wastewater systems. A significant portion of our Services Group's marketing and sales efforts is spent demonstrating the benefits of contract operations to elected officials and municipal authorities. Employee unions and certain "public interest" groups generally oppose the principle of outsourcing and are active opponents in this process. The political environment means that decisions are made based on many factors, not just economic factors.

•

Our business depends on trained, qualified employees.

State regulations set the employee training, experience and qualifications standards required to operate specific water and wastewater facilities. We must recruit, retain and develop qualified employees, maintain training programs and support employee advancement. We must also obtain the proper management and operational people, finding state-certified and qualified employees to support the operation of water and wastewater facilities. Failure to do so could put us at risk, among other things, for operational errors at the facilities, for improper billing and collection processes, and for loss of contracts and revenues.

•

Events such as hurricanes, tornadoes and floods may affect our results of operations.

Our Services Group contract operations can be impacted by heavy rainfall which may limit our ability to perform certain billable work such as pipeline maintenance, manhole rehabilitation and other outdoor services. Severe weather conditions, such as hurricanes, tornadoes and floods, may result in additional labor and material costs that may not necessarily be recoverable under our firm, fixed-price O&M contracts, and may adversely impact our revenues and profitability. However, for our non-fixed-priced contracts, these events may provide additional billable opportunities to provide cleanup and repair work.

•

Our Services Group contracts have certain performance risks.

Our Services Group operating contracts require high levels of service to our clients. If we are unable to provide such services, the client may refuse payment, terminate the contract and may initiate a claim against us. Though we provide training programs, maintain close management oversight, provide performance bonds to our clients and follow other best practice activities, should we fail to properly provide these services. Such a failure may adversely impact our revenues and profitability.

Additionally, in certain circumstances our billing and collection business may use estimates in calculating invoices sent to tenants on behalf of our landlord clients. These estimates may involve allocations of common area space, extrapolation of usage data, allocation of usage between billing periods, correction of incorrect meter readings, and usage allocation based upon facility size, tenant load, occupancy term and other factors. We cannot assure you that we will not face claims regarding the use of such estimates, which may impact our profitability.

•

Services Group contracts for the design and construction of water and wastewater projects may expose us to certain completion and performance risks.

We have entered into, and may continue to enter into, design and construction contracts for water and wastewater facilities. These construction activities involve potential risks, including shortages of materials and labor, work stoppages, labor relations disputes, weather interference, engineering,

16

environmental, permitting or geological problems and unanticipated cost increases for reasons beyond our control. These issues could give rise to delays, cost overruns or performance deficiencies, or otherwise adversely affect the design, construction or operation of the project. To minimize our exposure to the risks associated with construction projects, we attempt to procure maximum price contracts from significant subcontractors, and secure performance and completion bonds from those subcontractors.

Certain of our contracts are fixed-price contracts, where we may bear all, or a significant portion of, the risk for cost overruns. Under these fixed-price contracts, our contract pricing is established in part based on fixed, firm subcontractor quotes or contracts and on cost and scheduling estimates. These estimates may be based on a number of assumptions, including assumptions about prices and availability of labor, equipment and materials, and other issues. If these subcontractor quotations or cost estimates prove inaccurate, or if circumstances change, cost overruns may occur, and we could experience reduced profits or, in some cases, a loss for that project. There can be no assurance that we can avoid additional costs under these types of contracts.

We may have contracts where we guarantee project completion by a scheduled date. At times, we may guarantee that the project, when completed, will achieve certain performance standards. If we subsequently fail to complete the project as scheduled, or if the project subsequently fails to meet guaranteed performance standards, we may face claims for cost impacts and/or penalties to the client resulting from any delay or for the costs to cause the project to achieve the performance standards. To the extent that these events occur, and are not due to circumstances for which the customer accepts responsibility, and cannot be mitigated against performance bonds or our subcontractor contracts, the total costs of the project would exceed our original estimates and we could experience reduced profits or, in some cases, a loss for the project.

Our customers may require us to secure performance and completion bonds for certain contracts and projects. Since September 2001, the market environment for surety companies has become risk averse. We secure performance and completion bonds for our contracts from these surety companies. To the extent we are unable to obtain bonds, new contracts would not be awarded to us and as a result, we could experience reduced revenues and profits. There can be no assurance that we can secure performance and completion bonds on new future projects, or obtain bond renewals on existing contracts or projects.

We may manage engineering and construction activities for water and wastewater facilities where design, construction or systems failures can result in injury or damage to third parties. Any liability in excess of claims against our subcontractors, the performance bonds and our insurance limits at facilities so managed could result in liability claims against us, which may adversely impact our profits. In addition, if there is a customer dispute regarding our performance of project management services, the customer may decide to delay or withhold payment to us. If we were ultimately unable to collect these payments, our profits would be reduced.

•

We use third party equipment and subcontractors.

Our submetering business relies on third parties for certain product design, product manufacture and assembly, and product installation and service. In selecting these third party service providers we attempt to ensure that they will provide a service that meets high quality standards. We receive guarantees from certain of these vendors, but we cannot guarantee that such guarantees completely protect us from the risk of quality failure in the design, manufacture, and installation of submetering equipment. We cannot assure that we will not face claims regarding product and installation quality for equipment placed in service either before after our acquisition of our submetering business. Such claims could have an adverse impact on our profitability.

17

•

Our Services Group is subject to environmental and water quality risks.

Our clients, municipalities or public agencies, are the owners of the facilities that we operate under contract. These facilities must be operated in accordance with various Federal and state water quality standards. We also handle certain hazardous materials at these facilities, primarily chlorine gas. Any failures of our operation of the facilities, including sewage spills, noncompliance with water quality standards, hazardous material leaks and spills, and similar events, could expose us to environmental liabilities, claims and litigation costs. We cannot assure you that we will successfully manage these issues, and failure to do so could have a material adverse effect on future results of operations.

•

We operate a large fleet of vehicles that could expose us to liabilities.

The Services Group has a fleet in excess of 500 vehicles. Our employees drive over 8 million miles per year. We are subject to normal vehicle risks associated with operating a fleet this large, including automobile accidents causing damage or injury to our own leased vehicles or employees, as well as third party damage to other property, vehicles or possible injury to others. Although we have vehicle insurance that covers material third party damage and liability, inability to manage this large fleet could have a material adverse impact on our profitability.

•

Our operating costs may rise faster than our revenues.

Many of our contracts with municipalities include contractual price increases tied to national consumer price indices. However, our costs are subject to market conditions and other factors, which may increase significantly higher than a generalized price index. The largest component of our operating costs is made up of salaries and wages. These costs are impacted by the local supply and demand for qualified labor. Other large components of our costs are general insurance, workers compensation insurance, employee benefits and health insurance costs. These costs may increase at rates higher than a price index and may have a material adverse effect on our future results of operations.

•

Our operating contracts may be canceled, reducing our revenues and backlog.

Our Service Group revenue backlog consists of new and existing contracts. We include new contracts in the backlog when we have a signed contract. Revenues included in our backlog may be realized over a multi-year period. The O&M contracts signed by our Services Group typically have durations of three to five years, and the uncompleted remaining portion of these existing contracts is reflected in the backlog. Although our Services Group tends to experience high renewal rates, municipalities and cities periodically change operators or terminate outsourcing at the end of a contract. The inability to renew existing contracts could have a material adverse impact on our Services Group. In addition, a municipality could cancel a long-term contract without notice. This would result in loss of revenues and operating profits and could involve us in litigation if a breach of contract occurs.

As of December 31, 2003, our backlog was approximately $320 million. We believe that this backlog is firm. However, we cannot guarantee that the revenues projected in our backlog will be realized or, if realized, will result in profits.

Risk Factors that affect our Utility Group operations

•

Weather conditions can affect the financial results of our Utility Group.

Rainfall and weather conditions affect our utility operations, with most water consumption occurring during the second and third quarters of each year when weather tends to be hot and dry. During this period, our marginal costs of water may exceed our marginal revenues as we use

18

higher-cost purchased water to meet customer demand. Therefore, while our revenues may increase, we may experience lower profit margins during periods of peak demand.

Drought or unusually wet conditions may also adversely impact our revenues and profitability. During a drought, we may experience both lower revenues due to consumer conservation efforts and higher water costs due to supply shortages. Since a fairly high percentage of our water is used outside of our customers' homes to water yards and fill pools, unusually wet conditions could result in decreased customer demand, lower revenues and lower profit. Consequently, the results of operations for one quarter should not be used to predict the results of future quarters.

•

Changes in the regulatory environment, including restrictions on the rates we are allowed to charge customers, may adversely affect our results of operations.

The regulated utility subsidiaries are subject to regulation by governmental agencies which establish the rates that we may charge our customers. These rates are intended, in concept, to permit our utilities to recover operating costs and earn a rate of return on our investment in utility plant and equipment. Each state regulatory agency sets the rules and policies that allow our utilities to file applications to increase rates as expenses or investment needs increase. These rules and policies may require that we estimate future expenses or may require that we incur specific expenses before there can be a change in rates. As a result, our revenues and earnings may fluctuate depending on the accuracy of our estimates, timing of our investments or expenses, or other factors. For example, electric power costs in California have been volatile. While we intend to use energy-efficient techniques and appropriate equipment, we may seek an increase in rates. If we were unable to obtain a rate increase that completely offsets the effect of higher power costs, we would realize a decrease in our profitability.

The regulatory agencies may change their rules and policies which may adversely impact our profitability. In some states regulators are elected by popular vote, and the results of elections may change the rules and policies of the agency. Changes in rules and policies may adversely impact our profitability.

•

We own assets in areas subject to natural disasters.

Some of our utility operations are located in an area of southern California that is subject to earthquakes and other natural disasters. While we maintain insurance policies to help reduce our financial exposure, a significant seismic event could adversely impact our ability to deliver water.

•

We are subject to regulatory and environmental risks and may not be able to provide an adequate supply of water to our customers.

Several factors impact our ability to provide water to our customers. We face contamination and pollution issues regarding our water supplies. Improved detection technology, increasingly stringent regulatory requirements, and heightened consumer awareness of water quality issues contribute to an environment of increased focus on water quality. While we continuously treat and test our water supplies to ensure that the water we distribute complies with water quality standards, we cannot assure you that we will be able in the future to reduce the amounts of contaminants in our wells to acceptable levels. In addition, the standards that we must meet are constantly changing and becoming more stringent. For example, in February 2002, the EPA lowered the arsenic standard in drinking water from 50 parts per billion to 10 parts per billion. If we cannot find an adequate treatment method to reduce arsenic in our New Mexico utility's well water, we would have to find alternative sources of supply. Our success in finding such alternative sources of supply at reasonable prices cannot be guaranteed.

To date, we have been able to produce and purchase enough water to meet our current customer requirements in California. However, we cannot assure you that we will be able to produce or

19

purchase enough water to fully satisfy future customer demand in our California service area. We are currently examining various options to increase our available water supply in California. These options include drilling new wells, adding connections to our existing MWD supply lines and constructing water treatment facilities. We cannot assure you that the results of drilling the wells will be successful, that we will be able to obtain necessary permits to add new supply lines and connections, or that we will be able to obtain regulatory or legislative approval to operate new water treatment facilities. During 2003, we drilled two new wells that are now producing water at approximately 5,500 gallons per minute. Additionally, we added four new pipelines that provide us access to additional sources of supply.

Each of our utilities obtains its water from various sources. The preferred source is pumping water from aquifers within our service areas. In the event that our wells cannot meet the customer demand, we have the ability to purchase water from surrounding municipalities, agencies and other utilities. However, it usually costs us more to purchase water than to produce it. Furthermore, these alternative sources may not always have an adequate supply to sell us. For example, our California utility purchases water from the Metropolitan Water District of California, which receives water from the Colorado River. In 2003, the US Department of the Interior restricted the amount of water that California may receive from the Colorado River. This restriction may impact the amount of water that the Metropolitan Water District can sell to our California utility in the future. We can make no guarantee that we will always have access to an adequate supply of water that will meet all quality standards, or that the cost of our water will not adversely affect our revenues and profits.

•

We need access to capital to continue to invest in our utility assets.

To meet the regulatory requirements for rates, increases in customer connections, and environmental challenges we need to continue our investment in utility plant and property. Currently we obtain the funds for our capital projects from the acceptance of contributions from developers, the issuance of our equity securities to the public and the use of both short and long-term debt. In the event that the capital markets for any of these sources were not available, or if we could not raise the capital in a manner acceptable to our regulators, our financial performance could be adversely affected.

Other Risk Factors

•

Our capital resources may restrict our ability to operate and expand our business.

We anticipate that our available line of credit borrowing capacity, cash balances, cash flow generated from operations, and execution of additional financing alternatives will enable us to continue operating and expanding our business. We may be unable to renew our credit facilities when they expire. We may be unable to execute additional financing alternatives at terms that we find acceptable. If we were unable to renew our existing lines of credit, or if we were unable to execute additional financing alternatives, our capital spending would be reduced or delayed, and any future acquisitions would be delayed or eliminated. While we have the ability to take these actions they could negatively impact our revenues, revenue growth, and profitability.

•

If we continue to grow, we may fail to effectively manage our growth or we may fail to effectively manage the growth we have experienced.

During the past few years, we have expanded our business both through internal growth and through acquisitions. We may actively seek acquisitions and joint ventures in each of our business lines. The success of our future business development and growth opportunities depends on our ability to attract and retain experienced and qualified persons to operate and manage our business ventures. In addition, our future success depends, in part, upon our ability to prudently manage

20

past and future acquisitions, if any. We cannot assure you that we will successfully manage our growth, or acquisitions, and failure to do so could have a material adverse effect on our future results of operations.

•

Our business may be affected by the general economic conditions of real estate development in the United States.

Both our Services Group and our Utility Group operations are impacted by the general economic conditions for real estate, the pace and location of real estate development activities within the United States. Increases in the number of water and wastewater connections, connection fees and billing and collection accounts are the result of expanded real estate development in areas we serve. We have little or no ability to control the pace and location of real estate development activities which affect our business. We cannot assure you that we will be able to continue to increase the number of customer connections and accounts, which may adversely affect our revenue growth.

•

We are subject to increasing costs of producing products and services.

The cost of water (whether produced from our own wells or purchased from outside sources), electric power and natural gas represents a substantial portion of the combined operating costs of our water utilities. Purchased water is significantly more expensive than water produced by our utilities. As a result, each utility attempts to produce as much as possible of the water it delivers and to use water purchases only to supplement its own production. Factors such as drought, water contamination issues and customer demand can increase water purchases and the overall cost of water for our utilities. Such factors are not within our control and may decrease our profitability if we are unable to obtain rate increases from a regulatory agency.

Electric power costs in California have been volatile. The cost of natural gas has increased significantly in the United States in recent years. Our response to these increases is to utilize energy-efficient techniques, new and better equipment and seek rate relief from the regulating agencies. We may not, however, have the ability to completely offset the effect of these cost increases. Continued increases in the costs of these services may decrease our profitability. Such factors are not within our control and may decrease our profitability if we are unable to obtain rate increases from regulatory agencies.

•

Our operations are subject to certain risks due to their location.

We own and/or operate water and wastewater facilities in numerous locations in numerous states and, consequently, we are subject to weather, political, water supply, labor supply, utility cost, regulatory, economic and other risks in the areas we service. We cannot control these risks. However, we believe that our broad geographic service area, while exposing us to these risks in numerous local markets, provides us a certain amount of geographical diversification against these risks at a consolidated company level.

COMPANY INFORMATION

        We make available free of charge through our Internet website our press releases, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. Our Internet website also contains our Code of Ethical Conduct for all employees and our Code of Ethics for Directors and Executive Officers. The Code of Ethics for Directors and Executive Officers applies to our Chief Executive Officer and senior financial officers. We will provide without charge to any person, on the written or oral request of said person, a copy of our Ethics Code. Requests should be directed to the Director of Corporate Communications,

21

Southwest Water Company, 624 South Grand Avenue, Suite 2900, Los Angeles, California 90017-3782 (telephone number (213) 929-1800). Our Internet website address is "www.swwc.com".

ITEM 2.    PROPERTIES

Facilities

Administrative Offices

        We lease administrative office and warehouse space at 13 locations in California, Texas, New Mexico, Colorado, Georgia, and Mississippi. In aggregate, these office and warehouse facilities total approximately 78,000 square feet. In addition we own administrative and warehouse space at four locations in California, Texas and New Mexico. In the aggregate, the facilities we own total approximately 19,300 square feet of office space and approximately 10 acres of land. We believe that these facilities are adequate to meet the needs of our existing operations and provide reasonable space for growth. Our operations do not require uniquely specialized facilities, and we believe that additional or alternative office space is available, if required, at reasonable prices. We may relocate some of our offices as leases terminate to improve the location or size of the facility, or to provide better coordination among our operating units.

        The majority of our property plant and equipment is held in the Utility Group. Net holdings as of December 31, 2003 are as follows:

		Net Property Plant and Equipment
		(in millions)
Utility Group
	California	$	87.3
	New Mexico		65.5
	Texas		55.5
Utility Group Total			208.3
Services Group			10.4
Corporate Other			0.8
		$	219.5

Water Production and Distribution Facilities

        Our utilities subsidiaries own and operate water production and distribution systems including well pumping plants, booster pumping stations, water treatment facilities, reservoir storage facilities, transmission and distribution mains, and service connections to individual customers. Our utilities have rights-of-way and easements in their service areas necessary to provide water services. Water production and distribution facilities held by our utilities as of December 31, 2003 were as follows:

	California	New Mexico	Texas
Transmission and distribution mains (in miles)	839	194	85
Storage reservoirs	30	5	11
Storage reservoir capacity (in millions of gallons)	69	12	3
Active wells	15	6	17
Pumping capacity (in gallons per minute)	18,900	10,400	7,895

22

Wastewater Facilities

        Our New Mexico utility owns and operates a sewer collection system consisting of one lift station and approximately 147 miles of interceptor and collector lines. Wastewater is treated at a city-owned facility.

        Our Texas utilities own and operate three sewer collection systems, including seven lift stations and approximately 85 miles of interceptor and collector lines. In 2002, one of these wastewater treatment facilities was expanded to increase our combined processing capacity from approximately 1.9 million gallons per day of sewage to over 3.7 million gallons per day.

Capital Expenditures, Repairs and Maintenance

        We believe that our properties are maintained in good condition and in accordance with current standards of good industry practice. We believe that the facilities used in the operation of our business are in good condition in terms of suitability, adequacy and utilization. We intend to continue our capital expenditure program, constructing and replacing reservoirs, wells and transmission and distribution lines in future years as needed and as approved by the regulating authorities. Our employees perform normal maintenance and construction work on these facilities while major construction projects are performed by general contractors. Ongoing maintenance and repairs expenses in our Utility Group for the three years ended December 31, 2003 were as follows:

	Years ended December 31,
	2003		% of Revenue		2002		% of Revenue		2001		% of Revenue
	(in millions except percentages)
Maintenance and repairs	$	3.7	2	%	$	4.1	3	%	$	1.9	2	%

Mortgages and Liens

        Virtually all of our California utility's property is subject to the lien of an Indenture of Mortgage and Deed of Trust dated October 1, 1986, as amended, (the California Indenture), securing our California utility's First Mortgage Bonds. The California Indenture contains certain restrictions common to such types of instruments regarding the disposition of property and includes various covenants and restrictions, including limitations on the amount of cash dividends that our California utility may pay to Southwest Water. Our California utility pays regular quarterly dividends to Southwest Water. As of December 31, 2003, our utility in California was in compliance with dividend limitations mandated by the California Indenture.

        Virtually all of our utility property in New Mexico is subject to the lien of an Indenture of Mortgage and Deed of Trust dated February 14, 1992, as amended (the New Mexico Indenture), securing our New Mexico utility's First Mortgage Bonds. The New Mexico Indenture contains certain restrictions common to such types of instruments regarding the disposition of such property and includes various covenants and other restrictions, including limitations on the amount of cash dividends that our New Mexico utility may pay to Southwest Water. Our utility in New Mexico pays regular quarterly dividends to Southwest Water. At December 31, 2003, our New Mexico utility was in compliance with dividend limitations mandated by the New Mexico Indenture.

        Substantially all of the assets of the Company's Windermere subsidiary in Texas have been identified as security for Windermere's 10-year $10.0 million secured bank term loan.

ITEM 3.    LEGAL PROCEEDINGS

        Southwest Water and a subsidiary have been named as defendants in twelve lawsuits alleging various injuries as a result of water contamination in the San Gabriel Valley Main Basin. The

23

California Supreme Court (the Court) ruled in February 2002 that the plaintiffs cannot challenge the adequacy of the water quality standards established by California Department of Health Services (DOHS). The plaintiffs may sue and collect damages from CPUC-regulated water companies only by proving that water delivered did not meet these water quality standards. Our subsidiary believes that it has complied with DOHS water quality standards. The Court directed that the cases be sent to a trial court for further proceedings. At this time a number of cases, including the twelve involving Southwest and its subsidiary, have been consolidated before a single judge. The parties are now engaged in initial discovery and motions to determine whether, in light of the ruling by the Court, the plaintiffs can plead and prove any violation of water quality standards by the CPUC regulated water companies. Southwest Water and this subsidiary have requested defense and indemnification from our liability insurance carriers for these lawsuits. Several of the liability insurance carriers are currently absorbing the costs of defense of the lawsuits. We cannot predict the outcome of these lawsuits. Based upon information available at this time, we do not expect that these actions will have a material adverse effect on our financial position, results of operations or cash flows.

        In April 2003, Southwest Water filed a lawsuit in the United States District Court for the District of Colorado against the minority owner of Master Tek for certain issues associated with both our initial acquisition of 80% of the stock of Master Tek and subsequent costs we incurred. In December 2003, the Company came to a final resolution of the litigation against the minority owner. The agreement called for a payment of approximately $2.7 million to the minority owner as final payoff of the remaining $1.5 million note payable and acquisition of the remaining 10% interest in Master Tek stock. All other future obligations to the minority owner were terminated. The final agreement provided for indemnifications from the minority owner to cover certain unasserted claims. The settlement payout of approximately $2.7 million was made in January 2004.

        Southwest Water and its subsidiaries are the subjects of litigation arising from the ordinary course of operations. We believe the ultimate resolution of such matters will not materially affect our financial position, results of operations or cash flows.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        None.

ITEM 4A.    EXECUTIVE OFFICERS

        Our Board of Directors elects executive officers each year at the first meeting following the Annual Meeting of Stockholders. There are no family relationships among any of the executive officers of Southwest Water Company, and there are no agreements or understandings between any such officer and another person pursuant to which he or she was elected as an officer. There are no legal proceedings that involve any executive officer of the type requiring disclosure pursuant to the instructions to this item. The executive officers of Southwest Water Company are as follows:

Anton C. Garnier—Chief Executive Officer

Age: 63

        Mr. Garnier has served as President and Chief Executive Officer of the Company since 1968. He is a past president of the National Association of Water Companies and served on the board of the San Gabriel Valley Watermaster, and he has been actively involved in the American Water Works Association and California Water Association. Mr. Garnier also serves as the president and a director of East Pasadena Water Company, California-Michigan Land and Water Company, and is a board member of California Domestic Water Company. Mr. Garnier's other current and past affiliations include the World Business Council, Chief Executives Organization, Cal Tech Executive Forum, Fellows

24

of the Huntington Library, Young Presidents Organization, 1984 U.S. Olympics, Whittier College Business Department Advisory Board, and the Boy Scouts of America.

Peter J. Moerbeek—President and Chief Operating Officer, Southwest Water and President, Southwest Water Company Services Group

Age: 56

        Mr. Moerbeek began his career at Southwest Water Company in 1995 as vice president finance and chief financial officer. In 1997 he was appointed to the additional position of chief operating officer of ECO Resources Inc., (ECO) a wholly owned subsidiary of Southwest Water. He was appointed to the position, President, Southwest Water Company Services Group when that position was created in 2002. In February 2004, Mr. Moerbeek assumed his current position as President and Chief Operating Officer of Southwest Water. He continues as the President of the Services Group. In 2001, Mr. Moerbeek was appointed to the Board of Directors of Southwest Water Company. From 1989 to 1995 Mr. Moerbeek served as Executive Vice President—Finance and Operations for Pico Products, a publicly held manufacturer and importer of cable television equipment and parts. From 1986 to 1989 Mr. Moerbeek served as Vice President and Controller for Ortel Corporation, a high-tech laser manufacturing start-up. From 1982 to 1985 he served as Vice President, Finance and Administration for Eisenman Chemical Company, a provider of products and services to the oil industry. Mr. Moerbeek has an MBA and a Bachelor of Science in Electrical Engineering from the University of Washington.

Richard J. Shields—Chief Financial Officer

Age: 46

        Mr. Shields has served as our Chief Financial Officer since October 2002. From 2001 to 2002, Mr. Shields served as Vice President and Chief Financial Officer of Day Software, Inc. From 1999 to 2001 he served as Chief Financial Officer of Winfire, Inc. From 1996 to 1999 Mr. Shields served as Chief Financial Officer of Frame-n-lens Optical, Inc. From 1988 through 1996 Mr. Shields held various finance management positions at AST Research, Inc., including Director of the Americas Region Finance. From 1985 to 1988 Mr. Shields served in various management positions at Taco Bell Corporation. Mr. Shields began his career in 1982 with Price Waterhouse. Mr. Shields has a Bachelor of Arts in accounting from Eastern Washington University and an MBA from the University of Notre Dame.

Shelley A. Farnham—Vice President Human Resources and Secretary

Age: 48

        Ms. Farnham has been Vice President of Human Resources since July 1998. She oversees organizational planning and development, employee relations, training, compensation and benefits administration for the company and its subsidiaries. She provided human resources leadership to the marketing organization of Atlantic Richfield's Products Company from 1995 to 1998. From 1988 to 1995 Ms. Farnham held numerous positions in human resources, ranging from recruiter to training manager to interstate personnel manager with the Federal Reserve Bank of New York and Northrop Corporation. She has a Bachelor of Science degree in Management/Finance from Simmons College in Boston, Massachusetts, and she has earned certificates in training and human resources and organizational development from UCLA.

25

Maurice W. Gallarda—Vice President New Business Development

Age: 50

        Mr. Gallarda has been with the Company since 1998. As vice president of new business development he manages strategic growth planning as well as internal growth and opportunities for expansion into new markets and services. From 1995 to 1998 Mr. Gallarda was chief executive officer of Watershed Holdings, Inc., a company he founded to provide engineering, analytical and manufacturing services to the environmental industry. From 1987 through 1995 Mr. Gallarda served as President of Thorne Environmental, Inc., and Park Environmental Corporation where his responsibilities included the integration of existing business into the expanding environmental industry. He is also active in several professional organizations including the American Society of Civil Engineers, the Water Environment Federation, the California Environmental Bar Association and the National Society of Professional Engineers. An appointee of former California Governor Pete Wilson, Mr. Gallarda served on the California Regional Water Quality Control Board. Mr. Gallarda has a Bachelor of Science degree in Civil Engineering from California State University, Sacramento. He is licensed as a professional civil engineer in multiple states.

Michael Miller—Corporate Controller

Age: 39

        Mr. Miller was appointed Corporate Controller in September 2003. Prior to that, Mr. Miller served as the finance executive responsible for SEC Compliance and Public Reporting at Artemis International Solutions Corporation. From 1996 to 2002 Mr. Miller was a finance executive with EarthLink Inc., and served as Director of Finance and Public Reporting from 1996 to 2002. Mr. Miller served in the audit practice of Ernst & Young LLP from 1988 to 1990 and PricewaterhouseCoopers LLP, from 1990 to 1996. Mr. Miller has a Bachelor of Science in Business Administration-Accounting from California State University, Northridge.

Michael O. Quinn—President, Southwest Water Company Utility Group

Age: 57

        Mr. Quinn has held a variety of positions with Southwest Water Company and its subsidiaries since 1970. He is president of the Utility Group of Southwest Water Company and has been President of Suburban Water Systems since 1996. From 1992 to 1996 he was chief operating officer for Suburban Water Systems. From 1985 to 1992 he was president of ECO Resources, Inc. Prior to that he was controller/treasurer at Suburban Water Systems. Mr. Quinn holds a Bachelor of Arts in Business Management from California State University at Fullerton. Among his water industry affiliations, Mr. Quinn is immediate past president of the California Water Association, is president elect of the National Association of Water Companies and serves on the board of the Citrus Valley Health Foundation board.

Thomas C. Tekulve—Vice President and Treasurer

Age: 52

        Mr. Tekulve joined Southwest Water Company in 1999 as Vice President, Finance and became Vice President, Treasurer in 2002. He oversees finance and treasury and provides guidance in strategic planning for the corporation and its subsidiaries. From 1995 to 1999 Mr. Tekulve served as vice president and chief financial officer of Safeguard Health Enterprises, Inc. From 1984 to 1994 he served in a variety of executive positions at Beckman Instruments, Inc., including Director of Finance for International Operations and Corporate Controller. He began his career with Arthur Andersen & Co. Mr. Tekulve has a Bachelor of Science in Business Administration-Accounting from California State University, Northridge and an MBA from Portland State University in Oregon.

26

PART II

ITEM 5.    MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

        The following table shows the range of market prices of Southwest Water's common shares. The prices shown reflect the intra-day high and low bid prices for our common stock without retail markup, markdown or commissions and may not necessarily represent actual transactions. The price ranges shown in the table, as well as cash dividends declared in each quarter, reflect a 4-for-3 stock split in the form of a stock dividend on January 1, 2004 and a 5% stock dividend on January 1, 2003. Our common stock is traded on the NASDAQ Stock Market under the symbol SWWC. At December 31, 2003, there were 2,457 stockholders of record.

		Southwest Water Company
		Stock Price Range
						Cash Dividends
		High		Low
YEAR ENDED DECEMBER 31, 2002
	First Quarter	$	11.57	$	9.60	$	0.040
	Second Quarter		13.64		10.17		0.040
	Third Quarter		13.58		8.43		0.040
	Fourth Quarter		10.72		9.02		0.044
YEAR ENDED DECEMBER 31, 2003
	First Quarter		10.50		9.08		0.044
	Second Quarter		10.92		8.96		0.044
	Third Quarter		10.88		9.56		0.044
	Fourth Quarter		12.38		10.43		0.048
YEAR ENDING DECEMBER 31, 2004
	First Quarter through March 12, 2004		15.79		11.89

Dividend Policy

        Since 1960, our practice has been to pay common stock dividends quarterly in January, April, July and October. The amount and timing of future dividends depends on our growth, results of operations, profitability and financial condition, as well as other factors deemed relevant by our board of directors. Our current quarterly dividend rate is $0.0475 per share of common stock.

27

ITEM 6.    SELECTED FINANCIAL DATA

        Earnings per common share, cash dividends per common share and basic and diluted weighted average outstanding common shares reflect the following:

•

a 4-for-3 stock split in the form of a stock dividend on January 1, 2004,

•

a 5% stock dividend on January 1, 2003,

•

a 5% stock dividend on October 1, 2001,

•

a 5-for-4 stock split in the form of a stock dividend on January 1, 2001, and

•

a 3-for-2 stock split in the form of a stock dividend on October 1, 1999.

	Years Ended December 31,
	2003			2002		2001		2000		1999
	(in thousands, except per common share data)
Summary of Income Statement Data:
Revenues	$	172,974		$	130,800	$	115,547	$	104,741	$	80,849
Operating income		14,792			10,774		11,731		11,039		8,979
Gain on sales of land		728			119		—		128		2,855
Other income (expense)(a),(b)		(70	)		2,551		298		161		387
Net income(d)		7,193			6,002		5,451		4,839		5,430
Net income available for common shares(d)		7,166			5,975		5,424		4,812		5,403
Common Share Data:
Earnings per common share:
Basic(a),(b),(c)	$	0.51		$	0.46	$	0.43	$	0.39	$	0.46
Diluted(a),(b),(c)	$	0.49		$	0.44	$	0.41	$	0.39	$	0.45
Cash dividends per common share	$	0.18		$	0.16	$	0.16	$	0.13	$	0.12
Balance Sheet Data:
Capital additions, gross	$	28,122		$	34,602	$	16,589	$	10,768	$	9,509
Total assets		296,222			268,744		225,186		196,652		142,950
Long-term portion of lines of credit and debt		73,102			80,985		58,063		46,351		33,454
Stockholders' equity		79,667			61,837		55,718		49,078		40,718

(a)

In 2001 we were required to shut down some of our wells due to chemical contamination. This resulted in our California utility purchasing a significant portion of its water supply from the MWD and other sources since 2001. In May 2002, an agreement was reached among some of the parties responsible for the contamination and a number of affected water companies, including our California water utility. As a result of the agreement we recorded income of approximately $1.7 million, which covered certain water and energy costs, incurred in 1999, 2000 and 2001 arising from the contamination that were prior to the commencement of monthly payments. This agreement was an unusual event and we recorded the $1.7 million in other income rather than as an increase to Operating Income, in accordance with the provisions of APB No. 30, Reporting the Results of Operations. See Summary of Significant Accounting Policies in the footnotes of our financial statements.

As a result of this contamination, we have received payments, and we expect to continue to receive payments until completion of remediation, for the incremental cost of purchasing water over the cost that would have been incurred by us to pump water from our wells had they not been shut down as a result of contamination. For 2003 the amount of reimbursed expenses was approximately $4.0 million. This reimbursement pertains to our agreement with the parties responsible for the contamination. It is ongoing and is no longer considered an unusual event. As such, the reimbursement is recorded as a reduction to "Operating Expenses—Utility Group" for 2003. The reimbursement, net of tax, for 2003 was $0.17 per share.

(b)

Results of operations for 2002 include other income of $1.7 million of income from an agreement with cooperating respondents, as well as a $1.0 million gain on termination of a pension plan. The effect those items, net of taxes was $0.08 per share of income, from an agreement with cooperating respondents, as well as $0.05 per share gain on termination of a pension plan.

(c)

Results of operations for 1999 include a $0.15 per share gain, net of taxes, in 1999 on the sale of surplus land formerly used in water utility operations.

(d)

Excludes amortization of goodwill beginning in 2002. The expense for amortization of goodwill was $104,000 and $63,000, net of taxes, in 2001 and 2000, respectively. There was no amortization of goodwill in prior years.

28

ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information in this discussion contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. See "Forward-looking Statements" above for additional information.

        The following discusses the financial condition and results of operations of Southwest Water Company and subsidiaries and should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report.

Overview

        Southwest Water Company and Subsidiaries ("Southwest Water", "we" "us," "our" or the "Company"), provide a broad range of services including water production and distribution, wastewater collection and treatment, public works services, utility customer billing services and construction management. We provide services to more than two million people in 36 states. Our business is segmented into two operating groups; our Services Group and our Utility Group.

        Our Services Group operates our contract service businesses in which we operate and maintain water supply and wastewater facilities owned by cities, public agencies, municipal utility districts and private entities primarily in Texas, New Mexico, California, Colorado, Alabama, Mississippi and Georgia. While state and federal agencies issue regulations regarding standards of water quality, safety, environmental and other matters which affect these operations, our Services Group prices are not subject to regulation. We also provide utility submetering and billing and collection services in numerous states.

        Our Utility Group owns and operates public water and wastewater utilities in California, New Mexico and Texas. State and federal agencies issue regulations regarding standards of water quality, safety, environmental and other matters which affect these operations. The rates that our regulated utility subsidiaries charge for water and wastewater services are established by state authorities.

29

Results of Operations

        The following table sets forth the percentage of total revenues represented by certain items in our consolidated statements of operations for the periods indicated:

	Years Ended December 31,
	2003			% of Revenue		2002			% of Revenue		2001			% of Revenue
	($ amounts in millions)
Revenues:
Services group	$	116.0		67		$	78.8		60		$	66.5		58
Utility group		56.9		33			52.0		40			49.0		42
		172.9		100			130.8		100			115.5		100
Expenses:
Operating expenses—services group		101.4		59			67.9		52			57.0		49
Operating expenses—utility group		33.9		20			33.8		26			29.3		25
Selling, general and administrative expenses		22.8		13			18.4		14			17.5		15
		158.1		92			120.1		92			103.8		89
Operating Income		14.8		8			10.7		8			11.7		11
Other Income (Expense):
Interest expense		(4.6	)	(3	)		(4.5	)	(3	)		(3.7	)	(3	)
Interest income		0.4		—			0.3		—			0.6		1
Gain on sales of land		0.7		1			0.1		—			—		—
Other		(0.1	)	—			2.6		2			0.3		—
		(3.6	)	(2	)		(1.5	)	(1	)		(2.8	)	(2	)
Income Before Income Taxes		11.2		6			9.2		7			8.9		9
Provision for Income Taxes		4.0		2			3.2		2			3.5		3
Net Income	$	7.2		4		$	6.0		5		$	5.4		6

2003 Compared to 2002

Revenues

Services Group

        Services Group revenue represents fees earned for water and wastewater facility operations and maintenance services, equipment maintenance and repair, sewer pipeline cleaning, billing and collection services, public works and state-certified water and wastewater laboratory analysis. Our Services Group also facilitates the design, construction, project management, and operating aspects of various water and wastewater projects. Services Group revenues for 2003 increased approximately $37.2 million, or 47%, to $116.0 million from $78.8 million during the prior year. The increase is due to the following:

•

The acquisition of Aqua Services in November 2002. In November 2002, we acquired certain contract operations of Aqua Source, Inc., a provider of contract water and wastewater services in Texas, Colorado and South Dakota. Upon closing of the transaction we began operating the majority of this business under the name Aqua Services, LP (Aqua Services) while the remaining part was incorporated into one of our existing subsidiaries, ECO Resources, Inc. (ECO). Revenues from Aqua Services were approximately $19.2 million and $1.3 million during 2003 and 2002, respectively.

30

•

An increase in revenues of approximately $12.9 million from the construction of a reverse osmosis water treatment facility in California to $13.6 million during 2003 from $0.7 million in 2002.



•

An increase in revenues from our Texas service operations of approximately $4.3 million to $64.2 million during 2003 from $59.9 million during the prior year. The revenue increase is largely attributable to increased tapping and inspection revenue driven by real estate development activity in Texas.

Utility Group

        Utility Group revenue represents fees earned for the production and distribution of water and the collection and treatment of sewage for residential, business, industrial and public authority use. Revenues in the Utility Group increased approximately $4.9 million, or 9%, to $56.9 million during 2003 from $52.0 million during the prior year. The increase is primarily due to the favorable effect of rate increases in our California and Texas utilities and increased customer connections in our New Mexico and Texas utilities. The effect of increases in rates was partially offset by decreases in water consumption due to variations in weather in our California Utility. The changes are represented as follows:

	(in millions)
Favorable effect of rate increase in revenues	$	4.8
Favorable effect of increase in connections		0.9
Reduction in water consumption		(0.8	)
Net increase in revenue	$	4.9

Operating Expenses

Services Group

        Operating expenses—services group represent salaries, wages and employee benefits, facilities costs, supplies and equipment, repairs and maintenance, professional fees and other costs. Operating expenses—services group represented approximately 87% and 86% of the Services Group revenues for 2003 and 2002, respectively. Operating expenses increased approximately $33.5 million, or 49%, to $101.4 million during 2003 from $67.9 million during 2002. The increase was due to the following:

•

the acquisition of Aqua Services in November 2002, which generated operating costs of approximately $19.0 million and $1.3 million during 2003 and 2002, respectively, and



•

costs related to the construction of a reverse osmosis water treatment facility for the city of San Juan Capistrano, California which accounted for approximately $12.9 million of the increase in operating expenses.

        The remaining increase of approximately $2.9 million for 2003, compared to the prior year, resulted from increased operations and construction activity in the Services Group's operations.

        The increase in operating expenses as a percentage of operating revenues in 2003 was primarily due to the Company's project to construct and operate the reverse osmosis water treatment facility. We are accounting for the project under the percentage of completion method during the construction phase. The construction phase is expected to be completed in 2004.

Utility Group

        Operating expenses—utility group represent the costs of purchasing and producing water, treating wastewater, salaries, wages and employee benefits, facilities costs, supplies and equipment, repairs and

31

maintenance, professional fees and other costs. Operating expenses—utility group represented approximately 60% and 65% of revenues from utility operations for 2003 and 2002, respectively. Operating expenses were substantially unchanged from 2002 to 2003. The decrease in operating expenses as a percentage of revenue was due to the aforementioned increase in Utility Group revenues, which was primarily due to an increase in rates at our California utility. Operating expenses for our Utility Group increased $0.2 million, or 1%, to $33.9 million during 2003, from $33.7 million during 2002.

        Operating expenses incurred by our New Mexico utility increased $409,000, or 10%, during 2003 as compared to 2002. The City of Albuquerque has increased sewage treatment rates approximately 9%. In addition, our New Mexico utility has incurred additional fuel costs due to increased volume.

        As expected, operating expenses at our California and Texas Utilities did not change in a significant amount.

Selling, general and administrative expenses

        Selling, general and administrative expenses consist mainly of costs related to personnel, facilities, insurance and professional services, which support our sales, marketing, human resources, finance and administration functions. Selling general and administrative expenses increased approximately $4.4 million, or 24%, to $22.8 million for 2003 from $18.4 million during the prior year. The increase was largely due to the inclusion of approximately $1.3 million from Aqua Services and the increased costs company-wide for employee health benefits, insurance and compensation expenses. As a percentage of revenues, selling, general and administrative expenses decreased from 14% in 2002 to 13% in 2003.

Other income (expense)

Interest Expense

        The major components of interest expense for 2003 and 2002 are as follows:

	For the year ended December 31,
	2003			2002
	(in millions)
Interest expense—convertible subordinate debentures	$	1.4		$	1.4
Interest expense—bank lines of credit		0.9			0.6
Interest expense—mortgage bonds and bank term loan		2.1			2.2
Interest expense—other		0.7			0.5
Total interest expense before capitalized interest		5.1			4.7
Capitalized interest		(0.5	)		(0.2	)
Total interest expense	$	4.6		$	4.5

        We increased borrowings during the first six months of 2003 to finance capital improvements in our Utility Group. Our benefit from lower interest rates and higher capitalized interest from increased construction activity in our Utility Group was offset by higher borrowings on our bank lines of credit and increased interest expense related to our Texas utility bank term loan. In August 2002, one of our Texas utilities obtained a 10-year; $10.0 million secured bank term loan which increased our long-term debt outstanding and consequently, our interest expense. Our effective interest rates for 2003 and 2002 were 6.6% and 6.8%, respectively.

32

Gains on Sales of Land

        In the second quarter of 2003, we recognized a $0.7 million pretax gain on the sale of surplus land, and in the second quarter of 2002 we recognized a $0.1 million pretax gain on the sale of surplus land.

Other

        We report material events that are unusual in nature or occur infrequently, but not both, in Other Income (Expense) rather than in Operating Income, in accordance with the provisions of APB No. 30 Reporting the Results of Operations. Included in Other Income for 2002 is the effect of a one-time, non-taxable gain in 2002 of approximately $1.0 million resulting from the termination of the Company's defined benefit plan (as more fully disclosed in Note 12 to the consolidated financial statements). There were no similar pension related gains in 2003. Included in Other Income for 2002 is a $1.7 million agreement reached among parties responsible for the contamination, the ("Cooperating Respondents"), and our California utility regarding water-quality-related expenses incurred in 1999, 2000 and 2001 (see Note 1 in the accompanying consolidated financial statements). In 2003 and subsequent years, such reimbursements will be recorded as a reduction to Operating Expenses—Utilities.

Income Taxes

        Our effective tax rate for 2003 was approximately 36% compared to approximately 35% for 2002. Our effective tax rate for 2002 reflected the benefit of a one-time gain on the termination of a pension plan, which was excluded from ordinary taxable income.

2002 Compared to 2001

Revenues

Services Group

        Services Group revenues increased $12.3 million, or 18%, to $78.8 million during 2002 from $66.5 million during 2001. The increase is due to the following:

•

We acquired OpTech in August 2001 and had the benefit of revenues earned by OpTech for a full year during 2002 versus a partial year in 2001. Revenues recorded by OpTech during the period August 1, 2001 through December 31, 2001 and during the year ended December 31, 2002 were $3.7 million and $11.7 million, respectively,



•

Approximately $1.3 million in revenues from the acquisition of Aqua Services in November of 2002, and



•

An increase of approximately $6.5 million of O&M revenues due to the origination of contracts with new customers and expansion of services with existing customers.

Utility Group

        Utility Group revenues increased $2.9 million, or 6%, to $52.0 million during 2002 from $49.1 million during 2001. Revenues at our California utility increased $2.0 million or 5% to $39.7 million in 2002 from $37.7 million in 2001. The number of water connections served by our California Utility remained relatively stable at 74,846 and 74,665 at December 31, 2002 and 2001, respectively. The increase in revenue recorded by our California utility was due to increased consumption driven by hot, dry weather in 2002, which was one of the driest years in recent history.    Revenues at our New Mexico utility increased $0.5 million or 7% to $7.3 million in 2002 from $6.8 million in 2001. Connections served by our New Mexico utility increased to 11,365 at

33

December 31, 2002 from 10,006 at December 31, 2001, an increase of approximately 13%. However, the increase was partially offset by a reduction in per customer volume due to changes in weather.

        Revenues at our Texas utilities increased approximately $0.2 million or 7% to $2.8 million during 2002 from $2.6 million during 2001. The increase is primarily due to an increase in volume and consistent with the increase in connections to 5,754 at December 31, 2002 from 5,316 at December 31, 2001.

Operating Expenses

Services Group

        Operating expenses—services group represented approximately 86% of the Services Group revenues for 2002 and 2001, respectively. Operating expenses increased approximately $10.9 million, or 19%, to $67.9 million during 2002 from $57.0 million during 2001. The increase was due to the following:

•

The acquisition of Aqua Services. in November 2002, which generated operating costs of approximately $1.3 million during 2002.



•

Operating costs related to the OpTech acquisition during the period August 1, 2001 through December 31, 2001 were $3.5 million compared to costs of $12.7 million incurred during the year ended December 31, 2002.



•

An increase of approximately $6.3 million of operating expense due to the origination of contracts with new customers and expansion of services with existing customers.

Utility Group

        Operating expenses—utility group represented approximately 65% and 60% of revenues from utility operations for 2002 and 2001, respectively. Operating expenses for our Utility Group increased $4.4 million, or 15%, to $33.7 million during 2002, from $29.3 million during 2001. The increase in operating expenses incurred by our California utility was $3.3 million to $26.9 million during 2002 from $23.6 million during 2001. The increase in operating expenses for our California utility was due to increased water production driven by hot, dry weather in 2002. Volume-related costs were $5.5 million greater in 2002 than 2001. We had to purchase additional water from higher priced sources in order to address the overall increase in demand. However, the increased water costs were partially offset by the recoveries from Cooperating Respondents. In addition, in 2001, our California utility was able to defer recognizing certain costs of approximately $0.7 million until future rate cases through the use of a balancing account. As of November 29, 2001, the CPUC eliminated the use of balancing accounts, which had the effect of increasing operating expense for 2002.

        Operating expenses incurred by our New Mexico utility increased $1.0, or 33%, to $4.1 million during 2002 from $3.1 million during 2001. The increase was primarily due to an increase in the number of connections served by our New Mexico utility. In addition, the City of Albuquerque allowed our New Mexico utility to increase sewage treatment rates it charged in 2002.

        Operating expenses for our Texas utilities increased approximately 4% to $2.8 million during 2002 from $2.7 million during 2001. The increase is primarily due to an increase in volume and is consistent with the increase in connections to 5,754 at December 31, 2002 from 5,316 at December 31, 2001.

Selling, General and Administrative Expenses

        Selling, general and administrative expenses increased 5% to $18.4 million during 2002, compared to $17.5 million for 2001. As a percentage of consolidated revenues, selling, general and administrative expenses were 14% and 15% in 2002 and 2001, respectively. The increase in selling, general and

34

administrative expenses was primarily attributable to i) the acquisition of OpTech in August 2001, ii) the acquisition of Aqua Services in November 2002, iii) increases in medical and general insurance costs, iv) marketing and new business development expenses and v) an increase in stock-based compensation expense, of $0.2 million to $1.0 million in 2002. In addition, due to changes in the Company's stock price, options issued in 2002 were calculated to have a higher per option value than the options issued in 2001.

Other Income (Expense)

Interest Expense

        Total interest expense increased 22% to $4.5 million during 2002, compared to $3.6 million in 2001. The increase reflects interest expense on our 20-year convertible subordinate debentures that were issued in July 2001. This increase was partially offset by decreases in the interest expense on our bank lines of credit because we paid down a portion of our line of credit borrowing with the proceeds from the debentures. The interest expense on the bank lines of credit also decreased due to generally lower interest rates in 2002 compared to 2001. The effective interest rates on our indebtedness were approximately 6.8% and 7.4% in 2002 and 2001, respectively. The reduction in capitalized interest during 2002, compared to the prior year, was due primarily to a reduction in company-financed utility projects.

        The major components of interest expense for 2002 and 2001 were as follows:

	For the years ended December 31,
	2002			2001
	(in millions)
Interest expense—convertible subordinate debentures	$	1.4		$	0.6
Interest expense—bank lines of credit		0.6			1.2
Interest expense—mortgage bonds and bank term loan		2.2			2.3
Interest expense—other		0.5			0.3
Total interest expense before capitalized interest		4.7			4.4
Capitalized interest		(0.2	)		(0.8	)
Total interest expense	$	4.5		$	3.6

Other

        We report material events that are unusual in nature or occur infrequently, but not both, in Other Income (Expense) rather than in Operating Income, in accordance with the provisions of APB No. 30 Reporting the Results of Operations. Included in Other Income on the Company's Consolidated Statements of Income is the effect of a one-time, non-taxable gain in 2002 of approximately $1.0 million resulting from the termination of the Company's defined benefit pension plan (as more fully disclosed in Note 11 to the consolidated financial statements). Also included in Other Income for 2002 is a $1.7 million settlement reached between parties responsible for the contamination and our California utility regarding water-quality-related expenses incurred in 1999, 2000 and 2001.

Income Taxes

        Our effective tax rate for 2002 was approximately 35% compared to approximately 39% for 2001. Our effective tax rate for 2002 was reduced when we recorded a one-time gain on termination of a pension plan, which is excluded from ordinary taxable income.

35

Liquidity and Capital Resources

        Our operating activities provided approximately $8.8 million in cash during 2003 consisting of net income of $7.2 million, adjusted for certain non-cash items including depreciation and amortization of $7.5 million, deferred income taxes of $3.5 million and stock-based compensation of $0.9 million. Operating cash flow was further increased by a net increase in liabilities of $3.0 million. Operating cash flow was reduced by (i) an increase in accounts receivable of $3.1 million, (ii) an increase in other assets of $5.7 million, (iii) a gain of $0.7 million from the sale of land, and (iv) an increase in restricted cash of $2.8 million and (v) approximately $1.0 million in other items. The $3.1 million increase in trade accounts receivable was due to the following:

•

Approximately $2.1 million represents the excess of amounts earned over the amounts collected in connection with the Company's $25.0 million project to design and build a reverse osmosis water treatment plant for the city of San Juan Capistrano, California.



•

Our California utility made a general rate case filing on April 2, 2002 and was granted an average 17% increase in rates. Approximately $1.2 million of the accounts receivable increase was due to the increase in monthly revenue as a result of the rate increase.

        Our investing activities used cash of $17.6 million during 2003. Capital expenditures of $18.4 million were primarily for the acquisition of property, plant and equipment for regulated water system assets used by our Utility Group, including new wells and transmission lines and the construction of a lift station and water line in Texas. The effect of these expenditures was partially offset by proceeds from sales of land of approximately $0.8 million.

        The following table summarizes our activity for additions to property, plant and equipment during 2003 and 2002:

	For the years ended December 31,
	2003		2002
	(in millions)
Company-financed additions	$	13.8	$	13.3
Capital improvement reimbursements		2.5		4.3
Contributions paid for by developers		2.1		8.0
Total cash additions to property, plant and equipment		18.4		25.6
Property contributed by developers		9.8		9.0
Total additions to property, plant and equipment	$	28.2	$	34.6

        Financing activities provided cash of approximately $9.8 million. Net proceeds from our private placement of equity in May 2003 were approximately $10.9 million. We collected approximately $1.3 million in net proceeds from our dividend reinvestment and employee stock purchase plans. Proceeds from asset sale-leaseback arrangements were approximately $1.7 million. Reimbursements to our California utility under an expense reimbursement agreement were approximately $2.5 million. Contributions in Aid of Construction (CIAC) represent contributions in the form of cash, services or property received from developers, governmental agencies, municipalities or individuals for the purpose of constructing utility plant. CIAC and advances for construction were approximately $1.4 million. Cash used to reduce debt and to pay dividends was approximately $5.8 million and $2.6 million, respectively.

        Our liquidity is influenced primarily by cash flows from operations and by capital expenditures at our Utility Group for the addition, replacement and renovation of water and wastewater utility facilities. Our capital resources are used for debt service on our bonds and debentures and are also influenced by investments in new business opportunities, including the acquisition of companies and acquisition of contract operations.

36

Off-Balance Sheet Arrangements

        The Company does not have any material off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial conditions, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.

Contractual Obligations

        A summary of our future contractual obligations and commercial commitments as of December 31, 2003 is as follows:

		Year ending December 31,
		2004		2005		2006		2007		2008 and thereafter		Total
		(in thousands)
Long-term debt
	Bank lines of credit	$	—	$	16,609	$	—	$	—	$	—	$	16,609
	Bank term loan		500		500		500		500	$	7,375		9,375
	Economic development revenue bonds		90		95		100		105		1,755		2,145
	Mortgage bonds		900		900		13,500		—		8,000		23,300
	Convertible subordinate debentures(1)		—		—		—		—		19,682		19,682
	Notes payable		1,207		1,311		1,378		386		406		4,688
Advances for construction			181		181		181		181		181		905
Obligations under non-cancellable operating leases			5,030		4,313		3,468		2,426		12,918		28,155
Other			417		455		495		987		1,607		3,961
		$	8,325	$	24,364	$	19,622	$	4,585	$	51,924	$	108,820

(1)

The convertible subordinate debentures are due in 2021. There are no intermediate put rights attached to the debentures.

        We anticipate that mortgage bonds that come due in 2006 will be refinanced through the sale of new mortgage bonds or may be funded through the additional issuance of our equity capital. If we were unable to refinance these bonds, or to raise capital to provide for these funds, the Company would expect to utilize cash flows generated from operations and a portion of our line of credit borrowing capacity from our commercial banks.

        We anticipate that our available line of credit borrowing capacity and cash flows generated from operations will be sufficient to fund our activities during the next 12 months. If we were unable to renew our existing lines of credit or if we were unable to execute additional financing alternatives, our capital spending and any future acquisitions would be reduced, eliminated or delayed.

        We have filed with the Securities and Exchange Commission a registration statement, which is effective for the issuance of up to $50 million aggregate principal amount of common stock, debt securities and warrants. We may offer any of these securities for sale at any time and from time to time.

        On December 31, 2003, we had working capital of approximately $4.0 million with available cash and cash-equivalent balances of approximately $2.6 million (excluding restricted cash balances), as well as aggregate lines of credit totaling $30.0 million consisting of three separate unsecured lines of credit from three commercial banks. Our total borrowing availability under lines of credit was approximately $13.6 million on December 31, 2003. One line of credit expires in April 2005; the other two expire in September 2005.

37

        For 2003 and 2002, we had weighted average borrowing rates on our bank lines of credit of 2.79% and 3.40%, respectively.

        In January 2003, we expanded one of our lines of credit from one of our commercial banks by $3.4 million. This facility was utilized to issue a standby letter of credit in that amount as collateral for performance under a service contract to design and construct a reverse osmosis water treatment facility and associated wells. This standby letter of credit is in force for the estimated two-year construction period of the project. Upon acceptance of the completed project, expected in 2004, the standby letter of credit and the related credit facility will be terminated.

        In addition to our lines of credit, we have excess borrowing capacity under our first mortgage bond indentures of approximately $72.8 million as of December 31, 2003. However, the additional borrowing available under our current commercial lines of credit is limited by financial covenants that restrict additional borrowing to an amount no greater than the remaining unused credit line amount.

        We expect to maintain our lines of credit in the normal course of business. Each of the line of credit agreements contains certain financial covenants. During 2003, we were in compliance with all applicable covenants under each of the line of credit agreements.

Critical Accounting Policies

        Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The significant accounting policies that we believe are important to aid in fully understanding and evaluating our reported financial results include the following:

•

Revenue recognition,



•

Valuation of long-lived and intangible assets,



•

Accounting for regulated business in accordance with SFAS 71,



•

Stock-based compensation,



•

Deferred costs, and



•

Unusual events.

        In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management's judgment in its application. There are also areas in which management's judgment in selecting among available GAAP alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with our Audit Committee.

Revenue recognition

        Revenues for contract operations are billed based on a monthly fee to provide a specific level of service as outlined in each individual contract. We generally bill for additional services provided beyond the scope of the base contract on a time-and-materials basis as such services are rendered.

        Revenues for construction projects are recorded using the percentage-of-completion method of accounting. The percentage of completion method recognizes revenue and income as work progresses

38

on a project based on the expected total project costs and the expected total project revenues. This method is based on an estimate of the revenue and income earned to date, less the revenue and income recognized in earlier periods. If management determines the Company will ultimately suffer a loss on a construction project, the entire estimated loss is recorded in the period such a determination is made.

        Water utility revenues are recognized when water is delivered to customers. At the end of an accounting period, estimated amounts for unbilled revenues are accrued for water usage since the previous billing period.

        The Company has adopted the provisions of Emerging Issues Task Force (EITF) 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, on a prospective basis as of July 1, 2003. EITF 00-21 modified the application of existing contract accounting literature followed by the Company. EITF 00-21 governs how to identify whether goods or services, or both, that are to be delivered separately in a bundled sales arrangement should be accounted for separately. In most circumstances, EITF 00-21 also limits the recognition of revenue in excess of amounts billed (e.g. unbilled revenue) to the amount that would be received if the client contract were terminated for any reason.

        The Company provides design, build, finance and operation services under time-and-material, unit-price and fixed-price contracts, which may extend up to 20 or more years.

        If a contract involves the provision of a single element, revenue is generally recognized when the product or service is provided and the amount becomes billable. If services are provided evenly during the contract term but service billings are irregular, revenue is recognized on a straight-line basis over the contract term.

        If a contract involves the provision of multiple elements, total estimated contract revenue is allocated to each element based on the relative fair value of each element, provided the elements qualify for separation under EITF 00-21. The amount of revenue allocated to each element is limited to the amount that is not contingent upon the delivery of another element in the future. Revenue is then recognized for each element as described above for single-element contracts, except revenue recognized on a straight-line basis for a non-construction service will not exceed amounts currently billable unless the excess revenue is recoverable from the client upon any contract termination event. If the amount of revenue allocated to a construction service is less than its relative fair value, costs to deliver such service, limited to the difference between allocated revenue and the relative fair value, are deferred and amortized over the contract term. If total construction service costs are estimated to exceed the relative fair value for the construction service contained in a multiple-element arrangement, then a provision for the estimated loss is made in the period in which the loss first becomes apparent.

        Revenues for submetering billing and collection services are recognized and billed at the end of the month in which services are performed. Revenues for installation of submetering equipment are accounted for using the percentage-of-completion method.

Valuation of long-lived and intangible assets

        Our acquisitions have been accounted for using the purchase method of accounting. In accordance with SFAS No. 144, Accounting for the impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, we assess intangible assets and other long-lived assets for recoverability whenever events or changes in circumstances indicate that their carrying value may not be recoverable through the estimated undiscounted future cash flows resulting from the use of the assets. If we determine that the carrying value of intangible assets or other long-lived assets may not be recoverable, we measure impairment by using the projected discounted cash-flow method in accordance with Statement No. 144.

        We have made acquisitions in the past that resulted in recording goodwill and intangible assets. In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires

39

that goodwill and intangible assets with indefinite useful lives are not amortized, but instead are tested for impairment at least annually. For intangible assets with definite useful lives, SFAS No. 142 requires amortization over their estimated useful lives. SFAS No. 142 became effective for fiscal years beginning after December 15, 2001. At December 31, 2003, other assets include approximately $21.4 million of goodwill, which was no longer subject to amortization beginning in 2002. There were no impairment charges to goodwill as of December 31, 2003 and no events have occurred that indicated diminution in the value of recorded goodwill.

        Under the provisions of SFAS No. 141, Business Combinations, we identified approximately $0.2 million of intangible contract costs in connection with our acquisition of Aqua Services and approximately $1.1 million of intangible contract costs in connection with our acquisition of OpTech. We are amortizing the intangible contract costs over a period of four years, which is the average estimated life of the contracts.

Accounting for regulated businesses

        Our regulated businesses, which include our utilities in California, New Mexico and Texas, are required to be accounted for under the provisions of SFAS No. 71, Accounting for the Effects of Certain Types of Regulation, which specifies certain revenue, expense and balance sheet treatment as required by each state regulatory authority. Each state authority establishes rates which are intended to permit each utility to recover its costs and earn a reasonable rate of return. Each utility may file and process general rate applications on a periodic basis. Since the established rates may be in effect for several years, our utilities attempt to anticipate cost increases and apply for rates sufficient to permit recovery of those cost increases when incurred, where permitted by state law.

        One of our Services Group subsidiaries has contracted with our utilities in Texas and New Mexico to perform operating services, maintenance, and construction work, and to manage capital projects. These contracts were established utilizing terms and conditions equivalent to prevailing industry rates for similar work performed by our Services Group for non-affiliated customers. In accordance with SFAS No. 71, our Services Group recognizes profit from work performed and does not eliminate the intercompany profit when the contract sales price is reasonable and it is probable that the costs and capital will be recoverable by the utility through the rate-making process. Accordingly, the intercompany profit, for construction as well as O&M services, and the related receivables and payables, on such work have not been eliminated in the accompanying condensed consolidated financial statements. However, all revenue in excess of profits has been eliminated in consolidation, consisting of approximately $8.3 million, $9.5 million and $5.9 million for the years ended December 31, 2003, 2002 and 2001, respectively.

        Our California water utility has recorded a balancing account receivable in the amount of approximately $2.3 million, representing the difference between actual water production costs incurred and CPUC-adopted water production costs. Historically, the CPUC allowed such balancing accounts in the income statements of water utilities, with a corresponding liability or asset on the balance sheet. However, the CPUC changed this policy by eliminating the use of balancing accounts as of November 29, 2001. In December 2002, the CPUC issued a decision that we believe will allow our water utility in California to recover the $2.3 million that was held in the balancing account as of November 29, 2001.

        Beginning in December 2001, our water utility has recognized all water costs as incurred. Currently the differences between actual and CPUC-adopted water production costs are expensed as incurred. These differences are tracked in a memorandum account and we will attempt to recover these expenses in future rate hearings.

40

Stock-Based Compensation

        In 2002, we adopted the fair value recognition provisions of SFAS No. 123, which requires valuation of stock options issued based upon an option pricing model and recognition of this value as an expense over the period in which the options vest. In accordance with the provisions of SFAS No. 148, we elected to recognize stock-based compensation using the retroactive restatement method. Under this change in accounting method, we restated our accompanying condensed consolidated financial statements for periods prior to 2002 to reflect stock-based compensation expense under a fair value based accounting method for all options granted, modified or settled in fiscal years beginning after December 15, 1994.

        We use the Black-Scholes option valuation model to estimate the fair value of our stock options. This option valuation model was developed for use in estimating the fair value of traded options that do not have vesting restrictions and that are fully transferable. Option valuation models require subjective assumptions such as the expected future volatility of the stock price. Because the stock options we grant have characteristics that are significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the calculated results, in management's opinion, the stock option valuation models, including Black-Scholes, may not necessarily provide a reliable single measure of the fair value of employee stock options.

Deferred Costs

        The Company defers and subsequently amortizes certain direct contract acquisition costs related to activities to enable the provision of contracted services to the client. Deferred contract acquisition costs are amortized on a straight-line basis over the remaining original contract term unless revenue patterns indicate a more accelerated method is appropriate. Deferred contract costs of $1.5 million are shown net of accumulated amortization at December 31, 2003. Amortization expense related to deferred contract costs was $372,530, $280,636 and $281,520 for 2003, 2002 and 2001, respectively. The recoverability of all long-lived assets associated with a particular contract, including deferred contract costs, is analyzed on a periodic basis. If long-lived assets are determined to be impaired, an impairment is recognized for the amount by which the carrying value of the long-lived assets exceeds the fair value of those assets.

Unusual Events

        Southwest Water reports material events that are unusual in nature or occur infrequently, but not both, in other income (expense) rather than in operating income, in accordance with the provisions of APB No. 30 Reporting the Results of Operations. APB No. 30 provides that unusual or infrequent events are separately disclosed and excluded from operating income, and that the nature and financial effects of each event or transaction should be disclosed on the face of the income statement. Included in other income on our consolidated statements of income is the effect of a one-time, non-taxable gain in 2002 of approximately $1.0 million resulting from the termination of our defined benefit plan (as more fully disclosed in Note 11 to the consolidated financial statements). Also included in other income for 2002 is a $1.7 million agreement reached among parties responsible for the contamination and our California utility regarding water-quality-related expenses incurred in 1999, 2000 and 2001.

Recent Accounting Pronouncements

        In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments. This statement is effective for contracts entered into or modified after June 30, 2003. We adopted this statement in the third quarter of 2003 and it did not have a material effect on our consolidated financial statements.

41

        In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes accounting standards with respect for how a company classifies and measures financial instruments that have characteristics of both liabilities and equity. This statement is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted this statement in the third quarter of 2003, and it did not have a material effect on our consolidated financial statements.

        In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interest in variable interest entities created or obtained after January 31, 2003. For public companies, such as ours, the Interpretation is applied to the enterprise no later than the end of the first annual reporting period beginning after June 15, 2003. The application of this Interpretation has not had a material effect on our Consolidated Financial Statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that an entity will consolidate or disclose information about variable interest entities when the Interpretation becomes effective.

        FASB Staff Position No. FIN 46-R, Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities deferred the effective date for applying the provisions of FIN 46 for interests held by public entities in variable interest entities or potential variable interest entities created before February 1, 2003. A public entity need not apply the provisions of FIN 46 to an interest held in a variable interest entity or potential variable interest entity until the end of the first interim or annual period ending after December 15, 2003 if both of the following apply:

1.

The variable interest entity was created before February 1, 2003, and



2.

The public entity has not issued financial statements reporting interests in variable interest entities in accordance with FIN 46, other than certain required disclosures.

        We will adopt the provisions of FIN 46 for our financial statements for the periods ending after January 31, 2004 for any variable interest entities created before February 1, 2003. We do not expect the adoption of FIN 46 to have a material impact on our financial statements.

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We have certain indebtedness that is subject to variable rate interest. As a result, Southwest Water's interest expense is affected by changes in the general level of interest rates. The interest expense paid on our line of credit borrowings and certain term loans is determined based upon a rate formula that fluctuates with short-term LIBOR rates and cannot exceed the banks' prime rate minus one-quarter percent.

        We completed a $20.0 million, 20-year convertible subordinate debenture offering in July 2001, which bears a fixed interest rate of 6.85% per annum. The proceeds were used to pay down certain variable rate indebtedness. Our long-term debentures were sold with a fixed interest rate, and are not subject to market fluctuation of interest rates. Our debentures are convertible into Southwest Water common stock and at such time as our diluted earnings exceed $0.53 per share, the debentures will be considered to be common stock equivalents and will be included in the calculation of diluted earnings per share after adjusting net income for the after-tax effect of the debenture interest expense.

42

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements and Financial Statement Schedules

	Page
Independent Auditors' Report	44
Consolidated Statements of Income—Three Years Ended December 31, 2003	45
Consolidated Balance Sheets—December 31, 2003 and 2002	46
Consolidated Statements of Changes in Stockholders' Equity—Three Years Ended December 31, 2003	47
Consolidated Statement of Cash Flows—Three Years Ended December 31, 2003	48
Notes to Consolidated Financial Statements	49
Schedule I—Condensed Financial Information of Registrant	79
Schedule II—Valuation and Qualifying Accounts-Three Years Ended December 31, 2003	84

43

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of Southwest Water Company:

        We have audited the consolidated financial statements of Southwest Water Company and subsidiaries (the Company) as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.

        We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Southwest Water Company and subsidiaries as of December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

        As discussed in Note 1 to the consolidated financial statements, in 2002, the Company changed its method for accounting for the amortization of goodwill.

/s/ KPMG LLP

Los Angeles, California
March 12, 2004

44

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

	For the Years Ended December 31,
	2003			2002			2001
	(in thousands except per share data)
Revenues:
Services group	$	116,041		$	78,833		$	66,476
Utility group		56,933			51,967			49,071
		172,974			130,800			115,547
Expenses:
Operating expenses—services group		101,440			67,876			57,049
Operating expenses—utility group		33,973			33,752			29,275
Selling, general and administrative expenses		22,769			18,398			17,492
		158,182			120,026			103,816
Operating Income		14,792			10,774			11,731
Other Income (Expense):
Interest expense		(4,600	)		(4,494	)		(3,694	)
Interest income		367			265			655
Gain on sales of land		728			119			—
Other		(70	)		2,551			298
		(3,575	)		(1,559	)		(2,741	)
Income Before Income Taxes		11,217			9,215			8,990
Provision for Income Taxes		4,024			3,213			3,539
Net Income		7,193			6,002			5,451
Dividends on Preferred Shares		27			27			27
Net Income Available for Common Shares	$	7,166		$	5,975		$	5,424
Earnings per Common Share:
Basic	$	0.51		$	0.46		$	0.43
Diluted	$	0.49		$	0.44		$	0.41
Weighted Average Outstanding Common Shares:
Basic		13,971			12,967			12,732
Diluted		14,661			13,668			13,217

See accompanying notes to consolidated financial statements.

45

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	December 31,
	2003		2002
	(in thousands)
ASSETS
Current Assets:
Cash and cash equivalents	$	2,570	$	1,606
Restricted cash		2,806		—
Trade accounts receivable, less allowance for doubtful accounts ($1,782 in 2003 and $2,037 in 2002)		19,759		16,657
Other current assets		10,259		11,573
		35,394		29,836
Property, Plant and Equipment:
Utility property, plant and equipment—at cost		271,502		245,134
Non-regulated operations property, plant and equipment—at cost		15,917		19,715
		287,419		264,849
Less accumulated depreciation and amortization		67,900		61,954
		219,519		202,895
Other Assets:
Goodwill, net		21,388		20,151
Intangible assets, net		2,026		3,535
Other assets		17,895		12,327
	$	296,222	$	268,744
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt	$	2,697	$	1,969
Accounts payable		11,448		11,390
Other current liabilities		17,244		18,264
		31,389		31,623
Other Liabilities and Deferred Credits:
Long-term debt		56,493		60,827
Bank lines of credit		16,609		20,158
Advances for construction		7,238		7,352
Contributions in aid of construction		81,556		70,658
Deferred income taxes		10,590		8,411
Other liabilities and deferred credits		12,680		7,878
Total Liabilities and Deferred Credits		216,555		206,907
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $0.01 par value, (aggregate liquidation preference of $507 and $513 at December 31, 2003 and 2002, respectively)		507		513
Common stock, $0.01 par value, 25,000 shares authorized, 14,666 and 13,016 shares issued and outstanding at December 31, 2003 and 2002, respectively		147		130
Paid-in capital		55,981		42,755
Retained earnings		23,032		18,439
Total Stockholders' Equity		79,667		61,837
	$	296,222	$	268,744

See accompanying notes to consolidated financial statements.

46

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN

STOCKHOLDERS' EQUITY

	Preferred Stock				Common Stock
	Number of Shares	Amount			Number of Shares	Amount		Paid-In Capital			Retained Earnings			Total Stockholders' Equity
	(in thousands)
Balance at December 31, 2000	10	$	514		12,545	$	125	$	37,299		$	11,140		$	49,078
Dividend reinvestment and employee stock purchase plans	—		—		72		1		634			—			635
Stock options exercised, net	—		—		106		1		161			—			162
Stock-based compensation	—		—		—		—		765			—			765
Excess tax benefits from stock-based compensation	—		—		—		—		323			—			323
Stock issued on acquisition	—		—		135		1		1,299			—			1,300
Preferred stock redeemed	—		(1	)								—			(1	)
5 percent stock dividend	—		—		—		—		4			(4	)		—
Net income	—		—									5,451			5,451
Cash dividends declared	—		—									(1,995	)		(1,995	)
Balance at December 31, 2001	10		513		12,858		128		40,485			14,592			55,718
Dividend reinvestment and employee stock purchase plans	—		—		60		1		626			—			627
Stock options exercised, net	—		—		83		1		386			—			387
Stock-based compensation	—		—		—				963			—			963
Excess tax benefits from stock-based compensation	—		—		—		—		136			—			136
Debenture conversions	—		—		15		—		154			—			154
5 percent stock dividend	—		—		—				5			(5	)		—
Net income	—		—		—		—		—			6,002			6,002
Cash dividends declared	—		—		—		—		—			(2,150	)		(2,150	)
Balance at December 31, 2002	10		513		13,016		130		42,755			18,439			61,837
Private issuance of common stock	—		—		1,477		15		10,883			—			10,898
Dividend reinvestment and employee stock purchase plans	—		—		71		1		680			—			681
Stock options exercised, net	—		—		102		1		588			—			589
Stock-based compensation	—		—		—		—		934			—			934
Preferred stock redeemed	—		(6	)	—		—		(20	)		—			(26	)
Excess tax benefits from stock-based compensation	—		—		—		—		124			—			124
Four shares for three stock dividend									37			(37	)		—
Net income	—		—		—		—		—			7,193			7,193
Cash dividends declared	—		—		—		—		—			(2,563	)		(2,563	)
Balance at December 31, 2003	10	$	507		14,666	$	147	$	55,981		$	23,032		$	79,667

See accompanying notes to consolidated financial statements.

47

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

			For the Years Ended December 31,
			2003			2002			2001
			(in thousands)
Cash Flows From Operating Activities:
Net income			$	7,193		$	6,002		$	5,451
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization				7,549			6,619			6,060
Stock-based compensation expense				934			963			765
Deferred income taxes				3,477			903			1,072
Gain on sales of land				(728	)		(119	)		—
Changes in assets and liabilities, net of effects of acquisitions:
	Restricted cash			(2,806	)		—			—
	Trade accounts receivable			(3,115	)		4,049			(3,291	)
	Other current assets			(1,476	)		(597	)		(1,025	)
	Other assets			(5,708	)		(1,374	)		(1,477	)
	Accounts payable			65			5,179			2
	Other current liabilities			(1,132	)		1,461			(2,135	)
	Other liabilities			4,061			283			(50	)
	Other			494			(1,283	)		(1,334	)
Net cash provided by operating activities				8,808			22,086			4,038
Cash Flows From Investing Activities:
Additions to property, plant and equipment				(18,352	)		(25,587	)		(15,008	)
Purchase of minority interest				—			(2,000	)		—
Acquisition of businesses, net of cash acquired				—			(10,317	)		(3,276	)
Proceeds from sales of land				741			165			—
Other investments, net				—			(833	)		—
Net cash used in investing activities				(17,611	)		(38,572	)		(18,284	)
Cash Flows From Financing Activities:
Gross proceeds from issuance of long-term debt				—			10,000			20,000
Net proceeds from private issuance of common stock				10,898			—			—
Capital improvement reimbursements				2,524			4,278			—
Contributions in aid of construction and LUE fees				2,087			3,687			2,877
Net borrowings on (repayment of) bank notes payable				(3,575	)		4,166			(6,728	)
Net proceeds from dividend reinvestment, debenture conversion, employee stock purchase and stock option plans				1,270			1,168			797
Proceeds from sale/leaseback of assets				1,687			—			—
Dividends paid				(2,563	)		(2,142	)		(1,981	)
Payments on long-term debt				(2,218	)		(3,507	)		(900	)
Payments on advances for construction, net				(343	)		(347	)		(409	)
Net cash provided by financing activities				9,767			17,303			13,656
Net increase (decrease) in cash and cash equivalents				964			817			(590	)
Cash and cash equivalents at beginning of year				1,606			789			1,379
Cash and cash equivalents at end of year			$	2,570		$	1,606		$	789
Supplemental Disclosure of Cash Flow information
Cash paid during the year for:
	Interest		$	4,990		$	5,134		$	4,376
	Income taxes		$	3,390		$	2,335		$	2,502
Non-cash investing and financing activities:
	Purchase of businesses
		Fair value of assets acquired	$	—		$	16,781		$	9,764
		Cash paid		—			(11,317	)		(3,530	)
		Notes issued		—			(1,000	)		(3,000	)
		Stock issued		—			—			(1,300	)
		Liabilities assumed	$	—		$	4,464		$	1,934
Non-cash contributions in aid of construction and advances for construction conveyed to Company by developers			$	9,770		$	9,015		$	1,581
Acquisition of Master Tek minority interest in exchange for extinguishment of debt and future cash consideration			$	1,187		$	—		$	—

See accompanying notes to consolidated financial statements.

48

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2003 and 2002

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        Description of Business:    Southwest Water Company and its subsidiaries (Southwest Water or the Company) provide a broad range of services, including water production and distribution, wastewater collection and treatment and public works services. The Company also provides billing, collection and customer service work as part of its range of services. Southwest Water owns regulated public utilities and also serves cities, utility districts and private companies under contract.

        Principles of Consolidation:    The consolidated financial statements include the accounts of Southwest Water and its wholly owned and majority-owned subsidiaries, as well as a majority-owned partnership. All significant intercompany transactions have been eliminated, except where appropriate under by Statement of Financial Accounting Standards (SFAS) No. 71, Accounting for the Effects of Certain Types of Regulation, for intercompany transactions with regulated water utilities.

        Stock Dividends and Splits:    All information regarding common stock, stock options, warrants, other common stock equivalents and related per share amounts has been restated within this report to reflect the following:

•

a 4-for-3 stock split in the form of a stock dividend on January 1, 2004,



•

a 5% stock dividend on January 1, 2003,



•

a 5% stock dividend on October 1, 2001, and



•

a 5-for-4 stock split in the form of a stock dividend on January 1, 2001.

        Use of Estimates:    The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. The reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period could be affected by changes in such estimates. Actual results may differ from these estimates.

        Regulation:    Our regulated utility subsidiaries conform to the Uniform System of Accounts prescribed by the California Public Utilities Commission (CPUC), the New Mexico Public Regulation Commission (NMPRC) or the Texas Commission on Environmental Quality (TCEQ), formerly the Texas Natural Resource Conservation Commission.

49

        Utility Accounting:    Regulatory assets deemed recoverable are recorded in accordance with SFAS No. 71. Included in regulatory assets are the following:

		December 31,
		2003			2002
		(in thousands)
Assets
	Supply cost balancing account—2001 and prior	$	2,329		$	2,329
	Supply cost memorandum account—2002		(73	)		—
	Supply cost memorandum account—2003		(197	)		—
	Income taxes		2,016			1,836
	Department of Health Services fees		—			297
	Rate case filing expenses and other		62			251
Liabilities:
	Income taxes		3,362			2,644

        Income tax assets are included in rate base and earn a return. Income tax liabilities are included in rate base and reduce the Company's return. The supply cost balancing account, while excluded from rate base, does earn interest during the recovery period pursuant to CPUC policy.

        Department of Health Services (DOHS) fees and rate case filing expenses and other do not earn a return. Department of Health Services fees are deferred and recovered through a surcharge when approved in the regulatory process. The regulatory asset related to rate case filing expenses represents costs associated with filing for rate increases, which are submitted for recovery to the regulatory commission. These amounts are recovered through increased rates and disallowed portions are written-off when determined recoveries are lower than the associated capitalized costs.

        The Company's New Mexico utility and Texas utilities have contracted with companies in the Services Group to perform operating services, normal maintenance and construction work. These contracts were established utilizing terms and conditions equivalent to prevailing industry rates for similar work performed by the Services Group for non-affiliated customers. In accordance with SFAS No. 71, the Services Group recognizes a profit margin from the contract work performed and does not eliminate the intercompany profit on the construction contract work performed when the contract price is reasonable and it is probable that the costs and capital will be recoverable through the rate making process. Accordingly, the intercompany profits have not been eliminated in the accompanying consolidated financial statements.

        Earnings Per Share:    Basic earnings per share (EPS) measures the performance of the Company over the reporting period by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS measures the performance of the Company over the reporting period after giving effect to all potentially dilutive common shares that would have been outstanding if the shares had been issued. Stock options and warrants give rise to potentially dilutive common shares. The Company also has convertible subordinate debentures outstanding. The debentures are convertible into Southwest Water common stock and at such time as our diluted earnings exceed $0.53 per share, the debentures will be considered to be common stock equivalents and will be included in the calculation of diluted earnings per share after adjusting net income for the after-tax effect of the debenture interest expense.

        Recognition of Revenues:    Revenues for contract operations are billed based on a monthly fee to provide a specific level of service as outlined in each individual contract. We generally bill for additional services provided beyond the scope of the base contract on a time-and-materials basis as such services are rendered.

50

        Revenues for construction projects are recorded using the percentage-of-completion method of accounting. The percentage of completion method recognizes revenue and income as work progresses on a project based on the expected total project costs and the expected total project revenues. This method is based on an estimate of the revenue and income earned to date, less the revenue and income recognized in earlier periods. If management determines the Company will ultimately suffer a loss on a construction project, the entire estimated loss is recorded in the period such a determination is made.

        Water utility revenues are recognized when water is delivered to customers. At the end of an accounting period, estimated amounts for unbilled revenues are accrued for water usage since the previous billing period.

        Revenues for contract operations are billed based on a monthly fee to provide a specific level of service as outlined in each individual contract. The Company usually bills for additional services provided beyond the scope of the base contract on a time and materials basis as such services are rendered. The Company has adopted the provisions of Emerging Issues Task Force ("EITF") 00-21, Accounting for Revenue Arrangements with Multiple Deliverables, on a cumulative basis as of January 1, 2003. EITF 00-21 modified the application of existing contract accounting literature followed by the Company. EITF 00-21 governs how to identify whether goods or services, or both, that are to be delivered separately in a bundled sales arrangement should be accounted for separately. In most circumstances, EITF 00-21 also limits the recognition of revenue in excess of amounts billed (e.g. unbilled revenue) to the amount that would be received if the client contract were terminated for any reason.

        The Company provides design, build, finance and operation services under time-and-material, unit-price and fixed-price contracts, which may extend up to 20 or more years. If a contract involves the provision of a single element, revenue is generally recognized when the product or service is provided and the amount becomes billable. If services are provided evenly during the contract term but service billings are irregular, revenue is recognized on a straight-line basis over the contract term.

        If a contract involves the provision of multiple elements, total estimated contract revenue is allocated to each element based on the relative fair value of each element, provided the elements qualify for separation under EITF 00-21. The amount of revenue allocated to each element is limited to the amount that is not contingent upon the delivery of another element in the future. Revenue is then recognized for each element as described above for single-element contracts, except revenue recognized on a straight-line basis for a non-construction service will not exceed amounts currently billable unless the excess revenue is recoverable from the client upon any contract termination event. If the amount of revenue allocated to a construction service is less than its relative fair value, costs to deliver such service, limited to the difference between allocated revenue and the relative fair value, are deferred and amortized over the contract term. If total construction service costs are estimated to exceed the relative fair value for the construction service contained in a multiple-element arrangement, then a provision for the estimated loss is made in the period in which the loss first becomes apparent.

        Revenues for submetering billing and collection services are recognized and billed at the end of the month in which services are performed. Revenues for installation of submetering equipment are accounted for using the percentage-of-completion method.

        Other Income:    Southwest Water reports material events that are unusual in nature or occur infrequently, but not both, in other income (expense) rather than in operating income, in accordance with the provisions of APB No. 30 Reporting the Results of Operations. APB No. 30 provides that unusual or infrequent events are separately disclosed and excluded from operating income, and that the nature and financial effects of each event or transaction should be disclosed on the face of the income statement. Included in other income on the Company's consolidated statements of income is the effect of a one-time, non-taxable gain in 2002 of approximately $1.0 million resulting from the termination of

51

the Company's defined benefit plan (as more fully disclosed in Note 11 to the consolidated financial statements). Also included in other income for 2002 is a $1.7 million agreement reached among parties responsible for the contamination and our California utility regarding water-quality-related expenses incurred in 1999, 2000 and 2001.

        Cash and Cash Equivalents:    Southwest Water considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.

        Restricted Cash:    The Company has a commitment to facilitate construction of a $25.0 million reverse osmosis water treatment plant in the city of San Juan Capistrano, California. (See note 14 for further information.) Restricted cash represents cash on hand that has been restricted for use in completion of the project.

        Trade Accounts Receivable:    The $3.1 million increase in trade accounts receivable was due to the following:

•

Approximately $2.1 million represents the excess of amounts earned over the amounts collected in connection with the Company's $25.0 million project to design and build a reverse osmosis water treatment plant for the city of San Juan Capistrano, California, (the CVWD Project).



•

Our California utility made a general rate case filing on April 2, 2002 and was granted an average 17% increase in rates. Approximately $1.2 million of the increase was due to the increase in monthly revenue as a result of the rate increase.

        Fair Value of Financial Instruments:    The carrying value of financial instruments such as cash and cash equivalents, accounts receivable, accounts payable, and short-term debt approximates fair value. The fair value of our long term debt was approximately $65 million at December 31, 2003. The carrying value of the Company's bank lines of credit approximates fair value. At December 31, 2003, Southwest Water had no derivative financial instruments, financial instruments with off-balance sheet risk or financial instruments with concentrations of credit risks requiring accounting or disclosure under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.

        Regulated Utility Property, Plant and Equipment:    The cost of additions to utility plant includes labor, material and capitalized interest. Interest of approximately $473,000, $194,000 and $790,000 was capitalized in 2003, 2002 and 2001, respectively. The cost of utility plant retired is charged to accumulated depreciation. Depreciation expense on utility plant is recorded using the straight-line method over the useful lives of the assets as prescribed by the CPUC, the NMPRC and the TCEQ, and as permitted by SFAS No. 71. Depreciation expense on average gross depreciable plant was approximately 1.9% in 2003, 1.9% in 2002 and 2.3% in 2001. See further discussion in Note 4 to the consolidated financial statements. In accordance with SFAS No. 71, when a unit of property is retired from utility plant, with or without replacement, the book costs are to be credited to the utility plant account. If the unit of property is of a depreciable class the book cost of the unit retired is charged to the depreciation reserve provided for such property.

        Non-Regulated Operations Property, Plant and Equipment:    Property, plant and equipment used in contract billing services and contract operations are depreciated on the straight-line method over estimated useful lives ranging from three to 30 years.

        Goodwill and Intangible Assets:    In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, and specifies that identifiable intangible assets acquired in a purchase method business combination must be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives are not amortized, but instead

52

are tested for impairment at least annually. For intangible assets with definite useful lives, SFAS No. 142 requires amortization over their estimated useful lives to their estimated residual values, and requires review for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The Company's non-compete agreements and other purchased intangible assets are amortized over periods ranging from four to 10 years. SFAS No. 142 became effective for fiscal years beginning after December 15, 2001. The Company performed its transitional analysis for impairment of goodwill under SFAS No. 142 in the first quarter of 2002 and no impairment was identified. The Company performs an impairment review on an annual basis or when events or circumstances indicate potential impairment. For 2003 the Company entered into a one-time agreement with a valuation consultant to conduct the annual impairment review of goodwill in accordance with FAS No. 142. Based on the findings of the consultant, the Company concluded that the fair value of the reporting units holding goodwill exceeded their carrying value as of December 31, 2003. Accordingly, no goodwill impairment has been recorded. Beginning in 2002, goodwill incurred prior to June 2001 is no longer being amortized.

        Deferred Costs:    The Company defers and subsequently amortizes certain direct contract acquisition costs related to activities to enable the provision of contracted services to the client. Deferred contract acquisition costs are amortized on a straight-line basis over the remaining original contract term unless billing patterns indicate a more accelerated method is appropriate. Deferred contract costs of $1.5 million are shown net of accumulated amortization at December 31, 2003. Amortization expense related to deferred contract costs was $373,000, $281,000 and $282,000 for 2003, 2002 and 2001, respectively. The recoverability of all long-lived assets associated with a particular contract, including deferred contract costs, is analyzed on a periodic basis. If long-lived assets are determined to be impaired, an impairment is recognized for the amount by which the carrying value of the long-lived assets exceeds the fair value of those assets.

        Maintenance Costs:    Maintenance costs are recognized in the period in which they are incurred. The Company does not accrue for major maintenance projects prior to the periods in which they are actually incurred.

        Long-Lived Assets:    The Company regularly reviews its long-lived assets for impairment. This review includes regulatory assets and assets excluded from rate base by regulators. Potential impairment of assets held for use is determined by comparing the carrying amount of an asset to the future undiscounted cash flows expected to be generated by that asset. If assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less cost to sell. In August 2001, SFAS No. 144 was issued and became effective January 2002. SFAS No. 144 supercedes SFAS No. 121; however, it retains the requirement that long-lived assets be tested for recoverability when events or changes in circumstances indicate carrying amounts may not be recoverable.

        Long-Term Leases to Clients:    The Company has entered into two long-term agreements for the lease of various types of water production and distribution systems to Municipal Utility Districts (MUDs) in Texas. A MUD is created under the rules of the Texas Commission on Environmental Quality (TCEQ), formerly the Texas Natural Resource Conservation Commission, to provide water supply, wastewater treatment and drainage services to areas where existing municipal services are not available. Amounts due to the Company from the MUDs represents receivables under lease and have been accounted for as receivables from direct financing leases (see Note 3) and the leases expire over 10 years.

        Our rights, but not our obligations, under the two lease agreements have been assigned to financial institutions in return for a cash payment. The Company collects payments under these lease agreements with the MUDs and uses the amounts to pay its obligations under the assignment agreements with the

53

financial institutions. The Company is responsible for payments to the financial institutions under the assignment agreements. The Company's interest in the payments from MUDs is secured by a bank letter of credit from a financial institution and the leased property.

        Advances for Construction:    Advances for construction represent amounts advanced by developers primarily for water pipeline extensions. Advance contracts issued after June 1982 are refundable to the depositor at a rate of 2¹/2% each year over a 40-year period.

        Contributions in Aid of Construction and Living Unit Equivalents:    Contributions in Aid of Construction (CIAC) represent contributions in the form of cash, services or property received from developers, governmental agencies, municipalities or individuals for the purpose of constructing utility plant. Living Unit Equivalent (LUE) connection fees are cash contributions received from developers, also for the purpose of constructing utility plant. Depreciation expense related to utility plant additions from CIAC and LUE fees are charged as a reduction to the respective CIAC and LUE fee accounts instead of as depreciation expense.

        Stock-Based Compensation:    The Company has two plans which allow for the granting of stock options. As fully disclosed in Note 10, the Company applies FASB No. 123, Accounting for Stock-Based Compensation, in accounting for its stock option grants. Accordingly, compensation expense is recognized for fixed stock options as if the fair value of all stock options as of the grant date were recognized as expense over the vesting period in accordance with SFAS No. 123.

        Income Taxes:    Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recorded in order to recognize future tax effects attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as the recognition of operating losses and tax credit carry-forwards. Deferred tax assets and liabilities are recorded using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that the enactment occurs. The Company files a consolidated U.S. Federal income tax return, which includes all qualifying subsidiaries.

        In 1993, under the provisions of SFAS No. 109, Suburban and NMUI recorded additional deferred income taxes, as well as corresponding regulatory assets and regulatory liabilities as permitted by the CPUC and the NMPRC, respectively.

        Unamortized investment tax credits have been deferred and are amortized over the estimated productive lives of the related assets as allowed by the CPUC and the NMPRC.

        Reclassifications:    Certain reclassifications have been made to the prior year consolidated financial statement presentation to conform to the 2003 presentation.

Recent Accounting Pronouncements:

        In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments. This statement is effective for contracts entered into or modified after June 30, 2003. The Company adopted this statement in the third quarter of 2003 and it did not have a material effect on the consolidated financial statements.

        In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes accounting standards with respect for how a company classifies and measures financial instruments that have characteristics of both liabilities and equity. This statement is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period

54

beginning after June 15, 2003. The Company adopted this statement in the third quarter of 2003 and it did not have a material effect on the consolidated financial statements.

        In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2003, with early application encouraged. The adoption of SFAS No. 146 is not expected to have a material effect on the Company's consolidated financial statements.

        In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2003 and are not expected to have a material effect on Company's consolidated financial statements. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 15, 2002.

        In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interest in variable interest entities created or obtained after January 31, 2003. For public companies, such as ours, the Interpretation is applied to the enterprise no later than the end of the first annual reporting period beginning after June 15, 2003. The application of this Interpretation did not have a material effect on the Company's consolidated financial statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that an entity will consolidate or disclose information about variable interest entities when the Interpretation becomes effective.

        FASB Staff Position No. FIN 46-R, Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities deferred the effective date for applying the provisions of FIN 46 for interests held by public entities in variable interest entities or potential variable interest entities created before February 1, 2003. A public entity need not apply the provisions of FIN 46 to an interest held in a variable interest entity or potential variable interest entity until the end of the first interim or annual period ending after December 15, 2003 if both of the following apply:

1.

The variable interest entity was created before February 1, 2003, and



2.

The public entity has not issued financial statements reporting interests in variable interest entities in accordance with FIN 46, other than certain required disclosures.

        We will adopt the provisions of FIN 46 for our financial statements for the periods ending after January 31, 2004 for any variable interest entities created before February 1, 2003. We do not expect the adoption of FIN 46 to have a material impact on our financial statements.

55

NOTE 2. EARNINGS PER SHARE

        The following table is a reconciliation of the numerators and denominators used in both basic and diluted EPS calculations:

		For the Years Ended December 31,
Net income per share
		2003		2002		2001
		(in thousands except per share data)
Net Income		$	7,193	$	6,002	$	5,451
	Less: Dividends on Preferred Shares		27		27		27
Net Income Available for Common Shares		$	7,166	$	5,975	$	5,424
Weighted Average Outstanding Common Shares			13,971		12,967		12,732
Earnings per Common Share—Basic		$	0.51	$	0.46	$	0.43

	For the Years Ended December 31,
Net income per share—assuming dilution
	2003		2002		2001
	(in thousands except per share data)
Net Income Available for Common Shares	$	7,166	$	5,975	$	5,424
Weighted Average Outstanding Common Shares		13,971		12,967		12,732
Plus: Shares issued on assumed exercise of stock options and warrants		690		701		485
Weighted Average Outstanding Common Shares		14,661		13,668		13,217
Earnings per Common Share—Diluted	$	0.49	$	0.44	$	0.41

        The difference between basic and diluted EPS is the effect of stock options that, under the treasury share method, give rise to common stock equivalents. As described in Note 7, the Company issued $20.0 million of 6.85% fixed-rate convertible subordinate debentures in July 2001. The debentures are convertible at any time prior to maturity, unless previously redeemed, at a conversion price of $12.148. At such time as our diluted earnings exceed $0.53 per share, the debentures will be considered to be common stock equivalents and will be included in the calculation of diluted earnings per share after adjusting net income for the after-tax effect of the debenture interest expense.

        Approximately 42,000, 71,000 and 20,000 stock options were excluded from the computation of diluted earnings per share in 2003, 2002 and 2001, respectively, due to their antidilutive effect.

NOTE 3. OTHER ASSETS

        Included in other current assets at December 31, 2003 and 2002 are the following:

	December 31,
	2003		2002
	(in thousands)
Other receivables	$	2,035	$	3,874
Prepaid expenses		1,490		3,246
Accumulated balancing account receivable		2,329		2,329
Other		4,405		2,124
	$	10,259	$	11,573

56

        Under prior CPUC procedures (adopted by Suburban in 1991), Suburban recorded the difference between actual water production costs incurred and CPUC-adopted water production costs in balancing accounts in the income statement with a corresponding liability or asset on the balance sheet as permitted by SFAS No. 71. Under previous regulations, the differences recorded would be refunded to or recovered from utility customers through future CPUC-authorized rate adjustments. The CPUC significantly changed this policy by eliminating the use of balancing accounts as of November 29, 2001. In 2002, in place of the balancing account, Suburban began tracking the difference between actual and CPUC-adopted water production cost in a memorandum account. Memorandum accounts are not recorded on Suburban's books. Instead, costs are being accumulated and Suburban will attempt to recover these costs during its regularly scheduled general rate hearings with the CPUC.

        As of December 31, 2003 Suburban had a receivable of approximately $2.3 million in the balancing account. The disposition of the pre-November 29, 2001 balancing accounts became the subject of a CPUC rulemaking when, on December 17, 2002, the CPUC issued a decision favorable to the water industry that should allow Suburban to recover the $2.3 million that was in its balancing account prior to November 29, 2001.

        Included in other long-term assets at December 31, 2003 and 2002 are the following:

	December 31,
	2003		2002
	(in thousands)
Deferred regulatory tax assets		2,363		2,177
Other receivables, net		1,412		2,233
Deferred debt expense, net		1,679		1,838
Investments in joint venture, net		—		356
Investments in corporate-owned life insurance policies		1,519		845
Receivables from direct financing leases		3,310		—
Other		7,612		4,878
	$	17,895	$	12,327

        The Company has acquired several businesses and accounted for the transactions under the purchase method. Goodwill represents the excess of the purchase price over the net assets acquired in those transactions. During 2003, goodwill increased $1.2 million as a result of the Company's acquisition of the minority interest of Master Tek. There has been no impairment of goodwill during the years three years ended December 31, 2003. For 2003 the Company entered into a one-time agreement with a valuation consultant to conduct the annual impairment review of goodwill in accordance with FAS No. 142. The valuation consultant concluded that the fair value of the reporting units holding goodwill exceeded their carrying value as of December 31, 2003.

        In accordance with FAS 142 the Company ceased recording amortization expense on goodwill in 2002. The following table indicates the impact of goodwill amortization on earnings for the year ended December 31, 2001:

	For the year ended December 31, 2001
Net income available for common shares, as reported	$	5,424
Add back goodwill amortization (1)		140
Net income available for common shares, as adjusted	$	5,564

(1)

Net of income taxes

57

        A non-compete agreement with a net value of $1.5 million as of December 31, 2002 was canceled in conjunction with the Company's agreement to acquire the minority interest in Master Tek in December 2003. Intangible assets represented purchased contracts with a net unamortized value of $1.0 million at December 31, 2003 and certain FCC licenses with an unamortized value of $993,000 at December 31, 2003.

        Amortization expense for intangible contract costs for the year ended December 31, 2003 was approximately $392,000. At December 31, 2003, the future estimated contract amortization expense is as follows: 2004—$461,000, 2005—$370,000, 2006—$187,000 and $1,008,000 thereafter.

        To assist in funding the liabilities related to its supplemental executive retirement plan and deferred compensation liabilities, the Company has invested in corporate-owned life insurance policies. See Note 11 for further explanation.

NOTE 4. UTILITY PROPERTY, PLANT, AND EQUIPMENT

        The components of utility property, plant and equipment at December 31, 2003 and 2002 are as follows:

	December 31,
	2003		2002
	(in thousands)
Land and land rights	$	2,213	$	1,131
Source of supply		12,540		12,771
Pumping and purification		20,388		18,200
Transmission and distribution		197,870		183,134
General		9,917		10,046
Construction work in progress		28,574		19,852
	$	271,502	$	245,134

        Suburban has an investment of approximately $699,000 in two mutual water companies. The objective of the investments was to obtain certain water rights. Accordingly, the investments have been recorded as land and land rights. Suburban's investment in one of these mutual water companies is approximately 32% of the outstanding stock. The Company and Suburban do not have significant operating and financial influence over either of these mutual water companies. These investments are recorded at cost and are reflected in general utility property. Suburban purchased water from these mutual water companies at a cost of approximately $2.3 million, $3.7 million and $3.6 million in 2003, 2002 and 2001, respectively.

        The increase in construction in progress is primarily due to the construction of a project to supply wholesale water and wastewater services from the Company's Texas utilities to several communities in an area just east of Austin, Texas. The project is expected to be placed in service in 2004.

        At December 31, 2003, substantially all of the Company's utility plant and equipment was pledged as collateral for the First Mortgage Bonds issued by the Company as more fully described in Note 7.

58

        The components of the Company's non-regulated operations owned property, plant and equipment at December 31, 2003 and 2002 are as follows:

	December 31,
	2003		2002
	(in thousands)
Computer and office equipment	$	4,410	$	4,321
Machinery and office equipment		4,100		4,666
Construction work in progress		1,358		3,330
Leasehold improvements,		2,189		2,092
Buildings, land, and other		3,860		5,306
	$	15,917	$	19,715

        Depreciation expense for utility and non-regulated property, plant and equipment totaled approximately $6.9 million, $5.9 million and $5.4 million in 2003, 2002 and 2001, respectively.

NOTE 5. OTHER LIABILITIES

        Included in other current liabilities at December 31, 2003 and 2002 are the following:

	December 31,
	2003		2002
	(in thousands)
Accrued salaries, wages and benefits	$	4,887	$	4,506
Purchased water accrual		1,183		2,834
Franchise and other taxes		1,348		1,678
Deferred revenue and customer deposits		1,309		1,509
Other		8,517		7,737
	$	17,244	$	18,264

        Included in other long-term liabilities and deferred credits at December 31, 2003 and 2002 are the following:

	December 31,
	2003		2002
	(in thousands)
Non-compete liability	$	—	$	1,470
Regulatory deferred tax liability		1,256		1,287
Living Unit Equivalent (LUE) fees		1,544		876
Minority interest liabilities		830		561
Amounts payable under lease assignment		3,112		—
Other		5,938		3,684
	$	12,680	$	7,878

        The non-compete liability (relating to the Master Tek non-compete agreement) has been removed in 2003 as a result of the acquisition of the minority interest in Master Tek by the Company. See Note 14 for further details regarding that transaction.

NOTE 6. BANK LINES OF CREDIT

        On December 31, 2003, the Company had three unsecured lines of credit from three commercial banks with a total borrowing capacity of $30 million. One line of credit expires in April 2005; the other

59

two expire in September 2005. Two of the line of credit agreements require a commitment fee of ¹/4% per year of the unused portion of the available line of credit, calculated and payable on a quarterly basis. Each of the line of credit agreements, as amended, contains certain financial covenants, and the Company was in compliance with all applicable restrictions at December 31, 2003. The Company has issued certain letters of credit totaling $500,000 in 2003 and $100,000 in 2002. Our borrowing capacity under the lines is reduced by an amount equal to the balance of these letters of credit.

        In January 2003, the Company expanded one of its lines of credit from one of its commercial banks by $3.4 million. This facility was utilized to issue a standby letter of credit in that amount as collateral for performance under a service contract to design and construct a reverse osmosis water treatment facility and associated wells. This standby letter of credit is in force for the estimated two-year construction period of the project. Upon acceptance of the completed project, expected in 2004, the standby letter of credit and the related credit facility will be terminated.

        In addition to the Company's lines of credit, it has excess borrowing capacity under its first mortgage bond indentures of approximately $72.8 million as of December 31, 2003. However, the additional borrowing available under its current commercial lines of credit is limited by financial covenants that restrict additional borrowing to an amount no greater than the remaining unused credit line amount.

        A summary of borrowing on the lines of credit during the years ended December 31, 2003 and 2002 is presented below:

	For the year ended December 31,
	2003			2002
	(in thousands, except percentages)
Bank lines of credit outstanding at December 31	$	16,609		$	20,158
Weighted average interest rate at December 31		2.55	%		2.63	%
Maximum amount of borrowings outstanding at any month end	$	26,350		$	20,212
Weighted average borrowings during the year	$	19,063		$	13,026
Weighted average interest rate during the year		2.79	%		3.40	%

60

NOTE 7. LONG-TERM DEBT

        The long-term debt outstanding at December 31, 2003 and 2002 is as follows:

	December 31,
	2003			2002
	(in thousands)
Southwest Water Convertible Subordinate Debentures, due 2021, at 6.85% interest rate, with quarterly interest payments	$	19,682		$	19,732
Windermere 10-year bank term loan, with quarterly principal payments plus interest at LIBOR + 1.75%		9,375			9,875
Suburban First Mortgage Bond, Series A, due 2006, at 8.93% interest rate, with semi-annual interest payments		3,300			4,200
Suburban First Mortgage Bond, Series B, due 2022, at 9.09% interest rate, with semi-annual interest payments		8,000			8,000
Suburban First Mortgage Bond, Series C, due 2006, at 7.61% interest rate, with semi-annual interest payments		8,000			8,000
NMUI First Mortgage Bond, Series B, due 2006, at 7.64% interest rate, with semi-annual interest payments		4,000			4,000
Economic Development Revenue Bonds, Series 1998A, due 2018, at 5.5% interest rate, with semi-annual interest payments		1,810			1,810
Economic Development Revenue Bonds, Series 1998A, due 2008, at 6.0% interest rate, with semi-annual interest payments		335			590
Master Tek 10-year note payable dated April 2000, at 8.0% interest rate, due in monthly installments of principal and interest		—			1,611
OpTech 5-year notes payable dated August 2001, at 7.5% interest rate, with quarterly interest payments through 2003, followed by quarterly payments of principal and interest		2,820			2,820
Other 7-year notes payable dated December 2001, at 5.0% interest rate, due in monthly installments of principal and interest		1,868			2,158
Long-term debt before current maturities		59,190			62,796
Less current maturities		(2,697	)		(1,969	)
Long-term debt	$	56,493		$	60,827

        On July 20, 2001, Southwest Water issued $20.0 million of 6.85% fixed rate convertible subordinate debentures due July 1, 2021, and received net proceeds of approximately $18.9 million from the sale after underwriting discounts, commissions and remaining expenses of the offering. The net proceeds from the sale of these debentures were used to reduce borrowings on the Company's revolving lines of credit. Southwest Water is subject to certain financial covenants under the terms of the indenture agreement for the debentures. As of December 31, 2003, the Company was in compliance with all applicable restrictions. The debentures are convertible into shares of Southwest Water common stock at a conversion price of $12.148 per share. The debentures are convertible at any time prior to maturity unless previously redeemed. At such time as our diluted earnings exceed $0.53 per share, the debentures will be considered to be common stock equivalents and will be included in the calculation of diluted earnings per share after adjusting net income for the after-tax effect of the debenture interest expense. The Company may redeem the debentures in whole or in part at any time, at redemption prices from 105% beginning July 1, 2003 and declining 1% annually to par (100% of face value) after June 30, 2008. The issuance costs of the convertible subordinate debentures in the amount of approximately $1.1 million are being amortized over 20 years.

61

        In August 9, 2002 the Company's Windermere Utility Company subsidiary (Windermere) obtained a 10-year, $10.0 million secured bank term loan. The net proceeds of approximately $9.8 million were used to pay down bank lines of credit. The term loan bears interest at a rate equal to LIBOR plus 1.75%, with principal payments due quarterly, beginning in November 2002. The note is secured by substantially all of the assets of Windermere.

        The First Mortgage Bond, Series A issued by the Company's California Utility, Suburban Water Systems (Suburban), requires annual sinking fund payments of $900,000. The bond may be redeemed at the option of the Company at a price of par plus a call premium. Suburban's First Mortgage Bonds, Series B and C, and the First Mortgage Bonds, Series A and B issued by the Company's New Mexico Utilities, Inc. subsidiary (NMUI), do not require annual sinking fund payments. These bonds are nonrefundable and may be redeemed at any time by the Company at a price of par plus a call premium. Additional mortgage bonds may be issued subject to the provisions of the existing indentures. Substantially all of the Company's utility plant is pledged as collateral for these bonds as more fully described in Note 4.

        Certain debt instruments limit the amount of cash and property dividends that Suburban and NMUI may pay to the Company. As of December 31, 2003 and 2001, both Suburban and NMUI were in compliance with dividend limitations mandated in the indentures.

        In connection with the acquisition of Aqua Services in November 2002, we assumed two Economic Development Revenue Bonds (EDRBs) with principal balances of approximately $1.8 million and $590,000, respectively. The EDRB in the amount of $1.8 million is due in 2018, and bears interest at a rate of 6.0%, with annual principal payments beginning in 2009, while the EDRB in the amount of $590,000 is due in 2008, and bears interest at a rate of 5.5%, with annual principal payments until maturity. These revenue bonds are secured by certain wastewater treatment plant assets.

        The Company's note payable to a minority stockholder of Master Tek was eliminated in conjunction with the purchase of the minority interest in December 2003. (See Note 14).

        Notes payable were issued in connection with acquisitions made by the Company in 2001, and are payable to the former owners of the acquired entities. In general, these notes bear interest at rates ranging from 5% to 7.5% per annum, with interest payable either monthly or quarterly and with various contractual principal payments required.

        Principal payments, annual maturity and sinking fund requirements for all long-term debt are as follows:

		Years ending December 31,
		2004		2005		2006		2007		2008 and thereafter		Total
		(in thousands)
Long-term Debt
	Bank lines of credit	$	—	$	16,609	$	—	$	—	$	—	$	16,609
	Bank term loan		500		500		500		500		7,375		9,375
	Economic development revenue bonds		90		95		100		105		1,755		2,145
	Mortgage bonds		900		900		13,500		—		8,000		23,300
	Convertible subordinate debentures(1)		—		—		—		—		19,682		19,682
	Notes payable		1,207		1,311		1,378		386		406		4,668
		$	2,697	$	19,415	$	15,478	$	991	$	37,218	$	75,799

(1)

The convertible subordinate debentures are due in 2021. There are no intermediate put rights attached to the debentures.

62

        In addition to our lines of credit, we have excess borrowing capacity under our first mortgage bond indentures of approximately $72.8 million as of December 31, 2003. However, the additional borrowing available under our current commercial lines of credit is limited by financial covenants that restrict additional borrowing to an amount no greater than the undrawn line of credit balances.

NOTE 8. INCOME TAXES

        The components of the current and deferred income tax provisions are as follows:

		Years Ended December 31,
		2003			2002			2001
		(in thousands)
Current tax expense:
	Federal	$	3,209		$	1,993		$	2,012
	State		514			425			571
			3,723			2,418			2,583
Deferred income taxes (benefits):
	Federal		570			903			1,072
	State		31			—			—
			601			903			1,072
Change in regulatory assets and regulatory liabilities, net			(251	)		(59	)		(67	)
Investment tax credit amortization			(49	)		(49	)		(49	)
Provision for income taxes		$	4,024		$	3,213		$	3,539

        Current tax expense does not reflect benefit of $124,000, $136,000 and $323,000 for the years ended December 31, 2003, 2002 and 2001, respectively, related to the exercise of employee stock options recorded through "Additional paid-in capital" in the consolidated statements of stockholders' equity.

        A reconciliation of the statutory federal income tax rate to the Company's effective tax rate is as follows:

	For the Years Ended December 31,
	2003		2002		2001
Provision computed at statutory rates	34	%	34	%	34	%
State income taxes, net of federal tax benefit	3	%	3	%	5	%
Amortization and other non-deductible expense	1	%	1	%	2	%
Reversion of pension assets, net	—		(2	%)	—
Investment tax credits	—		—		(1	%)
Other, net	(2	%)	(1	%)	(1	%)
Effective tax rate	36	%	35	%	39	%

63

        Net deferred income tax liabilities consist of the following at December 31, 2003 and 2002:

		December 31,
		2003		2002
		(in thousands)
Deferred income tax assets:
	Contributions in aid of construction and advances for construction	$	2,823	$	2,512
	Accrued liabilities and reserves		1,977		935
	Investment tax credits		375		430
	Stock-based compensation		1,501		1,116
	Other		818		293
Total deferred income tax assets			7,494		5,286
Deferred income tax liabilities:
	Depreciation		12,483		10,690
	Section 1031 like-kind property exchange gain		1,059		1,109
	Production cost balancing accounts		801		896
	Gains on condemnation of land		623		554
	Other		1,541		448
Total deferred income tax liabilities			16,507		13,697
Net deferred income tax liabilities		$	9,013	$	8,411

        Based upon the Company's current and historical pre-tax earnings, management believes it is more likely than not that the Company will realize the benefit of its deferred income tax assets. Management believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income. However, there can be no assurance that the Company will generate any earnings or any specific level of continuing earnings in future years. Management regularly reviews the recoverability of deferred income tax assets and has determined that no valuation allowances were necessary at December 31, 2003 or 2002.

NOTE 9. STOCKHOLDERS' EQUITY

        The Company is currently authorized to issue 25,000,000 common shares at a par value of $.01 per share. The current quarterly cash dividend to common stockholders is $.0475 per share. As of December 31, 2003 and 2002, there were 14,665,833 and 13,012,220 common shares issued and outstanding, respectively.

        In May 2003 the Company completed a private placement of 1,477,377 shares of newly issued common stock to certain institutional investors. Gross proceeds from the private placement were $12.0 million from which commissions and fees of approximately $1.1 million were paid. The Company filed a registration statement with the Securities and Exchange Commission to register these shares for resale. The registration statement became effective on October 9, 2003.

        Holders of our common stock are entitled to one vote for each share held on all matters voted on by stockholders, including the election of directors. Upon liquidation or dissolution, the holders of common stock will be entitled to share ratably in the assets legally available for distribution to stockholders after payment of liabilities and subject to the prior rights of any holders of preferred stock then outstanding. Holders of our common stock do not have subscription, sinking fund, preemptive, redemption or conversion privileges. The rights, preferences and privileges of holders of our common stock are subject to the rights of the holders of shares of any series of preferred stock that is issued or that may be issued in the future.

64

        On April 6, 1998, the Company adopted a Share Purchase Rights Plan (Rights Plan) to preserve value for the Company's stockholders. The Rights Plan is designed to deter coercive takeover tactics, to encourage third parties interested in acquiring the Company to negotiate with the Board and to reduce any adverse effects that significant stockholders of the Company may have on the public market for the Company's common stock. In the event of certain triggering events as specified in the Rights Plan (e.g., accumulation of a significant block of shares by an acquiring person), the stockholders become entitled to purchase additional shares of common stock at a significant discount.

        The rights under the Rights Plan may only become exercisable under certain circumstances involving actual or potential acquisitions of 15% or more of our common stock. Depending on the circumstances, if the rights become exercisable, the holder is entitled to purchase from us one one-hundredth of a share of Series B Junior Participating Preferred Stock at an exercise price of $65.00, subject to adjustment. The rights remain in existence until April 6, 2008 unless they are earlier terminated, exchanged or redeemed. Information about the Stockholder's Rights Plan was filed on our Report 8-K, dated April 24, 1998.

        The Company is currently authorized to issue 250,000 preferred shares at a par value of $.01 per share. There were 10,076 and 10,264 Series A preferred shares issued and outstanding at December 31, 2003 and 2002, respectively. Series A preferred stockholders are entitled to annual dividends of $2.625 per share. Series A preferred shares may be called by the Company for a price of $52 per share and have preference in liquidation of $50 per share.

        Southwest Water has a Dividend Reinvestment and Stock Purchase Plan (DRIP) that allows common stockholders the option of receiving their dividends either in cash or in common stock at a 5% discount from the market value. The DRIP permits optional cash purchases of stock at current market values up to a maximum of $3,000 per stockholder each quarter. As of December 31, 2003, there were 720,000 shares authorized for issuance under the DRIP and 299,000 shares were available for issuance.

NOTE 10. STOCK-BASED PLANS

        At December 31, 2003, Southwest Water had three stock-based plans: the Stock Option Plan, the Director Stock Option Plan, and the Employee Stock Purchase Plan. In 2002, the Company adopted the fair value recognition provisions of SFAS No. 123, which requires that the Company value stock options issued based upon an option pricing model and recognize this value as an expense over the period in which the options vest. In 2002, the Company elected to recognize stock-based compensation using the retroactive restatement method in accordance with the provisions of SFAS No. 148. Under this change in accounting method, the Company restated its consolidated financial statements for all years prior to 2002 and presented herein to reflect stock-based compensation expense under a fair value based accounting method for all options granted, modified or settled in fiscal years beginning after December 15, 1994.

        The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that do not have vesting restrictions and that are fully transferable. In addition, option valuation models require the Company to make subjective assumptions including the expected future volatility of the stock price. Because the stock options granted by the Company have characteristics that are significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the value of an estimate, in management's opinion, the existing option valuation models, including Black-Scholes, do not necessarily provide a reliable single measure of the fair value of the Company's employee stock options.

65

        In the table below, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2003, 2002 and 2001:

	For the Years Ended December 31,
	2003		2002		2001
Dividend yield	1.8	%	1.8	%	1.7	%
Expected volatility	26.6	%	27.3	%	26.3	%
Risk free interest rate	2.7	%	4.6	%	4.7	%
Expected life in years	5.5		5.6		5.7

        Compensation expense arising from stock option grants as determined using the Black-Scholes fair value option model was approximately $934,000, $963,000 and $765,000 for the years ended December 31, 2003, 2002 and 2001, respectively.

        Stock Option Plan (SOP):    In 1988, the stockholders approved the SOP and in 2000, the stockholders approved an amendment to the SOP which increased the number of authorized and available shares for issuance by 1.25 million, provided for a 150,000 share annual award limit to any one individual, modified the eligibility requirements to include certain consultants to the Company and also extended the future grant date to May 23, 2010. In May 2003, the stockholders approved a further amendment to the SOP to increase the number of authorized and available shares for issuance by 1,000,000. As of December 31, 2003, there were 4,241,178 shares authorized for issuance under the SOP and 1,821,460 shares were available for issuance.

        Under the SOP, Southwest Water may grant non-qualified stock options to officers, employees and certain consultants at an exercise price not less than the fair value of the stock on the last trading date preceding the date of grant. The Company also granted non-qualified options to certain non-employee directors of the Company. Options granted subsequent to December 31, 1999 vest equally over a period of five years and expire seven years and one day from the date of grant. Options granted prior to January 1, 2000 expire 10 years and one day from the date of grant.

        Options issued under the SOP may be exercised in accordance with the provisions of the Internal Revenue Code concerning stock attestation. Options are forfeited when they expire or in the event a SOP participant terminates employment with the Company prior to the options vesting.

        Director Option Plan (DOP):    In 1996, the stockholders approved the DOP for non-employee directors, and in 2000, approved an amendment to the DOP, which provided for an increase of 220,500 shares reserved for issuance. As of December 31, 2003, there were 437,555 shares authorized for issuance under the DOP and 173,830 shares were available for issuance.

        The DOP provides for an automatic annual grant of options to purchase 5,000 shares of the Company's common stock to eligible non-employee directors of the Company on the date of the Company's Annual Meeting of Stockholders through 2006 at the fair market value of the Company's stock. New directors are granted an initial option to purchase 5,000 shares of the Company's common stock upon appointment to the Board of Directors. DOP options granted after December 31, 1999 vest equally over two years and expire seven years and one day after the date of grant. Options granted prior to January 1, 2000 expire 10 years and one day from the date of grant.

        Warrants:    There were 130,232 warrants to purchase Company stock outstanding and exercisable at December 31, 2003. The warrants were issued to consultants as compensation for their assistance in the Company's purchase of the City of West Covina's water distribution system and facilities.

66

        A combined summary of the status of the SOP, the DOP and warrants as well as changes during the years ended as of December 31, 2003, 2002 and 2001, is presented below:

	Stock Options and Warrants		Weighted Average Exercise Price
	(in thousands)
Outstanding at December 31, 2000	1,614		$	5.12
Granted	418			8.03
Exercised	(144	)		3.49
Forfeited	(8	)		4.29
Outstanding at December 31, 2001	1,880		$	5.90
Granted	493			9.99
Exercised	(89	)		11.21
Forfeited	(7	)		8.91
Outstanding at December 31, 2002	2,277		$	6.74
Granted	353			9.28
Exercised	(106	)		5.57
Forfeited	(33	)		7.79
Outstanding at December 31, 2003	2,491		$	6.91
Exercisable at December 31, 2001	866		$	4.65
Exercisable at December 31, 2002	1,167		$	5.11
Exercisable at December 31, 2003	1,404		$	5.56

        The following table summarizes information about stock options and warrants outstanding at December 31, 2003:

				Options and Warrants Outstanding				Options and Warrants Exercisable
Range of Exercise Prices				Number Outstanding at December 31, 2003	Weighted Average Remaining Contractual Life in Years	Weighted Average Exercise Price		Number Exercisable at December 31, 2003	Weighted Average Exercise Price
				(in thousands)				(in thousands)
$	1.50	$	3.75	344	1.1	$	2.59	344	$	2.59
	3.75		7.50	755	5.3		5.23	627		5.08
	7.50		11.25	1,344	4.8		8.83	412		8.27
	11.25		15.00	48	5.4		11.75	21		11.71
	1.50		15.00	2,491	4.6		6.91	1,404		5.56

        Employee Stock Purchase Plan (ESPP):    The Company has a stockholder-approved ESPP that allows eligible employees to purchase common stock through payroll deductions up to 10% of their salary (not to exceed $25,000 per year). The purchase price of the stock is 90% of the lower of the share price as calculated at the beginning and end of each three-month offering period. Under the ESPP, the Company issued 15,279 shares, 12,761 shares and 12,596 shares to employees in 2003, 2002 and 2001, respectively. At December 31, 2003, 1,139,532 shares were reserved for issuance under the ESPP and 870,249 shares were available for issuance.

67

NOTE 11. EMPLOYEE PENSION AND OTHER POST-RETIREMENT BENEFIT PLANS

        Defined Benefit Plan:    Prior to December 30, 1999, Southwest Water had a non-contributory defined benefit pension plan (the Pension Plan) certain employees of the Company. On August 5, 1999, the Company's Board of Directors adopted a resolution to terminate the Pension Plan, freeze the assets of the Pension Plan and cease all benefit accruals as of December 30, 1999. In connection with the termination of the Pension Plan, the Company amended the Pension Plan benefit calculation and enhanced its current defined contribution plan, covering certain employees of the Company. The Company applied for an Internal Revenue Service (IRS) determination in April 2000, and received a favorable determination in September 2001, thereby permitting the Company to proceed with the Pension Plan termination. In January 2002, the net assets of the Pension Plan were distributed to plan participants as permitted by the Employee Retirement Income Security Act (ERISA) and its related regulations. Following distribution of the plan assets of approximately $14.4 million to meet the benefit liabilities of the pension plan, and settlement of expenses paid by the Pension Plan in accordance with ERISA and its related regulations, the Pension Plan had excess assets of approximately $1.1 million.

        In February 2002, the Company's Board of Directors approved the transfer of excess assets to a qualified replacement plan. The funds were transferred to the Trustee of the qualified replacement plan in March 2002. Following the transfer of excess assets and payment of applicable excise taxes of approximately $173,000, the Pension Plan was considered settled in the first quarter of 2002 under the guidelines set forth in SFAS No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, because all benefit obligations were met and assets have been distributed. The Company no longer has responsibility for the pension benefit obligation. Accordingly, the Company accounted for the plan termination under SFAS No. 88 and recognized a net termination pre-tax gain of approximately $980,000 as income to the Company in the first quarter of 2002.

        During the third quarter of 2003, the IRS issued a revenue ruling which indicated that, when the excess assets of a terminated pension plan are transferred to a qualified replacement plan, such transfers are not subject to excise tax. Accordingly, the Company has applied for a refund of the previously paid excise taxes of approximately $173,000, and expects to receive this refund during the first half of 2004.

        Defined Contribution Plans:    The Company established a 401(k) profit sharing plan (the 401(k) Plan) covering employees of its Services Group. The 401(k) Plan provides for monthly enrollment by employees immediately following their date of hire. Participants may elect to contribute up to 60% of their salary to the 401(k) Plan. The Company matches a participant's contribution for an amount up to 50% of the first 4% of the participant's salary. Company contributions vest after one year. The assets of the ECO Plan are invested at the discretion of the individual employees in mutual funds consisting of stocks, bonds, and money market investments. The 401(k) Plan does not allow participants to invest in the stock of the Company.

        The Company established the Utility Group Retirement Savings Plan (the Retirement Plan) covering employees of the parent company, Suburban, NMUI and Windermere. Employees become eligible for participation on the first of the month following their date of hire. Under the Utility Plan, the Company matches 100% of the first 2% and 50% of the next 4% of the employees' contributions up to a maximum Company match of 4%. In addition, the Company contributes $250 semi-annually to each eligible employee. The Company contributions vest over a six year graduated schedule. The assets of the Retirement Plan are invested at the discretion of the individual employees in mutual funds consisting of stocks, bonds, and money market investments. The Utility Plan does not allow participants to invest in the stock of the Company. During 2002, the Utility Plan was identified as a qualified replacement plan and amended to permit the excess assets of the Pension Plan to be placed in a

68

suspense account. The amount currently held in the suspense account is used for company contributions to the Retirement Plan as permitted by the IRS, ERISA and the DOL.

        In connection with its acquisition of Master Tek, Southwest Water maintained a 401(k) plan for employees of Master Tek. In 2002, the Master Tek Plan was merged into the Retirement Plan.

        In connection with its acquisition of OpTech, Southwest Water maintained a 401(k) plan for employees of OpTech (the OpTech Plan). Employees became eligible for participation in the OpTech Plan after six months of employment. In 2003, the OpTech Plan was merged into the 401(k) Plan.

        The Company's contributions to the 401(k) plans were as follows:

	For the Years Ended December 31,
	2003		2002		2001
	(in thousands)
ECO Plan	$	200	$	206	$	212
Utility Plan		434		395		358
OpTech Plan		10		11		6
	$	644	$	612	$	576

        Supplemental Executive Retirement Plan (SERP):    Effective May 2000, the Company established a non-qualified supplemental executive retirement plan ("SERP") for certain key executive officers of the Company for the purpose of providing supplemental income benefits to plan participants or their survivors upon participant's retirement or death. Two executive officers of the Company have been selected by the Compensation Committee of the Board of Directors to participate in the SERP. Under the SERP, in most cases, a vested participant with five to ten years of service will be eligible for a yearly benefit for his or her lifetime beginning at age 65 equal to: (1) the participant's average annual compensation multiplied by (2) the applicable compensation percentage as defined by the SERP less (3) the Social Security benefit for the most recent five years of employment and less (4) benefits received under the "Pension Plan". The Pension Plan was terminated December 30, 1999. Compensation under the SERP is the participant's base salary and excludes bonus and other forms of compensation.

        To assist in funding the SERP liability, the Company has invested in a corporate-owned life insurance (COLI) policy. The cash surrender value of the Company-owned life insurance policy is designed to be equal to the net present value of the aggregate SERP liabilities. However, there is no direct relationship between the aggregate participants' SERP benefits and the COLI coverage.

        The cash surrender value of the COLI policy was $739,000 as of December 31, 2003, and is included in the other non-current assets section of the accompanying consolidated balance sheet (see note 4).

        The projected benefit obligation of the unfunded plan was $692,000 and $475,000 at December 31, 2003 and 2002, respectively. Net periodic pension cost was $216,000, $241,000 and $146,000, respectively, for 2003, 2002 and 2001. The discount rate was 6% and 6.5% for December 31, 2003 and 2002, respectively. The assumed rate of compensation increase was 8% and 5% for December 31, 2003 and 2002, respectively.

        Deferred Compensation Plan (DCP):    The Company adopted its non-qualified deferred compensation plan effective January 2002. Under the DCP the Company permits key employees to annually elect to defer a portion of their compensation until their retirement. The retirement benefit to be provided is based upon the amount of compensation deferred. Deferred compensation expense was

69

$48,000 and $24,000 in 2003 and 2002, respectively. Total deferred compensation liabilities were $681,000 and $286,000 at December 31, 2003 and 2002, respectively.

        To assist in funding the deferred compensation liability, the Company has invested in COLI policies. The cash surrender values of these policies were $829,000 and $305,000 at December 31, 2003 and 2002, respectively, and are presented as other non-current assets in the accompanying consolidated balance sheet. (See Note 3).

NOTE 12. SEGMENT INFORMATION

        Under SFAS No. 131, Segment Reporting, Southwest Water has two reportable segments: Services Group and Utility Group operations. The Services Group operates and manages water and wastewater treatment facilities owned by cities, public agencies, municipal utility districts and private entities. Revenue is derived through operations and maintenance contracts with smaller municipalities. Also included in the Services Group are construction operations and contract billing.

        The Utility Group owns and operates public water and wastewater utilities in California, New Mexico and Texas. State and federal agencies issue regulations regarding standards of water quality, safety, environmental and other matters which affect these operations. In the regulated utility subsidiaries, the rates that we charge for water and wastewater services are established by state authorities.

        Southwest Water's reportable segments are strategic business units that offer different services. They are managed separately since each business requires different operating and marketing strategies. The Services Group, while subject to certain environmental standards, is not regulated in its pricing, marketing or rates of return. The Utility Group subsidiaries are primarily governed by the regulatory bodies of the respective states and by the federal government. The service areas in which the Utility Group operates constitute monopolies with allowable rates of return determined by state regulatory agencies. The accounting policies of the segments are described in the summary of significant accounting policies in Note 1.

        The following table presents information about the operations of each reported segment for the three years ended December 31, 2003:

	Services Group(1)			Utility Group(2)			Total Segments Information			Corporate and Other(3)			Total Consolidated Information
	(in thousands)
For the Year Ended December 31, 2003
Total revenues(1)	$	116,041		$	56,933		$	172,974		$	—		$	172,974
Segment operating income		3,080			15,186			18,266			(3,474	)		14,792
Interest income		415			—			415			(48	)		367
Interest expense		(551	)		(2,429	)		(2,980	)		(1,620	)		(4,600	)
Gain on sales of land		—			728			728			—			728
Other income (expense)		201			(51	)		150			(220	)		(70	)
Income before income taxes		3,145			13,434			16,579			(5,362	)		11,217
For the Year Ended December 31, 2002
Total revenues(1)	$	78,833		$	51,967		$	130,800		$	—		$	130,800
Segment operating income		1,868			14,137			16,005			(5,231	)		10,774
Interest income		146			115			261			4			265
Interest expense		(410	)		(2,324	)		(2,734	)		(1,760	)		(4,494	)
Gain on sales of land		—			119			119			—			119
Other income (expense)		(95	)		1,635			1,540			1,011			2,551
Income before income taxes		1,509			13,682			15,191			(5,976	)		9,215

70

For the Year Ended December 31, 2001
Total revenues(1)	$	66,476	$	49,071		$	115,547		$	—		$	115,547
Segment operating income		2,215		14,756			16,971			(5,240	)		11,731
Interest income		645		—			645			10			655
Interest expense		169		(2,539	)		(2,370	)		(1,324	)		(3,694	)
Gain on sales of land		—		—			—			—			—
Other income (expense)		205		4			209			89			298
Income before income taxes		3,234		12,221			15,455			(6,465	)		8,990

(1)

In addition to services provided to external customers, certain companies in our Services Group provide construction; operations and maintenance services to companies in our Utility Group. In accordance with SFAS No. 71, the Company does not eliminate the intersegment profit on the work performed when the sales price is reasonable and it is probable that the costs and capital will be recoverable through the rate making process. Intersegment revenue eliminated was approximately $8.3 million, $9.5 million and $5.9 million for 2003, 2002 and 2001, respectively.

(2)

In May 2002, an agreement was reached among some of the parties responsible for the contamination and a number of affected water companies, including our California water utility. As a result of the agreement we recorded income of approximately $1.7 million, which covered certain water and energy costs, incurred in 1999, 2000 and 2001 arising from the contamination that were prior to the commencement of monthly payments. This agreement was an unusual event and we recorded the $1.7 million in Other Income (Expense) rather than as an increase to Operating Income, in accordance with the provisions of APB No. 30 Reporting the Results of Operations. (See Note 1—Summary of Significant Accounting Policies).

As a result of this contamination, we have received payments, and we expect to continue to receive payments until completion of remediation, for the incremental cost of purchasing water over the cost that would have been incurred by us to pump water from our wells had they not been shut down as a result of contamination and excluded costs covered in the $1.7 million agreement. For 2001, 2002, and 2003 the amount of these reimbursed expenses were $1.1 million, $4.3 million and $4.0 million respectively. These reimbursements pertain to our agreement with the parties responsible for the contamination and, as such, are recorded as a reduction to "operating expenses—utility group", which consequently increased our Operating Income.

(3)

"Other" consists of costs that include any corporate functional departments whose costs are not allocated and headquarters expenses.

        The following table presents information about the identifiable assets of each reported segment as December 31, 2003 and 2002:

	December 31,
	2003		2002
Services Group	$	67,831	$	63,706
Utility Group		222,436		199,537
Corporate and Other		5,955		5,501
Consolidated	$	296,222	$	268,744

71

NOTE 13. SIGNIFICANT ACQUISTIONS

        In April 2000, the Company purchased 80% of the outstanding common stock of Master Tek for $4.0 million. The purchase price consisted of $2.0 million in cash and a $2.0 million ten-year promissory note. The purchase agreement provides that the Company has the right to acquire the remaining 20% ownership for a price based on a formula related to the future financial performance of Master Tek over the following seven years. Under the terms of the purchase agreement, the minority owner of Master Tek had the right to require the Company to purchase his initial 20% minority interest in 5% increments at a price based on a formula, but not less than $1.0 million per year, over a four-year period commencing in April 2002. The acquisition was accounted for using the purchase method of accounting, and the results of Master Tek's operations have been consolidated with those of Southwest Water since April 3, 2000, the effective date of the transaction. The purchase price was allocated to the assets acquired and the liabilities assumed based on their estimated fair value at the date of acquisition. In April 2002, the Company paid $1.0 million to the minority owner for an additional 5% interest in Master Tek in accordance with the purchase agreement, thereby increasing our ownership to 85%. We subsequently acquired the remaining 15% of Master Tek.

        In August 2001, we purchased 90% of the outstanding shares of Operations Technologies, Inc. (OpTech), a provider of contract water and wastewater and public works services in the southeastern United States, for a purchase price of $8.2 million. The purchase price consisted of cash payments of $3.5 million in August 2001 and $0.4 million in January 2002, promissory notes in the aggregate amount of $3.0 million and shares our common stock with a market value of $1.3 million at August 31, 2001. We also entered into an employment agreement and a non-compete agreement with the owner of the remaining 10% of OpTech.

        In November 2002, we acquired certain contract operations of Aqua Source, a provider of contract water and wastewater services in Texas, Colorado and South Dakota. The purchase price consisted of approximately $10.3 million in cash. Upon closing of the transaction on November 22, 2002, we began operating the majority of this business under the name Aqua Services, LP (Aqua Services) while the remaining part was incorporated into one of our existing subsidiaries, ECO Resources, Inc. (ECO).

NOTE 14. COMMITMENTS AND CONTINGENCIES

Minority Interest Call and Put Rights

        The Company holds 90% of the outstanding common stock of OpTech. The Company has the right to acquire the remaining 10% of OpTech in August 2006 based on a formula relating to the profitability of OpTech. The minority owner has the option to sell the remaining 10% of OpTech to the Company using the same formula. However the selling price cannot be less than $1.0 million.

        The Company has an 80% interest in its Windermere utility in Texas. The purchase agreement provides that the Company has the right to acquire the remaining 20% ownership in Windermere at any point in time when the market value of the Company's stock increases to $13.61 per share (as adjusted for stock splits and dividends), for a purchase price of $6.0 million payable in Company common stock. The minority owner of Windermere has the right to require the Company to purchase the remaining 20% after October 1, 2005, for $6.0 million payable in Company common stock, subject to a limitation on the maximum and minimum number of shares issuable.

Long-term Lease Commitments

        The Company leases certain equipment and office facilities under operating leases that expire through 2014. Aggregate rental expense under all operating leases approximated $5.8 million,

72

$4.2 million, and $2.6 million in 2003, 2002 and 2001, respectively. At December 31, 2003, the future minimum rental commitments under existing non-cancelable operating leases are as follows:

Years ending December 31,	Long-term Lease Commitments
	(in thousands)
2004	$	5,030
2005		4,313
2006		3,468
2007		2,426
2008 and thereafter		12,918
Total	$	28,155

Bid Bonds

        As part of its contract process, ECO obtains bid bonds which secure, among other things, ECO's willingness to participate in contract discussions. The bid bonds range in value dependent upon the requirements of the potential client. Upon consummation of the contract, or cancellation of the negotiating process, the bid bond is canceled and ECO bears no further liability. The aggregate amount of bid bonds outstanding is usually less than $500,000 at any given time. The Company also secures its performance under operating and maintenance contracts with performance and completion bonds obtained from surety companies. The aggregate amount of these bonds at December 31, 2003 was approximately $2.3 million.

Legal proceedings

        Southwest Water and a subsidiary have been named as defendants in twelve lawsuits alleging various injuries as a result of water contamination in the San Gabriel Valley Main Basin. The California Supreme Court (the Court) ruled in February 2002 that the plaintiffs cannot challenge the adequacy of the water quality standards established by California Department of Health Services (DOHS). The plaintiffs may sue and collect damages from CPUC-regulated water companies only by proving that water delivered did not meet these water quality standards. The Company's believes that it has complied with DOHS water quality standards. The Court directed that the cases be sent to a trial court for further proceedings. At this time a number of cases, including the twelve involving Southwest Water and its subsidiary, have been consolidated before a single judge. The parties are now engaged in initial discovery and motions to determine whether, in light of the ruling by the Court, the plaintiffs can plead and prove any violation of water quality standards by the CPUC regulated water companies. Southwest Water and this subsidiary have requested defense and indemnification from our liability insurance carriers for these lawsuits. Several of the liability insurance carriers are currently absorbing the costs of defense of the lawsuits. The Company cannot predict the outcome of these lawsuits. Based upon information available at this time, the Company does not expect that these actions will have a material adverse effect on its financial position, results of operations or cash flows.

        In February 2003, the Company filed a lawsuit against the minority stockholder of Master Tek. In April 2003 the Minority Stockholder exercised his right to require the Company to purchase an additional 5% interest in Master Tek, which would increase the Company's ownership to 90%. Southwest made the purchase in April 2003, placing the funds in a trust account pending final settlement of the lawsuit. The lawsuit was settled in October 2003 with the following resolutions: (i) Southwest Water Company took ownership of the remaining 10% of shares of Master Tek stock, (ii) a final payment of $2.7 million to the minority owner, (iii) elimination of the Company's $1.5 million note payable to the minority stockholder, (iv) release of the Company from any claims

73

made by the minority stockholder and (v) certain indemnifications from the minority stockholder to cover certain potential or unasserted claims from third parties.

        At the time of the settlement, the Company's net unamortized assets and liabilities under the non-compete agreement with the minority stockholder were approximately $1,365,000 and $1,475,000, respectively. The parties agreed to (i) termination of the consulting agreement, (ii) termination of the Non-Compete Agreement, including all future payments required under the agreement and (iii) provision of a new 3-year "Exclusive Retainer Agreement" including an annual retainer fee and exclusive utilization of the minority stockholder as consultant.

        The minority stockholder owns the building occupied by Master Tek. As part of the settlement agreement, the building lease was amended so that the Company has the option to cancel the lease with 6 months notice and a six month penalty at the end of the notice period.

        The Company increased its balance of goodwill by $1.2 million as a result of the minority interest settlement transaction. Goodwill recorded in conjunction with the Master Tek transaction is reflected in the other assets of Southwest Water as of December 31, 2003, and will be reviewed for impairment pursuant to SFAS No. 142.

        Southwest Water and its subsidiaries are also the subjects of other litigation arising from the ordinary course of operations. The Company believes the ultimate resolution of such matters will not materially affect its consolidated financial position, results of operations or cash flow.

Commitments Under Long-term Service Contracts

        In September 2002, the Company agreed to facilitate the engineering and construction of a $25.0 million reverse osmosis water treatment plant in the city of San Juan Capistrano, California, for the Capistrano Valley Water District (CVWD). The project includes the drilling of eight new wells and the development of associated water lines. Subcontractor agreements with an engineering firm and a large construction firm are being used to fulfill significant obligations of this service contract. During 2002, the Company deferred approximately $0.8 million in pre-contract costs and began to recognize profit under the percentage-of-completion method of accounting.

        During construction of the CVWD plant, we have received payments upon completion of construction milestones and will continue to receive such payments until final completion of the construction. In addition, the CVWD awarded the Company a 20-year $20.0 million contract to operate the treatment plant after completion of construction. Construction of the plant commenced in December 2002. As of December 31, 2003, the plant is approximately 50% complete. The Company expects construction to be completed in 2004, at which time the Company will begin to operate and maintain the facility under the 20-year contract. Upon completion, the plant will have the capacity to treat approximately 5.0 million gallons of water per day.

        On January 8, 2003, the Company obtained an unsecured line of credit facility from a commercial bank used to issue a $3.4 million standby letter of credit as collateral for performance under a service contract for the CVWD to manage the design and construction project. This standby letter of credit is in force for the estimated two-year construction period of the project. Upon acceptance of the completed project by the CVWD, the standby letter of credit facility will be terminated.

        The CVWD service contract contains certain guarantees related to the performance of the Company and its affiliate ECO, including certain liquidated damages in the event of failure on the part of the Company to perform not caused by uncontrollable circumstances as defined in the service contract. Among other things, the Company is obligated to produce from the completed plant a specified volume of treated water by December 4, 2004. In the event of a delay beyond this date, not caused by a defined uncontrollable circumstance, specified delay liquidated damages are to be paid to CVWD. To mitigate these issues, the Company has secured from its construction subcontractors both

74

contractual liquidated damage provisions and performance and completion bonds. In addition, the Company may also be liable for liquidated damages relating to any lost payments from an agreement with a state water agency providing financial assistance to CVWD. During the 20-year operation period, the Company has made certain other guarantees to CVWD, including guarantees with respect to the quality and quantity of the finished water and the production efficiency of the facility.

        As part of the financing of this project, the CVWD was successful in the sale of insured municipal bonds. The Company entered into an agreement with the bond insurer to guarantee the Company's performance under the service contract, subject to certain liability caps to the bond insurer in the event of a default. Such liability caps will not exceed an amount equal to $6.0 million during the construction period of the project, and afterwards, during the 20-year operation of the facility, the liability cap will not exceed an amount equal to $4.0 million plus an amount no greater than the replacement cost of the actual reverse osmosis filtration unit within the facility estimated to be approximately $1.5 million.

Limitations on Dividends at our California Utility

        One of our wholly owned subsidiaries, Suburban Water Systems, is limited by its mortgage bond agreement in distributing funds to Southwest Water Company. The limitation prevents paying dividends that exceed aggregate undistributed net income subsequent to December 31, 1995. Dividend distributions have averaged approximately $2.0 million per year and are less than the dividend restriction threshold as of December 31, 2003 by approximately $21.0 million.

NOTE 15. SELECTED QUARTERLY FINANCIAL INFORMATION (Unaudited)

        Selected unaudited quarterly consolidated financial information of the Company is presented in the tables below. The fluctuations in revenues and operating income among quarters reflect the seasonal nature of the Company's operations.

		Dec. 31 2003		Sept. 30 2003		Jun. 30 2003		Mar. 31 2003
		(In thousands, except per share data)
Consolidated Statement of Operations Data:
	Revenues	$	43,984	$	51,412	$	41,464	$	36,114
	Operating income		3,771		6,603		3,497		921
	Net income (loss)		2,024		3,429		1,889		(149	)
	Net income (loss) available for common shareholders		2,017		3,423		1,882		(156	)
	Basic earnings (loss) per common share:	$	0.14	$	0.23	$	0.14	$	(0.01	)
	Diluted earnings (loss) per common share	$	0.13	$	0.22	$	0.13	$	(0.01	)
		Dec. 31 2002		Sept. 30 2002		Jun. 30 2002		Mar. 31 2002
		(In thousands, except per share data)
Consolidated Statement of Operations Data:
	Revenues	$	35,312	$	34,574	$	32,746	$	28,168
	Operating income		3,275		3,663		1,893		1,943
	Net income		1,410		1,720		1,708		1,164
	Net income available for common shareholders		1,403		1,714		1,701		1,157
	Basic earnings per common share:	$	0.11	$	0.13	$	0.13	$	0.09
	Diluted earnings per common share	$	0.10	$	0.12	$	0.12	$	0.09

75

ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

        None.

ITEM 9A.    CONTROLS AND PROCEDURES

        The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the Company's Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

        As required by Rule 13a-15(b) under the Exchange Act, the Company's management conducted an evaluation with the participation of the Chief Executive Officer and Chief Financial Officer of the effectiveness of our disclosure controls and procedures as of December 31, 2003, the end of the year covered by this Report. Based upon that evaluation, including the consideration of the reportable condition discussed below, the Chief Executive Officer and the Chief Financial Officer concluded that the disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2003.

        In March, 2004 management, in consultation with the Company's independent accountants, identified deficiencies in certain aspects of the monitoring and analysis components of the internal control procedures in our Services Group segment which constitute a reportable condition (as defined in AU 325, Communication of Internal Control Related Matters Noted in An Audit of the AICPA Professional Standards). These identified deficiencies impacted the quality and timeliness of the reporting and reconciliation of certain transactions in the Services Group. The matters involving the reportable condition have been discussed in detail among management, the audit committee of our board of directors, and our independent accountants. The identified deficiencies did not require any restatement of the Company's consolidated financial statements for any prior period. Management is taking the following steps to address the deficiencies described above:

•

Increasing the expertise and size of the Services Group accounting staff;



•

Increasing the management oversight of financial reporting processes;



•

Expanding the scope of internal audit procedures;



•

Implementing additional internal controls over financial reporting.

        Management estimates that it will take approximately six to nine months from the date of filing this Form 10-K to fully rectify these deficiencies. Management believes that this reportable condition did not have a material effect on the Company's consolidated financial statements through December 31, 2003. In the fourth quarter of 2003, no change occurred in the Company's internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting.

76

PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

        Information relating to the directors of the Company will be set forth under the captions "Item 1—Election of Directors—Information with Respect to Nominees and Continuing Directors in our Proxy Statement for our 2004 Annual Meeting of Stockholders. Such information is incorporated herein by reference. Information relating to our executive officers is set forth in Part I of this 10-K Information regarding compliance by our directors and executive officers and owners of more than 10% of the Company's common stock with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, will be set forth under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" of the Securities Exchange Act of 1934" in the above-referenced Proxy Statement.

ITEM 11.    EXECUTIVE COMPENSATION

        Information relating to management compensation will be set forth under the captions "Item 1—Election of Directors—Director Compensation and Stock Ownership Guidelines" and "Item 1—Election of Directors—Executive Officer Compensation" in our Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference, except for the information set forth under the captions "Executive Compensation—Audit and Compensation Committee Report on Executive Compensation" and "Performance Graph," which specifically is not so incorporated by reference.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

        Information regarding ownership of our securities by certain persons is set forth under the caption "Proposal 1—Election of Directors—Beneficial Ownership of the Company's Securities" in the Company's Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        Information regarding certain relationships and transactions between the Company and certain of our affiliates is set forth under the caption "Proposal 1—Election of Directors—Compensation Committee Interlocks and Insider Participation" in our Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.

ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES

        Information regarding principal accountant fees and services is set forth under the caption "Principal Auditor Fees and Services" in the Company's Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.

77

PART IV

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

		Page
(a)(1)	The financial statements listed below are filed in Part II of this report:
	Independent Auditors' Report	44
	Consolidated Statements of Income—Three Years Ended December 31, 2003	45
	Consolidated Balance Sheets—December 31, 2003 and 2002	46
	Consolidated Statements of Changes in Stockholders' Equity—Three Years Ended December 31, 2003	47
	Consolidated Statements of Cash Flows—Three Years Ended December 31, 2003	48
	Notes to Consolidated Financial Statements	49
(a)(2)	The supplementary financial statement schedules required to be filed with this report are as follows:
	Schedule I—Condensed Financial Information of Registrant	79
	Schedule II—Valuation and Qualifying Accounts	84
	Schedules not listed above are omitted because of the absence of conditions under which they are required, or because the information required by such omitted schedules is included in the consolidated financial statements or notes thereto.
(a)(3)	Exhibit Index	85
(b)	Reports on Form 8-K:
	On November 12, 2003, the Company filed a Current Report on Form 8-K furnishing an earnings release attached as Item 12 with respect to our financial results for the three and nine months ended September 30, 2003.
	On December 29, 2003, the Company filed a Current Report on Form 8-K to announce that it had filed a shelf registration statement on Form S-3 for the issuance of debt and equity securities of up to $50.0 million from time to time.

78

SOUTHWEST WATER COMPANY

SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT

Statements of Operations

	For the Years Ended December 31,
	2003			2002			2001
Revenues:	$	—		$	—		$	—
Expenses:
Selling, general and administrative		3,996			2,538			1,836
		3,996			2,538			1,836
Operating Loss		(3,996	)		(2,538	)		(1,836	)
Other Income (Expense):
Interest expense		(1,552	)		(1,137	)		(852	)
Interest income		—			4			15
Other		609			1,011			(1	)
		(943	)		(122	)		(838	)
Loss Before Income Taxes		(4,939	)		(2,660	)		(2,674	)
Income Tax Benefit		2,218			1,246			881
Net Loss Before Equity in Net Income of Subsidiaries		(2,721	)		(1,414	)		(1,793	)
Equity in Net Income of Subsidiaries		9,914			7,416			7,244
Net Income	$	7,193		$	6,002		$	5,451

See accompanying notes to condensed financial information of registrant.

79

SOUTHWEST WATER COMPANY

SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT

Balance Sheets

	December 31,
	2003		2002
	(in thousands)
ASSETS
Current Assets:
Cash and cash equivalents	$	621	$	664
Receivable from subsidiaries, net		39,337		21,022
Other current assets		—		1,318
		39,958		23,004
Property, plant and equipment, net		442		533
Investments in subsidiaries and affiliates		71,900		66,690
Deferred income taxes		1,979		1,263
Other assets		3,660		3,469
	$	117,939	$	94,959
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Other current liabilities	$	970	$	429
Long-term debt—convertible subordinate debentures		19,682		19,732
Long-term bank lines of credit		15,897		11,000
Other liabilities		1,723		1,961
Total Liabilities		38,272		33,122
Stockholders' Equity:
Cumulative preferred stock		507		513
Common stock		147		130
Paid-in capital		55,981		42,755
Retained earnings		23,032		18,439
Total Stockholders' Equity		79,667		61,837
	$	117,939	$	94,959

See accompanying notes to condensed financial information of registrant.

80

SOUTHWEST WATER COMPANY

SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT

Statements of Cash Flow

		For the Years Ended December 31,
		2003			2002			2001
		(in thousands)
Cash Flows from Operating Activities:
Net income		$	7,193		$	6,002		$	5,451
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Net income from subsidiaries			(9,916	)		(7,416	)		(7,244	)
Depreciation and amortization			67			106			59
Stock-based compensation			934			963			765
Deferred income taxes			(716	)		107			(236	)
Changes in assets and liabilities, net of effects of acquisitions:
	Other current assets		(329	)		(3,345	)		4,507
	Other current liabilities		546			(1,521	)		(454	)
	Other, net		3,251			5,235			(1,985	)
Net cash provided by operating activities			1,030			131			863
Cash Flows from Investing Activities:
Acquisition of businesses			—			(10,317	)		(3,880	)
Purchase of minority interest			—			(2,000	)		—
Additions to property, plant and equipment			(372	)		(95	)		(61	)
Dividends received from subsidiaries			3,630			2,005			2,793
Other investments, net			—			(188	)		—
Net cash provided by (used in) investing activities			3,258			(10,595	)		(1,148	)
Cash Flows from Financing Activities:
Net proceeds from private issuance of common stock			10,898			—			—
Net borrowings on (repayments of) bank lines of credit			4,822			1,337			(3,188	)
Proceeds from sale leaseback			396			—			—
Net change in intercompany balances			(19,154	)		10,841			(15,277	)
Net proceeds from dividend reinvestment, employee stock purchase and stock option plans			1,270			1,168			797
Dividends paid			(2,563	)		(2,142	)		(1,981	)
Conversion of debentures			—			(268	)		—
Gross proceeds from issuance of debentures			—			—			20,000
Net cash (used in) provided by financing activities			(4,331	)		10,936			351
Net (decrease) increase in cash and cash equivalents			(43	)		472			66
Cash and cash equivalents at beginning of year			664			192			126
Cash and cash equivalents at end of year		$	621		$	664		$	192

See accompanying notes to condensed financial information of registrant.

81

SOUTHWEST WATER COMPANY

NOTES TO SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT

        Basis of Presentation:    In accordance with the requirements of Regulation S-X of the Securities and Exchange Commission, the financial statements of the Registrant are condensed and omit many disclosures presented in the consolidated financial statements and the notes thereto.

        Long-Term Debt:    During 2001, the Registrant issued $20.0 million in long-term convertible subordinate debentures. The debentures bear a fixed interest rate of 6.85% percent and mature in 2021. The Registrant had outstanding borrowings on long-term bank lines of credit of approximately $15.9 million and $11.0 million as of December 31, 2003 and 2002, respectively.

        Stock-Based Compensation:    The Company has two plans which allow for the granting of stock options. As fully disclosed in Note 10, the Company applies FASB No. 123, Accounting for Stock-Based Compensation, in accounting for its stock option grants. Accordingly, compensation expense is recognized for fixed stock options as if the fair value of all stock options as of the grant date were recognized as expense over the vesting period in accordance with SFAS No. 123.

        Income Taxes:    Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recorded in order to recognize future tax effects attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as the recognition of operating losses and tax credit carry-forwards. Deferred tax assets and liabilities are recorded using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that the enactment occurs. The Company files a consolidated U.S. Federal income tax return, which includes all qualifying subsidiaries.

        Reclassifications:    Certain reclassifications have been made to the prior year consolidated financial statement presentation to conform to the 2003 presentation.

        Termination of Defined Benefit Plan:    Prior to December 30, 1999, the Registrant had a non-contributory defined benefit pension plan (the Pension Plan) for certain employees of the Company. On August 5, 1999, the Company's Board of Directors adopted a resolution to terminate the Pension Plan, freeze the assets of the Pension Plan and cease all benefit accruals as of December 30, 1999. In connection with the termination of the Pension Plan, the Company amended the Pension Plan benefit calculation and enhanced its current defined contribution plan, covering employees of the parent Company. The Company applied for an Internal Revenue Service (IRS) determination in April 2000, and received a favorable determination from the IRS in September 2001, thereby permitting the Company to proceed with the Pension Plan termination. In January 2002, the net assets of the Pension Plan were distributed to plan participants as permitted by the Employee Retirement Income Security Act (ERISA) and its related regulations. Following distribution of the plan assets of approximately $14.4 million to meet the benefit liabilities of the pension plan, and settlement of expenses paid by the Pension Plan in accordance with ERISA and its related regulations, the Pension Plan had excess assets of approximately $1.1 million.

        In February 2002, the Company's Board of Directors approved the transfer of excess assets to a qualified replacement plan. The funds were transferred to the Trustee of the qualified replacement plan in March 2002. Following the transfer of excess assets and payment of applicable excise taxes of approximately $0.2 million, the Pension Plan was considered settled in the first quarter of 2002 under the guidelines set forth in SFAS No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, because all benefit obligations were met and assets have been distributed. The Company no longer has responsibility for the pension benefit obligation. Accordingly, the Company accounted for the plan termination under SFAS No. 88 and

82

recognized a net termination pre-tax gain of approximately $1.0 million as income to the Company in the first quarter of 2002.

        See notes 10 and 15 to the accompanying consolidated financial statements for more complete disclosure.

        Contingencies:    Southwest Water is the subject of litigation arising from the ordinary course of operations. The Company believes the ultimate resolution of such matters will not materially affect its financial position, results of operations or cash flow.

        Minority Interest Call and Put Rights:    The Company holds 90% of the outstanding common stock of OpTech. The Company has the right to acquire the remaining 10% of OpTech in August 2006 based on a formula relating to the profitability of OpTech. The minority owner has the option to sell the remaining 10% of OpTech to the Company using the same formula. However the selling price cannot be less than $1.0 million.

        The Company has an 80% interest in its Windermere utility in Texas. The purchase agreement provides that the Company has the right to acquire the remaining 20% ownership in Windermere at any point in time when the market value of the Company's stock increases to $13.61 per share (as adjusted for stock splits and dividends), for a purchase price of $6.0 million payable in Company common stock. The minority owner of Windermere has the right to require the Company to purchase the remaining 20% after October 1, 2005, for $6.0 million payable in Company common stock, subject to a limitation on the maximum and minimum number of shares issuable.

        Commitment Under Long-term Service Contract:    As part of the financing of this project, the CVWD was successful in the sale of insured municipal bonds. The Company entered into an agreement with the bond insurer to guarantee the Company's performance under the service contract, subject to certain liability caps to the bond insurer in the event of a default. Such liability caps will not exceed an amount equal to $6.0 million during the construction period of the project, and afterwards, during the 20-year operation of the facility, the liability cap will not exceed an amount equal to $4.0 million plus an amount no greater than the replacement cost of the actual reverse osmosis filtration unit within the facility estimated to be approximately $1.5 million.

        Limitations on Dividends at our California Utility:    One of our wholly owned subsidiaries, Suburban Water Systems, is limited by its mortgage bond agreement in distributing funds to Southwest Water Company. The limitation prevents paying dividends that exceed aggregate undistributed net income subsequent to December 31, 1995. Dividend distributions have averaged approximately $2.0 million per year and are less than the dividend restriction threshold as of December 31, 2003 by approximately $21.0 million.

83

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS

For the Years Ended December 31, 2003, 2002 and 2001

	Balance at Beinning of Year		Provision Charged to Income		Recoveries/ Acquisitions/ Other		Accounts Written off			Balance at End of Year
2003
Allowance for Doubtful Accounts	$	2,037	$	140	$	182	$	(751	)	$	1,782
2002
Allowance for Doubtful Accounts	$	1,667	$	372	$	529	$	(531	)	$	2,037
2001
Allowance for Doubtful Accounts	$	1,468	$	236	$	—	$	(37	)	$	1,667

84

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

EXHIBIT INDEX

Exhibit No. and Applicable Section of Item 601 of Regulation S-K:

3.1	Registrant's Restated Certificate of Incorporation dated April 29, 2002 (incorporated by reference to Exhibit 4.1 of the Company's Registration Statement on Form S-3, File No. 333-106506).
3.1B	Certificate of Designation of Series E Convertible Preferred Stock Of Southwest Water Company dated January 12, 2000 (incorporated by reference to Exhibit 3.1E of Registrant's Form 10-K Report for the year ended December 31, 1999).
3.2	Amended and Restated Bylaws of Southwest Water Company dated May 18, 2001, (incorporated by reference to Exhibit 3.2D to Registrant's Form 10-K Report for the year ended December 31, 2001).
4.1	Indenture of Mortgage and Deed of Trust between Suburban Water Systems and U.S. Bank National Association, formerly First Trust of California, N.A. dated October 1, 1986 (incorporated by reference to Exhibit 4.3 to Registrant's Form 10-K Report for the year ended December 31, 1986).
4.1A	First Amendment and Supplement to Indenture of Mortgage and Deed of Trust between Suburban Water Systems and U.S. Bank National Association, formerly First Trust of California, N.A. dated February 7, 1990 (incorporated by reference to Exhibit 4.2A to Registrant's Form 10-K Report for the year ended December 31, 1989).
4.1B	Second Amendment and Supplement to Indenture of Mortgage and Deed of Trust between Suburban Water Systems and U.S. Bank National Association, formerly First Trust of California, N.A. dated January 24, 1992 (incorporated by reference to Exhibit 4.2B to Registrant's Form 10-K Report for the year ended December 31, 1991).
4.1C	Third Amendment and Supplement to Indenture of Mortgage dated October 9, 1996, between Suburban Water Systems and U.S. Bank National Association, formerly First Trust of California, N.A. (incorporated by reference to Exhibit 4.2C to Registrant's Form 10-K Report for the year ended December 31, 1996).
4.1D	Securities Purchase Agreement dated May 28, 2003 among Southwest Water Company and the purchases identified therein (incorporated by reference from Registration Statement on Form S-3, File No. 333-106506, filed June 25, 2003 by Southwest Water Company).
4.2	Bond Purchase Agreement dated October 1, 1986, for Suburban Water Systems (incorporated by reference to Exhibit 4.4 to Registrant's Form 10-K Report for the year ended December 31, 1986).
4.2A	Bond Purchase Agreement dated February 20, 1992, for Suburban Water Systems (incorporated by reference to Exhibit 4.3A to Registrant's Form 10-K Report for the year ended December 31,1991).
4.2B	Bond Purchase Agreement dated October 21, 1996, for Suburban Water Systems (incorporated by reference to Exhibit 4.3B to Registrant's Form 10-K Report for the year ended December 31, 1996).
4.3	Indenture of Mortgage dated February 14, 1992, between New Mexico Utilities, Inc., and Wells Fargo Bank, formerly Sunwest Bank of Albuquerque, N.A. (incorporated by reference to Exhibit 4.4 to Registrant's Form 10-K Report for the year ended December 31, 1991).

85

4.3A	First Supplement to Indenture of Mortgage dated May 15, 1992, between New Mexico Utilities, Inc. and Wells Fargo Bank, formerly Sunwest Bank of Albuquerque, N.A. (incorporated by reference to Exhibit 4.4A to Registrant's Form 10-K Report for the year ended December 31, 1996).
4.3B	Second Amendment and Supplement to Indenture of Mortgage dated October 21, 1996, between New Mexico Utilities, Inc. and Wells Fargo Bank, formerly Sunwest Bank of Albuquerque, N.A. (incorporated by reference to Exhibit 4.4B to Registrant's Form 10-K Report for the year ended December 31, 1996).
4.4	Bond Purchase Agreement dated March 12, 1992, for New Mexico Utilities, Inc. (incorporated by reference to Exhibit 4.5 to Registrant's Form 10-K Report for the year ended December 31, 1991).
4.4A	Bond Purchase Agreement dated November 8, 1996, for New Mexico Utilities, Inc. (incorporated by reference to Exhibit 4.5A to Registrant's Form 10-K Report for the year ended December 31, 1996).
4.5	Article Four of the Restated Certificate of Incorporation of the Registrant as to the rights, preferences, privileges and restrictions of all classes of stock (incorporated by reference to Exhibit 3.1 to Registrant's form 8-B Report filed with the Commission on July 5, 1988).
4.5A	Registration Statement for the Second Amendment to the Amended and Restated Southwest Water Company Stock Option and Restricted Stock Plan (incorporated by reference to Registrant's Form S-8 Registration Statement filed with the Commission October 29, 1997).
4.6	Stockholder's Rights Plan dated April 6, 1998 (incorporated by reference to the Registrant's Form 8-K Report filed with the Commission April 23, 1998).
4.8	Registration Statement for Southwest Water common stock for Operations Technologies, Inc., dated September 19, 2001 (incorporated by reference to Registrant's Form S-3 Registration Statement filed with the Commission on September 19, 2001).
4.9	Registration Statement for Southwest Water common stock for the Dividend Reinvestment and Stock Purchase Plan dated September 26, 2001, (incorporated by reference to Registrant's Form S-3 Registration Statement filed with the Commission on September 26, 2001).
10.1	Second Amended and Restated Stock Option Plan, dated May 23, 2000, as amended (filed herewith).*
10.1B	Form of Non-Qualified Stock Option Agreement pursuant to Second Amended and Restated Stock Option Plan, as amended (filed herewith).*
10.1B1	Certificate of Amendment to Second Amended and Restated Stock Option Plan, dated May 8, 2003 (filed herewith).*
10.1C	Stock Option Plan for Non-Employee Directors ("Director Option Plan"), as amended (filed herewith).*
10.1C1	Form of Non-Qualified Stock Option Agreement pursuant to Director Option Plan, as amended (filed herewith).*
10.1D	Amended and Restated Employee Stock Purchase Plan dated May 28, 1998 (incorporated by reference to Appendix B to Registrant's 1998 Proxy Statement filed with the Commission on April 20, 1998).*

86

10.2	Dividend Reinvestment and Stock Purchase Plan Dated December 1, 1992 (incorporated by reference to Registrant's Form S-3 Registration Statement filed with the Commission on December 1, 1992).*
10.3	Stock Purchase Agreement and First Amendment to Stock Purchase Agreement dated August 13, 1993, between ECO Resources, Inc., and Robert E. Hebert (incorporated by reference to Exhibit 10.11 to Registrant's Form 10-K Report for the year ended December 31, 1993).
10.4	Tolling Agreement between Suburban Water Systems and Aerojet dated June 20, 2000 (incorporated by reference to Exhibit 10.7 of Registrant's Form 10-Q Report for the quarter ended June 30, 2000).
10.5	Severance Compensation Agreement between Registrant and certain executive officers approved by the Compensation Committee of the Board of Directors on February 21, 1995 (incorporated by reference to Exhibit 10.11 to Registrant's Form 10-K Report for the year ended December 31, 1995).*
10.6A	Severance Compensation Agreement between Registrant and certain executive officers approved by the Compensation Committee of the Board of Directors on August 5, 1998 (incorporated by reference to Exhibit 10.9A to Registrant's Form 10-K Report for the year ended December 31, 1998).*
10.6B	Severance Compensation Agreement between Registrant and a certain executive officer approved by the Compensation Committee of the Board of Directors on August 31, 2001 (incorporated by reference to Exhibit 10.9B to Registrant's Form 10-Q Report for the quarter ended June 30, 2002).*
10.7	Credit Agreement between Registrant and Bank of America, N.A. dated October 6, 2003 (incorporated by reference herein).
10.8	Credit Agreement between Southwest Water and Union Bank of California, NA, dated June 6, 2003 (incorporated by reference to Exhibit 10.2 to Registrant's Form 10 Q Report for the quarter ended June 30, 2003).
10.9	Business Loan Agreement dated December 10, 1997 between New Mexico Utilities, Inc. and First Security Bank of New Mexico, N.A. (incorporated by reference to Exhibit 10.15 to Registrant's Form 10-K Report for the year ended December 31, 1998).
10.10	Modification Agreement between New Mexico Utilities, Inc. and First Security Bank of New Mexico, N. A. dated April 10, 1999 (incorporated by reference to Exhibit 10.15A to Registrant's Form 10-Q Report for the quarter ended September 30, 1999).
10.11	Modification Agreement between New Mexico Utilities, Inc. and First Security Bank of New Mexico, N.A., dated April 10, 2000 (incorporated by reference to Exhibit 10.15B to Registrant's Form 10-Q Report for the quarter ended March 31, 2000).
10.11B	Modification Agreement between New Mexico Utilities, Inc. and First Security Bank of New Mexico, N.A., dated July 10, 2003 (incorporated by reference herein).
10.11C	Business Loan Agreement between New Mexico Utilities, Inc. and Bank of the West dated April 10, 2002 (incorporated by reference to Exhibit 10.15C to Registrant's Form 10-Q Report for the quarter ended June 30, 2002).

87

10.12	Merger Agreement and Plan of Reorganization among Registrant, SW Utility Company, RTNT, Inc., Hornsby Bend Utility Company, Inverness Utility Company, Windermere Utility Company, Inc., HB Merger Sub, Inc. and IU Merger Sub, Inc. dated October 1, 2000 (incorporated by reference to Exhibit 10.19 to Registrant's Form 10-K Report for the year ended December 31, 2000).
10.13	Agreement and Plan of Merger between Registrant and OPT Acquisition Subsidiary, Inc., Operations Technologies, Inc., Operations Technologies Stockholder Trust and Robert W. Monette, dated August 31, 2001, (incorporated by reference to the Registrant's Form 8-K Report filed with the Commission on September 19, 2001).
10.14	Loan Agreement among Windermere Utility Co., Inc., Registrant and Bank of the West, dated August 9, 2002, (incorporated by reference to Exhibit 10.22 to the Registrant's Form 10-K Report for the year ended December 31, 2002).
10.15	LLC Purchase Agreement by and among Aqua Source, Inc., DQE, Inc. and Registrant, dated as of September 14, 2002 (incorporated by reference to Exhibit 10.23 to Registrant's Form 10-K for the year ended December 31, 2002).
10.16	Official Statement for $31,555,000 San Juan Basin Authority Lease Revenue Bonds (Ground Water Recovery Project) Issue of 2002 containing descriptions and summaries of various documents relating to the project, including the Service Contract for the Design, Construction, Financing and Operation of the San Juan Basin Desalter Project by and among ECO Resources, Inc., Registrant, and the Capistrano Valley Water District, Orange County, California, dated as of September 3, 2002. (incorporated by reference to Exhibit 10.24 to Registrant's Form 10 K for the year ended December 31, 2002).
21.1	Listing of Registrant's subsidiaries.
23.1	Consent of KPMG LLP.
31.1	Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated March 12, 2004, filed herewith.
31.2	Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated March 12, 2004, filed herewith.
32.1	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*

Management contracts or compensatory plans or arrangements required to be filed as exhibits to this Form 10-K by Item 601(b)(10)(iii) of Regulation S-K; previously filed where indicated and incorporated herein by reference.

88

SOUTHWEST WATER COMPANY SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized.

SOUTHWEST WATER COMPANY

By:	/s/  ANTON C. GARNIER ANTON C. GARNIER Chief Executive Officer (Principal Executive Officer) March 12, 2004
By:	/s/  RICHARD J. SHIELDS RICHARD J. SHIELDS Chief Financial Officer (Principal Financial Officer) March 12, 2004
By:	/s/  MICHAEL MILLER Michael Miller Corporate Controller (Principal Accounting Officer) March 12, 2004

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

/s/  JAMES C. CASTLE JAMES C. CASTLE Director March 12, 2004	/s/  DONOVAN D. HUENNEKENS DONOVAN D. HUENNEKENS Director March 12, 2004
/s/  H. FREDERICK CHRISTIE H. FREDERICK CHRISTIE Director March 12, 2004	/s/  MAUREEN A. KINDEL MAUREEN A. KINDEL Director March 12, 2004
/s/  ANTON C. GARNIER ANTON C. GARNIER Director March 12, 2004	/s/  PETER J. MOERBEEK PETER J. MOERBEEK Director March 12, 2004
/s/  LINDA GRIEGO LINDA GRIEGO Director March 12, 2004	/s/  RICHARD G. NEWMAN RICHARD G. NEWMAN Director March 12, 2004

89

QuickLinks

SOUTHWEST WATER COMPANY AND SUBSIDIARIES
PART I

ITEM 1. DESCRIPTION OF BUSINESS.

ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 4A. EXECUTIVE OFFICERS

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

EXHIBIT INDEX
SOUTHWEST WATER COMPANY SIGNATURES

EX-10.1

Exhibit 10.1

FORM OF EMPLOYEE NON-QUALIFIED STOCK OPTION AGREEMENT

THIS AGREEMENT, dated is made by and between Southwest Water Company, a Delaware corporation (the “Company”), and , an employee of the Company or a Subsidiary of the Company (the “Employee”).

WHEREAS, the Company wishes to afford the Employee the opportunity to purchase shares of its $.01 par value common stock (the “Common Stock”); and

WHEREAS, the Company wishes to carry out the Second Amended and Restated Southwest Water Company Stock Option Plan (the “Option Plan”) (the terms of which are hereby incorporated by reference and made a part of this Agreement); and

WHEREAS, the Committee of the Company’s Board of Directors (the “Committee”), appointed to administer said Option Plan, has determined that it would be to the advantage and best interest of the Company and its stockholders to grant the non-qualified option (the “Option”) provided for herein to the Employee as an inducement to join and remain in the service of the Company or its Subsidiaries and as an incentive for increased efforts during such service, and has advised the Company thereof and instructed the undersigned officers to issue said Option;

NOW, THEREFORE, in consideration of the mutual covenants herein contained and other good and valuable consideration, receipt of which is hereby acknowledged, the parties hereto do hereby agree as follows:

ARTICLE I DEFINITIONS

Whenever the following terms are used in this Agreement, they shall have the meanings specified below unless the context clearly indicates to the contrary.  The masculine pronoun shall include the feminine and neuter, and the singular the plural, where the context so indicates.

Section 1.1 - Code

“Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

Section 1.2- Company

“Company” shall mean Southwest Water Company.  In addition, “Company” shall mean any corporation assuming, or issuing new employee stock options in substitution for, the Option in a transaction to which Section 425(a) of the Code applies.

Section 1.3 - Director

“Director” shall mean a member of the Board of Directors or a member of the Board of Directors of a Subsidiary, as the same may be constituted from time to time.

1

Section 1.4 - Officer

“Officer” shall mean an officer of the Company as defined in Rule 16a-1(f) under the Securities Exchange Act of 1934, as amended, as such Rule may be amended in the future.

Section 1.5 - Option

“Option” shall mean the non-qualified option to purchase Common Stock of the Company granted under this Agreement.

Section 1.6 – Option Plan

“Option Plan” shall mean the Second Amended and Restated Southwest Water Company Option Plan, as amended from time to time.

Section 1.7 - Parent Corporation

“Parent Corporation” shall mean any corporation in an unbroken chain of corporations ending with the Company if each of the corporations other than the Company then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

Section 1.8 - Secretary

“Secretary” shall mean the Secretary of the Company.

Section 1.9 - Securities Act

“Securities Act” shall mean the Securities Act of 1933, as amended.

Section 1.10 - Subsidiary

“Subsidiary” shall mean any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

Section 1.11 - Termination of Employment

“Termination of Employment” shall mean the time when the employee-employer relationship between the Employee and the Company, a Parent Corporation or a Subsidiary is terminated for any reason, with or without cause, including, but not by way of limitation, a termination by resignation, discharge, removal, death or retirement, but excluding any termination where there is a simultaneous reemployment or continuing employment by the Company, a Parent Corporation or a Subsidiary.  The Committee, in its absolute discretion, shall determine the effect of all other matters and questions relating to Termination of Employment, including, but not by way of limitation, the question of whether a Termination of Employment resulted from a discharge for good cause, and all questions of whether particular leaves of absence constitute Terminations of Employment.

2

ARTICLE II GRANT OF OPTION

Section 2.1 - Grant of Option

In consideration of the Employee’s agreement to remain in the employ of the Company, its Parent Corporations or its subsidiaries and for other good and valuable consideration, on the date hereof the Company irrevocably grants to the Employee the option to purchase any part or all of an aggregate of shares of its $.01 par value Common Stock upon the terms and conditions set forth in this Agreement.

Section 2.2 - Purchase Price

The purchase price of the shares of stock covered by the option shall be per share without commission or other charge.

Section 2.3 - Consideration to Company

In consideration of the granting of this Option by the Company, the Employee agrees to render faithful and efficient services to the Company, a Parent Corporation or a Subsidiary, with such duties and responsibilities as the Company shall from time to time prescribe, for a period of at least one (1) year from the date this Option is granted.  Nothing in this Agreement or in the Option Plan shall confer upon the Employee any right to continue in the employ of the Company, any Parent Corporation or any Subsidiary, or shall interfere with or restrict in any way the rights of the Company, its Parent Corporations and its Subsidiaries, which are hereby expressly reserved, to discharge the Employee at any time for any reason whatsoever, with or without cause.

Section 2.4 - Adjustments in Option

In the event that the outstanding shares of the stock subject to the Option are changed into or exchanged for a different number or kind of shares or other securities of the Company or of another corporation by reason of reorganization, merger (including reincorporation effected by means of merger), consolidation, recapitalization, reclassification, stock split up, stock dividend or combination of shares, the Committee shall make an appropriate and equitable adjustment in the number and kind of shares as to which the Option, or portions thereof then unexercised, shall be exercisable, to the end that after such event the Employee’s proportionate interest shall be maintained as before the occurrence of such event.  Such adjustment in the Option shall be made without change in the total price applicable to the unexercised portion of the Option (except for any change in the aggregate price resulting from rounding-off of share quantities or prices) and with any necessary corresponding adjustment in the Option price per share.  Any such adjustment made by the Committee shall be final and binding upon the Employee, the Company and all other interested persons.

3

ARTICLE III PERIOD OF EXERCISABILITY

Section 3.1 - Commencement of Exercisability

(a)The Option shall become exercisable in five (5) cumulative installments as follows:

(i) The first installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the date of grant of the Option (the “First Anniversary Date”);

(ii) The second installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the First Anniversary Date (the “Second Anniversary Date”);

(iii) The third installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the Second Anniversary Date (the “Third Anniversary Date”);

(iv) The fourth installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the Third Anniversary Date (the “Fourth Anniversary Date”); and

(v) The fifth installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the Fourth Anniversary Date (the “Fifth Anniversary Date”).

(b)Excluding Saturdays, Sundays, and nationally recognized holidays, if the Optionee is absent from employment for any reason other than vacation for an aggregate period exceeding sixty (60) days during the annual period between the date of grant of the Option and the First Anniversary Date, or any successive Anniversary Date and the following Anniversary Date, then the latter Anniversary Date shall be postponed by the number of all such days of absence.

(c)No portion of the option, which is unexercisable at Termination of Employment of the Employee, shall thereafter become exercisable.

Section 3.2 - Duration of Exercisability

The installments provided for in Section 3.1 are cumulative.  Each such installment, which becomes exercisable pursuant to Section 3.1 shall remain exercisable until it becomes unexercisable under Section 3.3.

Section 3.3 - Expiration of Option

The Option may not be exercised to any extent by anyone after the first to occur of the following events:

4

(a)The expiration of seven (7) years and one (1) day from the date the Option was granted; or

(b)The time of the Employee’s Termination of Employment unless such Termination of Employment results from his death, retirement, disability or being discharged not for good cause; or

(c)The time of the Employee’s Termination of Employment with good cause, including, but not by way of limitation, a termination by reason of conduct which the Committee determines to have been knowingly fraudulent, deliberately dishonest, disloyal, or willful misconduct; or

(d)The expiration of three (3) months from the date of the Employee’s Termination of Employment by reason of his retirement or his being discharged not for good cause, unless the Employee dies within said three (3) month period; or

(e)The expiration of one (1) year from the date of the Employee’s Termination of Employment by reason of his disability; or

(f)The expiration of one (1) year from the date of the Employee’s death; or

(g)The effective date of either the merger or consolidation of the Company with or into another corporation, or the acquisition by another corporation or person of all or substantially all of the Company’s assets or 80% or more of the Company’s then outstanding voting stock, or the liquidation or dissolution of the Company, unless the Committee waives this provision in connection with such transaction.  At least ten (10) days prior to the effective date of such merger, consolidation, acquisition, liquidation or dissolution, the Committee shall give the Employee notice of such event if the Option has then neither been fully exercised nor become unexercisable under this Section 3.3.

Section 3.4 - Acceleration of Exercisability

In the event of the merger or consolidation of the Company with or into another corporation, or the acquisition by another corporation or person of all or substantially all of the Company’s assets or 80% or more of the Company’s then outstanding voting stock, or the liquidation or dissolution of the Company, the Committee may, in its absolute discretion and upon such terms and conditions as it deems appropriate, provide by resolution, adopted prior to such event and incorporated in the notice referred to in Section 3.3(g), that at some time prior to the effective date of such event this Option shall be exercisable as to all the shares covered hereby, notwithstanding that this Option may not yet have become fully exercisable under Section 3.1(a); provided, however, that this acceleration of exercisability shall not take place if:

(a)This Option becomes unexercisable under Section 3.3 prior to said effective date;

5

(b)In connection with such an event, provision is made for an assumption of this Option or a substitution therefor of a new option by an employer corporation or a parent or subsidiary of such corporation; or

6

(c)The Option has been granted to an Officer or Director, the exercise would occur in whole or in part within one (1) year after such Option was granted and the Committee in its absolute discretion determines that acceleration of exercisability is undesirable.

The Committee may make such determinations and adopt such rules and conditions as it, in its absolute discretion, deems appropriate in connection with such acceleration of exercisability, including, but not by way of limitation, provisions to ensure that any such acceleration and resulting exercise shall be conditioned upon the consummation of the contemplated corporate transaction and determinations regarding whether provisions for assumption or substitution have been made in accordance with subsection (b) above.

ARTICLE IV EXERCISE OF OPTION

Section 4.1 - Person Eligible to Exercise

During the lifetime of the Employee, only he may exercise the Option or any portion thereof.  After the death of the Employee, any exercisable portion of the Option may, prior to the time when the Option becomes unexercisable under Section 3.3, be exercised by the Employee’s personal representative or by any person empowered to do so under the Employee’s will or under the then applicable laws of descent and distribution.

Section 4.2 - Partial Exercise

Any exercisable portion of the Option or the entire option, if then wholly exercisable, may be exercised in whole or in part at any time prior to the time when the Option or portion thereof becomes unexercisable under Section 3.3; provided, however, that each partial exercise shall be for not less than one hundred (100) shares (or the minimum installment set forth in Section 3.1, if a smaller number of shares) and shall be for whole shares only.

Section 4.3 - Manner of Exercise

The Option, or any exercisable portion thereof, may be exercised solely by delivery to the Secretary or the Secretary’s office of all of the following prior to the time when such exercisable option or portion thereof becomes unexercisable under Section 3.3:

(a)Notice in writing signed by the Employee, or such other person then entitled to exercise the Option or portion thereof, stating that the option or portion thereof is thereby exercised, such notice complying with all applicable rules established by the Committee; and

(b)The payment to the Company for the aggregate Option exercise price of the shares to which the Option or portion thereof is being exercised; in:

(i) Cash (or check); or

7

(vi) Shares of the Company’s Common Stock owned by the Employee duly endorsed for transfer to the Company, or issuable to the Employee upon exercise of the Option, with a fair market value (as determined under Section 4.2(b) of the Option Plan) on the date of delivery equal to the aggregate exercise price of the shares to which such Option or portion is exercised; or

(vii) With the consent of the Committee, a full recourse promissory note bearing interest (of at least such rate as shall then preclude the imputation of interest under the Code) and payable upon such terms as may be prescribed by the Committee.  The Committee may also prescribe the form of such note and the security to be given for such note.  The Option may not be exercised, however, by delivery of a promissory note or by a loan from the Company when or where such loan or other extension of credit is prohibited by law; or

(viii) Any combination of the consideration provided in the foregoing subparagraphs (i), (ii) and (iii); and

(c)The payment to the Company (or other employer corporation) of all amounts which it is required to withhold under Federal, state or local law in connection with the exercise of the Option; with the consent of the Committee, shares of the Company’s Common Stock owned by the Employee duly endorsed for transfer, or issuable to the Employee upon exercise of the Option, valued in accordance with Section 4.2(b) of the Option Plan at the date of Option exercise, may be used to make all or part of such payment; and

(d)A bona fide written representation and agreement, in a form satisfactory to the Committee, signed by the Employee or other person then entitled to exercise such Option or portion thereof, stating that the shares of stock are being acquired for his own account, for investment and without any present intention of distributing or reselling said shares or any of them except as may be permitted under the Securities Act and then applicable rules and regulations thereunder, and that the Employee or other person then entitled to exercise such Option or portion thereof will indemnify the Company against and hold it free and harmless from any loss, damage, expense or liability resulting to the Company if any sale or distribution of the shares by such person is contrary to the representation and agreement referred to above.  The Committee may, in its absolute discretion, take whatever additional actions it deems appropriate to insure the observance and performance of such representation and agreement and to effect compliance with the Securities Act and any other Federal or state securities laws or regulations.  Without limiting the generality of the foregoing, the Committee may require an opinion of counsel acceptable to it to the effect that any subsequent transfer of shares acquired on an Option exercise does not violate the Securities Act, and may issue stop-transfer orders covering such shares.  Share certificates evidencing stock issued on exercise of this option shall bear an appropriate legend referring to the provisions of this subsection (d) and the agreements herein.  The written representation and agreement referred to in the first sentence of this subsection (d) shall, however, not be required if the shares to be issued pursuant to such exercise have been registered under the Securities Act, and such registration is then effective in respect of such shares; and

8

(e)In the event the Option or portion thereof shall be exercised pursuant to Section 4.1 by any person or persons other than the Employee, appropriate proof of the right of such person or persons to exercise the Option or portion thereof.

Section 4.4 - Conditions to Issuance of Stock Certificates

The shares of stock deliverable upon the exercise of the Option, or any portion thereof, may be either previously authorized but unissued shares or issued shares which have then been reacquired by the Company.  Such shares shall be fully paid and non-assessable.  The Company shall not be required to issue or deliver any certificate or certificates for shares of stock purchased upon the exercise of the option or portion thereof prior to fulfillment of all of the following conditions:

(a)The admission of such shares to listing on all stock exchanges, if any, on which such class of stock is then listed; and

(b)The completion of any registration or other qualification of such shares under any state or Federal law or under the rulings or regulations of the Securities and Exchange Commission or any other governmental regulatory body, which the Committee shall, in its absolute discretion, deem necessary or advisable; and

(c)The obtaining of any approval or other clearance from any state or Federal governmental agency which the Committee shall, in its absolute discretion, determine to be necessary or advisable; and

(d)The payment to the Company of all amounts which it is required to withhold under Federal, state or local law in connection with the exercise of the option; and

(e)The lapse of such reasonable period of time following the exercise of the Option as the Committee may from time to time establish for reasons of administrative convenience.

Section 4.5 - Rights as Stockholder

The holder of the Option shall not be, nor shall such holder have any of the rights or privileges of, a stockholder of the Company in respect of any shares purchasable upon the exercise of any part of the Option unless and until a certificate or certificates representing such shares shall have been issued by the Company to such holder.

9

ARTICLE V OTHER PROVISIONS

Section 5.1 - Administration

The Committee shall have the power to interpret the Option Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Option Plan as are consistent therewith and to interpret, amend or revoke any such rules.  All actions taken and all interpretations and determinations made by the Committee in good faith shall be final and binding upon the Employee, the Company and all other interested persons.  No member of the Committee shall be personally liable for any action, determination or interpretation made in good faith with respect to the Option Plan or the Option.  The Board of Directors shall have no right to exercise any of the rights and duties of the Committee under the Option Plan and this Agreement.

Section 5.2 - Transfer Restrictions

Neither the Option nor any interest or right therein or part thereof shall be subject to or liable for the debts, contracts or engagements of the Employee or his successors in interest or shall be subject to disposition by transfer, alienation, anticipation, pledge, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any attempted disposition thereof shall be null and void and of no effect; provided, however, that this Section 5.2 shall not prevent transfers by will or by the applicable laws of descent and distribution.

Section 5.3 - Shares to Be Reserved

The Company shall at all times during the term of the Option reserve and keep available such number of shares of stock as will be sufficient to satisfy the requirements of this Agreement.

Section 5.4 - Notices

Any notice to be given under the terms of this Agreement to the Company shall be addressed to the Company in care of its Secretary, and any notice to be given to the Employee shall be addressed to him at the address given beneath his signature hereto.  By a notice given pursuant to this Section 5.4, either party may hereafter designate a different address for notices to be given to him.  Any notice which is required to be given to the Employee shall, if the Employee is then deceased, be given to the Employee’s personal representative if such representative has previously informed the Company of his status and address by written notice under this Section 5.4. Any notice shall be deemed duly given when enclosed in a properly sealed envelope or wrapper addressed as aforesaid, deposited (with postage prepaid) in a post office or branch post office regularly maintained by the United States Postal Service.

Section 5.5 - Titles

Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of this Agreement.

10

Section 5.6 - Construction

This Agreement shall be administered, interpreted and enforced under the laws of the State of California.

Section 5.7 – Conformity to Security Laws

This Agreement and the Option granted hereunder are intended to conform to the extent necessary with all provisions of the Securities Act, the Securities Exchange Act of 1934, as amended, and any and all regulations and rules promulgated by the Securities and Exchange Commission thereunder, including without limitation Rule 16b-3.  Notwithstanding anything herein to the contrary, the Option may be exercised, only in such a manner as to conform to such laws, rules and regulations.  To the extent permitted by applicable law, the Option granted hereunder shall be deemed amended to the extent necessary to conform to such laws, rules and regulations.

SOUTHWEST WATER COMPANY
By:
	Anton C. Garnier, CEO

The Employee,                                       ,

By signing this Agreement, accepts all

Terms and conditions herein.

Dated:	, 20
(Employee Signature)

Employee’s Taxpayer Identification Number:

Shares Awarded:

Award Date:

Exercise Price:

11

EX-10.1(B)

Exhibit 10.1(b)

FORM OF EMPLOYEE NON-QUALIFIED STOCK OPTION AGREEMENT

THIS AGREEMENT, dated is made by and between Southwest Water Company, a Delaware corporation (the “Company”), and , an employee of the Company or a Subsidiary of the Company (the “Employee”).

WHEREAS, the Company wishes to afford the Employee the opportunity to purchase shares of its $.01 par value common stock (the “Common Stock”); and

WHEREAS, the Company wishes to carry out the Second Amended and Restated Southwest Water Company Stock Option Plan (the “Option Plan”) (the terms of which are hereby incorporated by reference and made a part of this Agreement); and

WHEREAS, the Committee of the Company’s Board of Directors (the “Committee”), appointed to administer said Option Plan, has determined that it would be to the advantage and best interest of the Company and its stockholders to grant the non-qualified option (the “Option”) provided for herein to the Employee as an inducement to join and remain in the service of the Company or its Subsidiaries and as an incentive for increased efforts during such service, and has advised the Company thereof and instructed the undersigned officers to issue said Option;

NOW, THEREFORE, in consideration of the mutual covenants herein contained and other good and valuable consideration, receipt of which is hereby acknowledged, the parties hereto do hereby agree as follows:

ARTICLE I DEFINITIONS

Whenever the following terms are used in this Agreement, they shall have the meanings specified below unless the context clearly indicates to the contrary.  The masculine pronoun shall include the feminine and neuter, and the singular the plural, where the context so indicates.

Section 1.1 - Code

“Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

Section 1.2- Company

“Company” shall mean Southwest Water Company.  In addition, “Company” shall mean any corporation assuming, or issuing new employee stock options in substitution for, the Option in a transaction to which Section 425(a) of the Code applies.

Section 1.3 - Director

“Director” shall mean a member of the Board of Directors or a member of the Board of Directors of a Subsidiary, as the same may be constituted from time to time.

1

Section 1.4 - Officer

“Officer” shall mean an officer of the Company as defined in Rule 16a-1(f) under the Securities Exchange Act of 1934, as amended, as such Rule may be amended in the future.

Section 1.5 - Option

“Option” shall mean the non-qualified option to purchase Common Stock of the Company granted under this Agreement.

Section 1.6 – Option Plan

“Option Plan” shall mean the Second Amended and Restated Southwest Water Company Option Plan, as amended from time to time.

Section 1.7 - Parent Corporation

“Parent Corporation” shall mean any corporation in an unbroken chain of corporations ending with the Company if each of the corporations other than the Company then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

Section 1.8 - Secretary

“Secretary” shall mean the Secretary of the Company.

Section 1.9 - Securities Act

“Securities Act” shall mean the Securities Act of 1933, as amended.

Section 1.10 - Subsidiary

“Subsidiary” shall mean any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

Section 1.11 - Termination of Employment

“Termination of Employment” shall mean the time when the employee-employer relationship between the Employee and the Company, a Parent Corporation or a Subsidiary is terminated for any reason, with or without cause, including, but not by way of limitation, a termination by resignation, discharge, removal, death or retirement, but excluding any termination where there is a simultaneous reemployment or continuing employment by the Company, a Parent Corporation or a Subsidiary.  The Committee, in its absolute discretion, shall determine the effect of all other matters and questions relating to Termination of Employment, including, but not by way of limitation, the question of whether a Termination of Employment resulted from a discharge for good cause, and all questions of whether particular leaves of absence constitute Terminations of Employment.

2

ARTICLE II GRANT OF OPTION

Section 2.1 - Grant of Option

In consideration of the Employee’s agreement to remain in the employ of the Company, its Parent Corporations or its subsidiaries and for other good and valuable consideration, on the date hereof the Company irrevocably grants to the Employee the option to purchase any part or all of an aggregate of shares of its $.01 par value Common Stock upon the terms and conditions set forth in this Agreement.

Section 2.2 - Purchase Price

The purchase price of the shares of stock covered by the option shall be per share without commission or other charge.

Section 2.3 - Consideration to Company

In consideration of the granting of this Option by the Company, the Employee agrees to render faithful and efficient services to the Company, a Parent Corporation or a Subsidiary, with such duties and responsibilities as the Company shall from time to time prescribe, for a period of at least one (1) year from the date this Option is granted.  Nothing in this Agreement or in the Option Plan shall confer upon the Employee any right to continue in the employ of the Company, any Parent Corporation or any Subsidiary, or shall interfere with or restrict in any way the rights of the Company, its Parent Corporations and its Subsidiaries, which are hereby expressly reserved, to discharge the Employee at any time for any reason whatsoever, with or without cause.

Section 2.4 - Adjustments in Option

In the event that the outstanding shares of the stock subject to the Option are changed into or exchanged for a different number or kind of shares or other securities of the Company or of another corporation by reason of reorganization, merger (including reincorporation effected by means of merger), consolidation, recapitalization, reclassification, stock split up, stock dividend or combination of shares, the Committee shall make an appropriate and equitable adjustment in the number and kind of shares as to which the Option, or portions thereof then unexercised, shall be exercisable, to the end that after such event the Employee’s proportionate interest shall be maintained as before the occurrence of such event.  Such adjustment in the Option shall be made without change in the total price applicable to the unexercised portion of the Option (except for any change in the aggregate price resulting from rounding-off of share quantities or prices) and with any necessary corresponding adjustment in the Option price per share.  Any such adjustment made by the Committee shall be final and binding upon the Employee, the Company and all other interested persons.

3

ARTICLE III PERIOD OF EXERCISABILITY

Section 3.1 - Commencement of Exercisability

(a)The Option shall become exercisable in five (5) cumulative installments as follows:

(i) The first installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the date of grant of the Option (the “First Anniversary Date”);

(ii) The second installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the First Anniversary Date (the “Second Anniversary Date”);

(iii) The third installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the Second Anniversary Date (the “Third Anniversary Date”);

(iv) The fourth installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the Third Anniversary Date (the “Fourth Anniversary Date”); and

(v) The fifth installment shall consist of one-fifth (1/5th) of the shares covered by the Option and shall become exercisable on the first anniversary of the Fourth Anniversary Date (the “Fifth Anniversary Date”).

(b)Excluding Saturdays, Sundays, and nationally recognized holidays, if the Optionee is absent from employment for any reason other than vacation for an aggregate period exceeding sixty (60) days during the annual period between the date of grant of the Option and the First Anniversary Date, or any successive Anniversary Date and the following Anniversary Date, then the latter Anniversary Date shall be postponed by the number of all such days of absence.

(c)No portion of the option, which is unexercisable at Termination of Employment of the Employee, shall thereafter become exercisable.

Section 3.2 - Duration of Exercisability

The installments provided for in Section 3.1 are cumulative.  Each such installment, which becomes exercisable pursuant to Section 3.1 shall remain exercisable until it becomes unexercisable under Section 3.3.

Section 3.3 - Expiration of Option

The Option may not be exercised to any extent by anyone after the first to occur of the following events:

4

(a)The expiration of seven (7) years and one (1) day from the date the Option was granted; or

(b)The time of the Employee’s Termination of Employment unless such Termination of Employment results from his death, retirement, disability or being discharged not for good cause; or

(c)The time of the Employee’s Termination of Employment with good cause, including, but not by way of limitation, a termination by reason of conduct which the Committee determines to have been knowingly fraudulent, deliberately dishonest, disloyal, or willful misconduct; or

(d)The expiration of three (3) months from the date of the Employee’s Termination of Employment by reason of his retirement or his being discharged not for good cause, unless the Employee dies within said three (3) month period; or

(e)The expiration of one (1) year from the date of the Employee’s Termination of Employment by reason of his disability; or

(f)The expiration of one (1) year from the date of the Employee’s death; or

(g)The effective date of either the merger or consolidation of the Company with or into another corporation, or the acquisition by another corporation or person of all or substantially all of the Company’s assets or 80% or more of the Company’s then outstanding voting stock, or the liquidation or dissolution of the Company, unless the Committee waives this provision in connection with such transaction.  At least ten (10) days prior to the effective date of such merger, consolidation, acquisition, liquidation or dissolution, the Committee shall give the Employee notice of such event if the Option has then neither been fully exercised nor become unexercisable under this Section 3.3.

Section 3.4 - Acceleration of Exercisability

In the event of the merger or consolidation of the Company with or into another corporation, or the acquisition by another corporation or person of all or substantially all of the Company’s assets or 80% or more of the Company’s then outstanding voting stock, or the liquidation or dissolution of the Company, the Committee may, in its absolute discretion and upon such terms and conditions as it deems appropriate, provide by resolution, adopted prior to such event and incorporated in the notice referred to in Section 3.3(g), that at some time prior to the effective date of such event this Option shall be exercisable as to all the shares covered hereby, notwithstanding that this Option may not yet have become fully exercisable under Section 3.1(a); provided, however, that this acceleration of exercisability shall not take place if:

(a)This Option becomes unexercisable under Section 3.3 prior to said effective date;

5

(b)In connection with such an event, provision is made for an assumption of this Option or a substitution therefor of a new option by an employer corporation or a parent or subsidiary of such corporation; or

6

(c)The Option has been granted to an Officer or Director, the exercise would occur in whole or in part within one (1) year after such Option was granted and the Committee in its absolute discretion determines that acceleration of exercisability is undesirable.

The Committee may make such determinations and adopt such rules and conditions as it, in its absolute discretion, deems appropriate in connection with such acceleration of exercisability, including, but not by way of limitation, provisions to ensure that any such acceleration and resulting exercise shall be conditioned upon the consummation of the contemplated corporate transaction and determinations regarding whether provisions for assumption or substitution have been made in accordance with subsection (b) above.

ARTICLE IV EXERCISE OF OPTION

Section 4.1 - Person Eligible to Exercise

During the lifetime of the Employee, only he may exercise the Option or any portion thereof.  After the death of the Employee, any exercisable portion of the Option may, prior to the time when the Option becomes unexercisable under Section 3.3, be exercised by the Employee’s personal representative or by any person empowered to do so under the Employee’s will or under the then applicable laws of descent and distribution.

Section 4.2 - Partial Exercise

Any exercisable portion of the Option or the entire option, if then wholly exercisable, may be exercised in whole or in part at any time prior to the time when the Option or portion thereof becomes unexercisable under Section 3.3; provided, however, that each partial exercise shall be for not less than one hundred (100) shares (or the minimum installment set forth in Section 3.1, if a smaller number of shares) and shall be for whole shares only.

Section 4.3 - Manner of Exercise

The Option, or any exercisable portion thereof, may be exercised solely by delivery to the Secretary or the Secretary’s office of all of the following prior to the time when such exercisable option or portion thereof becomes unexercisable under Section 3.3:

(a)Notice in writing signed by the Employee, or such other person then entitled to exercise the Option or portion thereof, stating that the option or portion thereof is thereby exercised, such notice complying with all applicable rules established by the Committee; and

(b)The payment to the Company for the aggregate Option exercise price of the shares to which the Option or portion thereof is being exercised; in:

(i) Cash (or check); or

7

(vi) Shares of the Company’s Common Stock owned by the Employee duly endorsed for transfer to the Company, or issuable to the Employee upon exercise of the Option, with a fair market value (as determined under Section 4.2(b) of the Option Plan) on the date of delivery equal to the aggregate exercise price of the shares to which such Option or portion is exercised; or

(vii) With the consent of the Committee, a full recourse promissory note bearing interest (of at least such rate as shall then preclude the imputation of interest under the Code) and payable upon such terms as may be prescribed by the Committee.  The Committee may also prescribe the form of such note and the security to be given for such note.  The Option may not be exercised, however, by delivery of a promissory note or by a loan from the Company when or where such loan or other extension of credit is prohibited by law; or

(viii) Any combination of the consideration provided in the foregoing subparagraphs (i), (ii) and (iii); and

(c)The payment to the Company (or other employer corporation) of all amounts which it is required to withhold under Federal, state or local law in connection with the exercise of the Option; with the consent of the Committee, shares of the Company’s Common Stock owned by the Employee duly endorsed for transfer, or issuable to the Employee upon exercise of the Option, valued in accordance with Section 4.2(b) of the Option Plan at the date of Option exercise, may be used to make all or part of such payment; and

(d)A bona fide written representation and agreement, in a form satisfactory to the Committee, signed by the Employee or other person then entitled to exercise such Option or portion thereof, stating that the shares of stock are being acquired for his own account, for investment and without any present intention of distributing or reselling said shares or any of them except as may be permitted under the Securities Act and then applicable rules and regulations thereunder, and that the Employee or other person then entitled to exercise such Option or portion thereof will indemnify the Company against and hold it free and harmless from any loss, damage, expense or liability resulting to the Company if any sale or distribution of the shares by such person is contrary to the representation and agreement referred to above.  The Committee may, in its absolute discretion, take whatever additional actions it deems appropriate to insure the observance and performance of such representation and agreement and to effect compliance with the Securities Act and any other Federal or state securities laws or regulations.  Without limiting the generality of the foregoing, the Committee may require an opinion of counsel acceptable to it to the effect that any subsequent transfer of shares acquired on an Option exercise does not violate the Securities Act, and may issue stop-transfer orders covering such shares.  Share certificates evidencing stock issued on exercise of this option shall bear an appropriate legend referring to the provisions of this subsection (d) and the agreements herein.  The written representation and agreement referred to in the first sentence of this subsection (d) shall, however, not be required if the shares to be issued pursuant to such exercise have been registered under the Securities Act, and such registration is then effective in respect of such shares; and

8

(e)In the event the Option or portion thereof shall be exercised pursuant to Section 4.1 by any person or persons other than the Employee, appropriate proof of the right of such person or persons to exercise the Option or portion thereof.

Section 4.4 - Conditions to Issuance of Stock Certificates

The shares of stock deliverable upon the exercise of the Option, or any portion thereof, may be either previously authorized but unissued shares or issued shares which have then been reacquired by the Company.  Such shares shall be fully paid and non-assessable.  The Company shall not be required to issue or deliver any certificate or certificates for shares of stock purchased upon the exercise of the option or portion thereof prior to fulfillment of all of the following conditions:

(a)The admission of such shares to listing on all stock exchanges, if any, on which such class of stock is then listed; and

(b)The completion of any registration or other qualification of such shares under any state or Federal law or under the rulings or regulations of the Securities and Exchange Commission or any other governmental regulatory body, which the Committee shall, in its absolute discretion, deem necessary or advisable; and

(c)The obtaining of any approval or other clearance from any state or Federal governmental agency which the Committee shall, in its absolute discretion, determine to be necessary or advisable; and

(d)The payment to the Company of all amounts which it is required to withhold under Federal, state or local law in connection with the exercise of the option; and

(e)The lapse of such reasonable period of time following the exercise of the Option as the Committee may from time to time establish for reasons of administrative convenience.

Section 4.5 - Rights as Stockholder

The holder of the Option shall not be, nor shall such holder have any of the rights or privileges of, a stockholder of the Company in respect of any shares purchasable upon the exercise of any part of the Option unless and until a certificate or certificates representing such shares shall have been issued by the Company to such holder.

9

ARTICLE V OTHER PROVISIONS

Section 5.1 - Administration

The Committee shall have the power to interpret the Option Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Option Plan as are consistent therewith and to interpret, amend or revoke any such rules.  All actions taken and all interpretations and determinations made by the Committee in good faith shall be final and binding upon the Employee, the Company and all other interested persons.  No member of the Committee shall be personally liable for any action, determination or interpretation made in good faith with respect to the Option Plan or the Option.  The Board of Directors shall have no right to exercise any of the rights and duties of the Committee under the Option Plan and this Agreement.

Section 5.2 - Transfer Restrictions

Neither the Option nor any interest or right therein or part thereof shall be subject to or liable for the debts, contracts or engagements of the Employee or his successors in interest or shall be subject to disposition by transfer, alienation, anticipation, pledge, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any attempted disposition thereof shall be null and void and of no effect; provided, however, that this Section 5.2 shall not prevent transfers by will or by the applicable laws of descent and distribution.

Section 5.3 - Shares to Be Reserved

The Company shall at all times during the term of the Option reserve and keep available such number of shares of stock as will be sufficient to satisfy the requirements of this Agreement.

Section 5.4 - Notices

Any notice to be given under the terms of this Agreement to the Company shall be addressed to the Company in care of its Secretary, and any notice to be given to the Employee shall be addressed to him at the address given beneath his signature hereto.  By a notice given pursuant to this Section 5.4, either party may hereafter designate a different address for notices to be given to him.  Any notice which is required to be given to the Employee shall, if the Employee is then deceased, be given to the Employee’s personal representative if such representative has previously informed the Company of his status and address by written notice under this Section 5.4. Any notice shall be deemed duly given when enclosed in a properly sealed envelope or wrapper addressed as aforesaid, deposited (with postage prepaid) in a post office or branch post office regularly maintained by the United States Postal Service.

Section 5.5 - Titles

Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of this Agreement.

10

Section 5.6 - Construction

This Agreement shall be administered, interpreted and enforced under the laws of the State of California.

Section 5.7 – Conformity to Security Laws

This Agreement and the Option granted hereunder are intended to conform to the extent necessary with all provisions of the Securities Act, the Securities Exchange Act of 1934, as amended, and any and all regulations and rules promulgated by the Securities and Exchange Commission thereunder, including without limitation Rule 16b-3.  Notwithstanding anything herein to the contrary, the Option may be exercised, only in such a manner as to conform to such laws, rules and regulations.  To the extent permitted by applicable law, the Option granted hereunder shall be deemed amended to the extent necessary to conform to such laws, rules and regulations.

SOUTHWEST WATER COMPANY
By:
	Anton C. Garnier, CEO

The Employee,                                     ,

By signing this Agreement, accepts all

Terms and conditions herein.

Dated:	, 20
(Employee Signature)

Employee’s Taxpayer Identification Number:

Shares Awarded:

Award Date:

Exercise Price:

11

EX-10.1(B)(1)

Exhibit 10.1(b)(1)

AMENDED AND RESTATED STOCK OPTION PLAN
FOR NON-EMPLOYEE DIRECTORS OF
SOUTHWEST WATER COMPANY

Southwest Water Company, a corporation organized under the laws of the State of Delaware (the “Company”), hereby adopts this Amended and Restated Stock Option Plan for Non-Employee Directors of Southwest Water Company (“Restated Director Option Plan”).  The Company originally adopted the Stock Option Plan for Non-Employee Directors of Southwest Water Company effective March 27, 1996.  This Restated Director Option Plan amends and restates the original plan effective as of May 23, 2000.

The purpose of this Restated Director Option Plan is to enable the Company to obtain and retain the services of experienced Non-Employee Directors considered essential to the long range success of the Company, and to motivate them by providing an opportunity to become owners of Common Stock of the Company pursuant to the exercise of options granted under this Restated Director Option Plan.

ARTICLE 1.
DEFINITIONS

Section 1.1 - General

Whenever the following terms are used in this Restated Director Option Plan they shall have the meaning specified below unless the context clearly indicates to the contrary.

Section 1.2 - Board

“Board” shall mean the Board of Directors of the Company as constituted from time to time.

Section 1.3 - Code

“Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

Section 1.4 - Common Stock

“Common Stock” shall mean the Common Stock, par value $.01 per share, of the Company.

Section 1.5 - Company

“Company” shall mean Southwest Water Company, a Delaware corporation.

Section 1.6 - Director

“Director” shall mean a person who is a member of the Board as constituted at that time.

Section 1.7 - Employee

“Employee” shall mean any employee (as defined in accordance with the Regulations and Revenue Rulings then applicable under Section 3401 (c) of the Code) of the Company, or of any corporation which is then a Subsidiary or a Parent corporation, whether such employee is so employed at the time this Restated Director Option Plan is adopted or becomes so employed subsequent to the adoption of this Restated Director Option Plan.

Section 1.8 - Non-Employee Director

“Non-Employee Director” shall mean any Director who is not at the same time an Employee.

Section 1.9 - Exchange Act

“Exchange Act” shall mean the Securities Exchange Act of 1934, as amended.

Section 1.10 - Option

“Option” shall mean a non-qualified stock option to purchase Common Stock of the Company granted under this Restated Director Option Plan.

Section 1.11 - Optionee

“Optionee” shall mean a Non-Employee Director to whom an Option is granted under this Restated Director Option Plan.

Section 1.12 - Parent Corporation

“Parent Corporation” shall have the meaning given in Section 424(e) of the Code.

Section 1.13 - Pronouns

The masculine pronoun shall include the feminine and neuter and the singular shall include the plural, where the context so indicates.

Section 1.14 - Restated Director Option Plan

“Restated Director Option Plan” shall mean this Amended and Restated Stock Option Plan for Non-Employee Directors of Southwest Water Company, as the same may be amended or restated from time to time.

Section 1.15 - Rule 16b-3

“Rule 16b-3” shall mean that certain Rule 16b-3 promulgated under the Exchange Act, as such rule may be amended from time to time.

Section 1.16 - Secretary

“Secretary” shall mean the Secretary of the Company.

2

Section 1.17 - Securities Act

“Securities Act” shall mean the Securities Act of 1933, as amended.

Section 1.18 - Subsidiary

“Subsidiary” shall mean any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

Section 1.19 - Termination as a Non-Employee Director

“Termination as a Non-Employee Director” shall mean the time when the Optionee who is a Non-Employee Director ceases to be a member of the Board by reason of such Optionee’s death, disability (within the meaning of Section 22(e)(3) of the Code), retirement, resignation or for any other reason.

ARTICLE 2.
SHARES SUBJECT TO RESTATED DIRECTOR OPTION PLAN

Section 2.1 - Shares Subject to Restated Director Option Plan

Subject to Section 4.6 (relating to adjustments in shares upon a Recapitalization, as defined therein), the shares of stock subject to Options shall be shares of Common Stock.  The aggregate number of shares of Common Stock which may be issued upon exercise of Options shall not exceed                       .  The foregoing gives effect to the 20% stock dividend issued on January 20, 1997, the 5% stock dividend issued on January 2, 1998, the 5-for-4 stock split issued on October 1, 1998, and the 3-for-2 stock split issued on October 20, 1999.

Section 2.2 - Unexercised Options

If any Option expires or is canceled without having been fully exercised, the number of shares subject to such Option but as to which such Option was not exercised prior to its expiration or cancellation may again be optioned hereunder, subject to the limitations of Section 2.1.

ARTICLE 3.
GRANTING OF OPTIONS

Section 3.1 - Eligibility

Subject to the provisions of Section 3.3, each person who is a Non-Employee Director shall be eligible to receive Options in accordance with Section 3.2.

Section 3.2 - Grant of Options to Non-Employee Directors

Subject to Section 3.3 below, each person who is elected or re-elected as a Non-Employee Director at the 1997 Annual Meeting of Stockholders shall be granted automatically as of the date of such meeting an initial Option to purchase 1,000 shares of Common Stock.  Each person who first becomes a Non-Employee Director after the 1997 Annual Meeting of Stockholders but prior to the 2000

3

Annual Meeting, by election or appointment to the Board shall be granted automatically on the date of such person’s election or appointment to the Board, an initial Option to purchase 1,000 shares of Common Stock, subject to anti-dilution adjustments in connection with any Recapitalization as governed by Section 4.6 hereof..  In addition, each person who is a Non-Employee director immediately following the 1997 Annual Meeting of Stockholders shall be granted automatically on the date of the Company’s Annual Meeting of Stockholders in (i) the year following the date upon which such Non-Employee Director is granted the initial Option hereunder, as provided in the preceding two sentences, and (ii) each year thereafter through the 1999 Annual Meeting of Stockholders, an Option to purchase an additional 1,000 shares of Common Stock, subject to anti-dilution adjustments in connection with any Recapitalization as governed by Section 4.6 hereof.  Effective as of the 2000 Annual Meeting of Stockholders, each person who is a Non-Employee Director immediately as of and following the 2000 Annual Meeting of Stockholders shall be granted automatically on the date of the 2000 Annual Meeting of Stockholders an additional option to purchase 5,000 shares of Common Stock.  Each person who first becomes a Non-Employee Director after the 2000 Annual Meeting of Stockholders by election or appointment to the Board shall be granted automatically on the date of such person’s election or appointment to the Board, an initial Option to purchase 5,000 shares of Common Stock, and shall be automatically granted on the date of each subsequent Company Annual Meeting of Stockholders as of and following which such person continues as a Non-Employee Director, an additional option to purchase 5,000 shares of Common Stock.  The 5,000 option share grants provided by this paragraph are not subject to anti-dilution adjustments in connection with any stock split, stock dividend, or stock combination as governed by Section 4.6 hereof.

Section 3.3 - No Option Grants When Prohibited by Law or Policy

No person shall be granted an Option under this Restated Director Option Plan if at the time of such Option grant, as provided in Section 3.2 above, the grant of such Option to such person is prohibited by applicable law or the policies of the employer of such person or of any other company on whose board of directors such person is a member.

ARTICLE 4.
TERMS OF OPTION

Section 4.1 - Option Agreement

Each Option shall be evidenced by a written Stock Option Agreement, which shall be executed by the Optionee and an authorized officer of the Company and which shall contain such terms and conditions as the Board shall determine, consistent with this Restated Director Option Plan.

Section 4.2 - Option Price

(a) The price per share of the Common Stock subject to each Option shall be 100% of the fair market value of a share of Common Stock on the date such Option is granted.

(b) For purposes of this Restated Director Option Plan, the fair market value of a share of Common Stock as of a given date shall be: (1) the closing price of a share of the Common Stock on the principal exchange on which shares of the Common Stock are then trading, if any, on the trading day preceding such date or, if shares were not traded on the day preceding such date, then on the next preceding trading day during which a sale occurred; or (ii) if the Common Stock is not traded on an exchange (x) the last sales price of a share of the

4

Common Stock on The Nasdaq Stock Market (if the stock is then traded on The Nasdaq Stock Market) on the trading day preceding such date, or, if shares were not traded on the day preceding such date, then on the next preceding trading day during which a sale occurred; or (y) the mean between the closing representative high and low prices for the Common Stock on the trading day next preceding such date as reported by the National Association of Securities Dealers, Inc. through Nasdaq or a successor quotation system or, if shares were not quoted on the day immediately preceding such date, then on the next preceding trading day during which a quote occurred, or (iii) if the Common Stock is not publicly traded on an exchange and prices are not provided through The Nasdaq Stock Market, NASDAQ or a successor quotation system, the mean between the closing high and low prices for the Common Stock on the trading day next preceding such date as determined in good faith by the Board; or (iv) if the Common Stock is not publicly traded, the fair market value of the Common Stock established by the Board acting in good faith.

Section 4.3 - Commencement of Exercisability

(a) No Option may be exercised in whole or in part during the first year after such Option is granted.

(b) Subject to the provisions of Sections 4.3(a), 4.3(c) and 7.3, Options shall become exercisable in two (2) cumulative installments as follows:

(i)The first installment shall consist of fifty percent (50%) of the shares covered by the Option and shall become exercisable on the first anniversary of the date the Option is granted.

(ii)The second installment shall consist of fifty percent (50%)of the shares covered by the Option and shall become exercisable on the second anniversary of the date the Option is granted.

(c)The portion, if any, of a previously granted Option which is unexercisable on the date of Termination as a Non-Employee Director shall become immediately exercisable.

Section 4.4 - Expiration of Options

No Option may be exercised to any extent by anyone after the first to occur of the following events:

(i)The expiration of a period of seven years and one day from the date such Option was granted; or

(ii)The expiration of one year from the date of the Optionee’s Termination as a Non-Employee Director for any reason, unless the Optionee dies within said one year period; or

(iii)The expiration of one year from the date of the Optionee’s death.

5

Section 4.5 - Consideration

In consideration of the granting of the Option, the Optionee shall agree, in the written Stock Option Agreement, to remain as a Non-Employee Director of the Company for a period of at least one year after the Option is granted, unless the stockholders of the Company fail to reelect the Non-Employee Director upon expiration of the Director’s term of office prior to the expiration of the one year period.

Section 4.6 - Adjustments in Outstanding Options

In the event that the outstanding shares of the Common Stock subject to Options are changed into or exchanged for a different number or kind of shares of the Company or other securities of the Company by reason of merger (including reincorporation by means of merger), consolidation, recapitalization, reclassification, stock split-up, stock dividend or combination of shares (a “Recapitalization”), the Board shall make an appropriate and equitable adjustment in (1) the number and kind of shares as to which all outstanding Options, or portions thereof then unexercised, shall be exercisable, to the end that after such event the Optionee’s proportionate interest shall be maintained as before the occurrence of such event and (ii) the limitations Section 2.1 above on the maximum number and kind of shares which may be issued on exercise of Options; provided, however, that after the 2000 Annual Meeting, no adjustment shall be so made to the number of options specified in Section 3.2 as a result of any such reclassification.  Such adjustment in an outstanding Option shall be made without change in the total price applicable to the Option or the unexercised portion of the Option (except for any change in the aggregate price resulting from rounding-off of share quantities or prices) and with any necessary corresponding adjustment in option price per share.  Any such adjustment made by the Board shall be final and binding upon all Optionees, the Company and all other interested persons.

Section 4.7 - Merger, Consolidation, Exchange, Acquisition, Liquidation or Dissolution

The Board may provide by the terms of any Option that such Option cannot be exercised after the merger or consolidation of the Company into another corporation, the exchange of all or substantially all of the assets of the Company for the securities of another corporation, the acquisition by another corporation of 80% or more of the Company’s then outstanding voting stock or the liquidation or dissolution of the Company; or the Board may, in its absolute discretion and on such terms and conditions as it deems appropriate, also provide that such Option shall be assumed or an equivalent option substituted by any successor corporation of the Company, or the Board may, in its absolute discretion and upon such terms and conditions as it deems appropriate, provided by resolution adopted prior to the occurrence of such merger, consolidation, exchange, acquisition, liquidation or dissolution, that, for some period of time prior to such event, that such Option shall be exercisable as to all shares covered thereby, notwithstanding anything to the contrary in Section 4.3(a) or Section 4.2(b).  Any determinations made by the Board pursuant to this Section 4.7 shall be applied uniformly to all Options outstanding on the date of such determination.

ARTICLE 5.
EXERCISE OF OPTIONS

Section 5.1 - Person Eligible to Exercise

During the lifetime of the Optionee, only the Optionee may exercise an Option granted to the Optionee, or any portion thereof; provided, however, that nothing in this Section 5.1 shall prevent the exercise of an Option by a person to whom such Option was lawfully transferred, in whole or in part,

6

pursuant to either the provisions of Section 7.1 or a qualified domestic relations order (as defined in the Code).  After the death of the Optionee, any exercisable portion of an Option may, prior to the time when such portion becomes unexercisable under Section 4.4 or Section 4.7 or any provisions of such Option, be exercised by his personal representative or by any person empowered to do so under the deceased Optionee’s will or under the then applicable laws of descent and distribution.

Section 5.2 - Partial Exercise

At any time and from time to time prior to the time when any exercisable Option or exercisable portion thereof becomes unexercisable under Section 4.4 or Section 4.7 or any provisions of such Option, such Option or portion thereof may be exercised in whole or in part; provided, however, that the Company shall not be required to issue fractional shares and partial exercises shall be at least one hundred (1 00) shares.

Section 5.3 - Manner of Exercise

An exercisable Option, or any exercisable portion thereof, shall be exercised solely by delivery to the Secretary or his office of all of the following prior to the time when such Option or such portion becomes unexercisable under Section 4.4 or Section 4.7:

(a) Notice in writing signed by the Optionee or other person then entitled to exercise such Option or portion, stating that such Option or portion is exercised; and

(b) The payment to the Company for the aggregate Option exercise price for the shares with respect to which such Option or portion is thereby exercised in:

(i)Cash;

(ii)(A) shares of the Company’s Common Stock owned by the Optionee duly endorsed for transfer to the Company, or (B) shares of the Company’s Common Stock issuable to the Optionee upon exercise of the Option, with a fair market value (as determined under Section 4.2(b)) on the date of Option exercise equal to the aggregate exercise Option price of the shares with respect to which such Option or portion is thereby exercised; or

(iii)A full recourse promissory note bearing interest (at no less than such rate as shall then preclude the imputation of interest under the Code or any successor provision) and payable upon such terms as may be prescribed by the Board.  The Board may also prescribe the form of such note and the security to be given for such note.  No Option may, however, be exercised by delivery of a promissory note or by a loan from the Company when or where such loan or other extension of credit is prohibited by law; or

(iv)Any combination of the consideration provided for in the foregoing subsections (i), (ii) or (iii); and

(c) The payment to the Company of all amounts which it is required to withhold under federal, state or local law in connection with the exercise of the Option or a portion

7

thereof.  All or any part of such payment may be made, with the consent of the Board (i) with Shares of the Company’s Common stock issuable to the Optionee upon exercise of the Option, or (ii) with shares of the Company’s Common Stock owned by the Optionee duly endorsed for transfer, in each case, valued in accordance with Section 4.2(b) at the date of Option exercise; and

(d) Such representations and documents as the Board, in its absolute discretion, deems necessary or advisable to effect compliance with all applicable provisions of the Securities Act and any other Federal or state securities laws or regulations.  The Board may, in its absolute discretion, also take whatever additional actions it deems appropriate to effect such compliance including, without limitation, placing legends on share certificates and issuing stop-transfer orders to transfer agents and registrars; and

(e) In the event that the Option shall be exercised pursuant to Section 5.1 by any person or persons other than the Optionee, appropriate proof of the right of such person or persons to exercise the Option.

(f) Notwithstanding anything herein to the contrary, an Optionee may satisfy the requirements of subsections (b) and (c) of this Section 5.3 concerning payment for the shares and all applicable withholding taxes, with the consent of the Board, through the delivery to the Secretary or his office of (i) an irrevocable written exercise notice containing instructions to the Company to deliver to Optionee’s broker the certificate(s) representing the shares with respect to which such Option or portion is thereby exercised and (ii) a copy of Optionee’s irrevocable written instructions to such broker to deliver to the Company, within five business days from the date of the Company’s receipt of such exercise notice, full payment (in cash or by check) for the shares with respect to which such Option or portion is thereby exercised and all amounts which the Company is required to withhold under federal, state or local law in connection with the exercise of the Option or portion thereof.  Provided the Optionee complies with clauses (i) and (ii) above and the Company receives such full payment the Optionee shall be deemed to have exercised such Option on the date of the Company’s receipt of the deliveries specified in clauses (i) and (ii) above.  Notwithstanding anything to the contrary in this Section 4.7, the Board shall not take any discretionary action which will result in the failure of the Restated Director Option Plan to satisfy any exemptive condition imposed by Rule 16b-3 or the Code with respect to the effected Option.

Section 5.4 - Conditions to Issuance of Stock Certificates

The shares of stock issuable and deliverable upon the exercise of an Option, or any portion thereof, may be either previously authorized but unissued shares or issued shares which have then been reacquired by the Company.  The Company shall not be required to issue or deliver any certificate or certificates for shares of stock purchased upon the exercise of any Option or portion thereof prior to fulfillment of all of the following conditions:

(a)The admission of such shares to listing on all stock exchanges, if any, on which such class of stock is then listed; and

8

(b)The completion of any registration or other qualification of such shares under any state or federal law or under the rulings or regulations of the Securities and Exchange Commission or any other governmental regulatory body, which the Board shall, in its absolute discretion, deem necessary or advisable; and

(c)The obtaining of any approval or other clearance from any state or federal governmental agency which the Board shall, in its absolute discretion, determine to be necessary or advisable; and

(d)The payment to the Company of all amounts which it is required to withhold under Federal, state or local law in connection with the exercise of the Option; and

(e)The lapse of such reasonable period of time following the exercise of the Option as the Board may establish from time to time for reasons of administrative convenience.

Section 5.5 - Rights as Stockholders

The holders of Options shall not be, nor have any of the rights or privileges of, stockholders of the Company in respect of any shares purchasable upon the exercise of any part of an Option unless and until certificates representing such shares have been issued and delivered by the Company to such holders.

Section 5.6 - Transfer Restrictions

No shares acquired upon exercise of any Option may be sold, assigned, pledged, encumbered or otherwise transferred until at least six months have elapsed from (but excluding) the date that such Option was granted; provided, however, that nothing in this Section 5.6 shall prevent transfers permitted under the provisions of Section 7.1, or transfers by will or by the applicable laws of descent and distribution, or, to the extent not prohibited by the Code, pursuant to a qualified domestic relations order.  The Board, in its absolute discretion, may impose such other restrictions on the transferability of the shares purchasable upon the exercise of an Option as it deems appropriate and any such restriction shall be set forth in the respective Stock Option Agreement and may be referred to on the certificates evidencing such shares.

ARTICLE 6.
ADMINISTRATION

Section 6.1 - Duties and Powers of Board

It shall be the duty of the Board to conduct the general administration of the Restated Director Option Plan in accordance with its provisions.  The Board shall have the power to interpret the Restated Director Option Plan and the Options and to adopt such rules for the administration, interpretation and application of the Restated Director Option Plan as are consistent therewith and to interpret, amend or revoke any such rules.

9

Section 6.2 - Professional Assistance; Good Faith Actions

All expenses and liabilities incurred by members of the Board in connection with the administration of the Restated Director Option Plan shall be borne by the Company.  The Board may employ attorneys, consultants, accountants, appraisers, brokers or other persons.  The Board and the Company shall be entitled to rely upon the advice, opinions or valuations of any such persons.  All actions taken and all interpretations and determinations made by the Board in good faith shall be final and binding.  No member of the Board shall be personally liable for any action, determination or interpretation made in good faith with respect to the Restated Director Option Plan or the Options, and all members of the Board shall be fully protected, indemnified and held harmless by the Company in respect to any such action, determination or interpretation.

ARTICLE 7.
MISCELLANEOUS PROVISIONS

Section 7.1 - Options Not Transferable

No Option or interest or right therein or part thereof shall be liable for the debts, contracts or engagements of the Optionee, or his successors in interest or shall be subject to disposition by transfer, alienation, anticipation, pledge, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy) and any attempted disposition thereof shall be null and void and of no effect; provided, however, that nothing in this Section 7.1 shall prevent transfers except to the extent that such disposition is permitted by the following paragraph, or by will or by the applicable laws of descent and distribution, or, to the extent not prohibited by the Code, pursuant to a qualified domestic relations order (as defined in the Code).

Notwithstanding the foregoing provisions of this Section 7.1, the Board, in its sole discretion, may determine to grant to any an Option which, by its terms or by determination of the Board after its grant, may be transferred by the Optionee, in writing and with prior written notice to the Board, by gift or as a contribution, to a family member of the Optionee, (as defined under the instructions to use of Form S-8), provided, that an Option that has been so transferred shall continue to be subject to all of the terms and conditions as applicable to the original Optionee, and the transferee shall execute any and all such documents requested by the Board in connection with the transfer, including without limitation to evidence the transfer and to satisfy any requirements for an exemption for the transfer under applicable federal and state securities laws.

Section 7.2 - Amendment, Suspension or Termination of the Restated Director Option Plan

The Restated Director Option Plan may be wholly or partially amended or otherwise modified, suspended or terminated at any time or from time to time by the Board.  However, without approval of the Company’s stockholders given within 12 months before or after the action by the Board, no action of the Board may, increase any limit imposed in Section 2.1 on the maximum number of shares which may be issued upon exercise of Options (except for anti-dilution adjustments), or modify the Restated Director Option Plan in a manner requiring stockholder approval under Rule 16b-3 or any other applicable rule or law.  Neither the amendment, suspension nor termination of the Restated Director Option Plan shall, without the consent of the holder of an Option, alter or impair any rights or obligations under any Option theretofore granted.  No Option may be granted during any period of suspension nor after termination of the Restated Director Option Plan, and in no event may any Option be granted under this Restated Director Option Plan after May 23, 2010.

10

Section 7.3 - Effect of Restated Director Option Plan Upon Other Options and Compensation Plans

The adoption of this Restated Director Option Plan shall not affect any other compensation or incentive plans in effect for the Company or any Subsidiary.  Nothing in this Restated Director Option Plan shall be construed to limit the right of the Company or any Subsidiary to grant or assume options otherwise than under this Restated Director Option Plan in connection with any proper corporate purpose, including, but not by way of limitation, the grant or assumption of options in connection with the acquisition by purchase, lease, merger, consolidation or otherwise, of the business, stock or assets of any corporation, firm or association.

Section 7.4 - Titles

Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of the Restated Director Option Plan.

Section 7.5 - Conformity to Securities Laws

The Restated Director Option Plan is intended to conform to the extent necessary with all provisions of the Securities Act and the Exchange Act and any and all regulations and rules promulgated by the Securities and Exchange Commission thereunder, including without limitation Rule 16b-3.  Notwithstanding anything herein to the contrary, the Restated Director Option Plan shall be administered, and Options shall be granted and may be exercised, only in such a manner as to conform to such laws, rules and regulations.  To the extent permitted by applicable law, the Restated Director Option Plan and Options granted hereunder shall be deemed amended to the extent necessary to conform to such laws, rules and regulations.

11

I hereby certify that the foregoing Plan, which amends and restates the Stock Option Plan Non-Employee Directors of Southwest Water Company was duly adopted by the Board of Directors of Southwest Water Company on February             , 2000, and was approved by the stockholders of Southwest Water Company on May 23, 2000.

Peter J. Moerbeek, Secretary

12

EX-10.1(C)

Exhibit 10.1(c)

FORM OF

NONQUALIFIED STOCK OPTION AGREEMENT

FOR NON-EMPLOYEE DIRECTORS

THIS AGREEMENT, dated, is made by and between Southwest Water Company, a Delaware corporation hereinafter referred to as the “Company,” and                       , a non-employee director of the Company or Subsidiary of the Company, hereinafter referred to as “Optionee”:

WHEREAS, the Company wishes to afford the Optionee the opportunity to purchase shares of its $.01 par value Common Stock;

WHEREAS, the Company wishes to carry out its Amended and Restated Stock Option Plan for Non-Employee Directors (the “Plan”) (the terms of which are hereby incorporated by reference and made a part of this Agreement); and

WHEREAS, the Plan provides for the grant of the Non-Qualified Stock Option set forth herein to the Optionee as an inducement to enter into or remain in the service of the Company or its Subsidiaries and as an incentive for increased efforts during such service, and has advised the Company thereof and instructed the undersigned officers to issue said Option;

NOW, THEREFORE, in consideration of the mutual covenants herein contained and other good and valuable consideration, receipt of which is hereby acknowledged, the parties hereto do hereby agree as follows:

ARTICLE I.

DEFINITIONS

Whenever the following terms are used in this Agreement, they shall have the meaning specified below unless the context clearly indicates to the contrary.  The masculine pronoun shall include the feminine and neuter, and the singular the plural, where the context so indicates.

Section 1.1Board

“Board” shall mean the Board of Directors of the Company as constituted from time to time.

Section 1.2Code

“Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

Section 1.3Common Stock

“Common Stock” shall mean the common stock of the Company, par value $.01 per share, of the Company.

Section 1.4Company

“Company” shall mean Southwest Water Company, a Delaware corporation, or any successor entity.

Section 1.5Director

“Director” shall mean a person who is a member of the Board as constituted at that time.

Section 1.6Employee

“Employee” shall mean any employee (as defined in accordance with the Regulations and Revenue Rulings then applicable under Section 3401(c) of the Code) of the Company, or of any corporation which is then a Subsidiary or a Parent Corporation, whether such employee is so employed at the time the Plan is adopted or becomes so employed subsequent to the adoption of the Plan.

Section 1.7Exchange Act

“Exchange Act” shall mean the Securities Exchange Act of 1934, as amended.

Section 1.8Fair Market Value

“Fair Market Value” of a share of Common Stock as of a given date shall be (i) the closing price of a share of Common Stock on the principal exchange on which shares of Common Stock are then trading, if any (or as reported on any composite index which includes such principal exchange), on the trading day preceding such date, or if shares were not traded on the trading day preceding such date, then on the next preceding trading day during which a sale occurred, or (ii) if the Common Stock is not traded on an exchange (x) the last sales price of a share of the Common Stock on The Nasdaq Stock Market (if the stock is then traded on The Nasdaq Stock Market) on the trading day preceding such date, or, if shares were not traded on the day preceding such date, then on the next preceding trading day during which a sale occurred; or (y) the mean between the closing representative bid and asked prices for the Common Stock on the trading day next preceding such date as reported by the National Association of Securities Dealers, Inc. through NASDAQ or a successor quotation system or, if shares were not quoted on the day immediately preceding such date, then on the next preceding trading day during which a quote occurred, or (iii) if the Common Stock is not publicly traded on an exchange and prices are not provided through The Nasdaq Stock Market, NASDAQ or a successor quotation system, the mean between the closing bid and asked prices for the Common Stock on the trading day next preceding such date as determined in good faith by the Board; or (iv) if the Common Stock is not publicly traded, the fair market value of the Common Stock established by the Board acting in good faith.

Section 1.9Non-Employee Director

“Non-Employee Director” shall mean any Director who is not at the same time an Employee.

Section 1.10Option

“Option” shall mean a non-qualified stock option to purchase Common Stock of the Company granted under this Agreement and Article 3 of the Plan.

Section 1.11Optionee

“Optionee” shall mean a Non-Employee Director to whom an Option is granted under this Agreement and the Plan.

Section 1.12Parent Corporation

“Parent Corporation” shall have the meaning given in Section 424(e) of the Code.

Section 1.13Plan

“Plan” shall mean the Amended and Restated Stock Option Plan for Non-Employee Directors of Southwest Water Company, as the same may be amended or restated from time to time.

Section 1.14Rule 16b-3

“Rule 16b-3” shall mean that certain Rule 16b-3 under the Exchange Act, as such Rule may be amended from time to time.

Section 1.15Secretary

“Secretary” shall mean the Secretary of the Company.

Section 1.16Securities Act

“Securities Act” shall mean the Securities Act of 1933, as amended.

Section 1.17Subsidiary

“Subsidiary” shall mean any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

Section 1.18Termination as a Non-Employee Director

“Termination as a Non-Employee Director” shall mean the time when the Optionee who is a Non-Employee Director ceases to be a member of the Board by reason of such Optionee’s death or disability (within the meaning of Section 22(e)(3) of the Code), retirement, resignation or for any other reason.

ARTICLE II.

GRANT OF OPTION

Section 2.1Grant of Option

In consideration of the Optionee’s agreement to serve as a Non-Employee Director of the Company or its Subsidiaries until the next annual meeting of stockholders of the Company and for other good and valuable consideration, effective as of «Award_Date», the Company irrevocably grants to the Optionee the option to purchase any part or all of an aggregate of «Shares» shares of its $.01 par value Common Stock upon the terms and conditions set forth in this Agreement.

Section 2.2Purchase Price

The price per share of the Common Stock subject to each Option shall be «Exercise_Price_» per share (which is the Fair Market Value of a share of Common Stock on the date of the granting of this Option) without commission or other charge.

Section 2.3Consideration to Company

In consideration of the granting of this Option by the Company, the Optionee agrees to render faithful and efficient services to the Company or a Subsidiary, with such duties and responsibilities as the Company shall from time to time prescribe, until the next annual meeting of stockholders of the Company.  Nothing in the Plan or this Agreement shall confer upon any Optionee any right to continue as a director of the Company, or shall interfere with or restrict in any way the rights of the Company and any Subsidiary, which are hereby expressly reserved, to discharge the Optionee at any time for any reason whatsoever, with or without good cause.

Section 2.4Adjustments in Option

In the event that the outstanding shares of the Common Stock subject to the Option are changed into or exchanged for a different number or kind of shares of the Company or other securities of the Company by reason of merger (including reincorporation by means of merger), consolidation, recapitalization, reclassification, stock split-up, stock dividend or combination of shares (a “Recapitalization”), the Board shall make an appropriate and equitable adjustment in the number and kind of shares as to which the Option, or portions thereof then unexercised, shall be exercisable, to the end that after such event the Optionee’s proportionate interest shall be maintained as before the occurrence of such event.  Such adjustment in the Option may include any necessary corresponding

adjustment in the Option price per share, but shall be made without change in the total price applicable to the Option or the unexercised portion of the Option (except for any change in the aggregate price resulting from rounding-off of share quantities or prices).  Any such adjustment made by the Board shall be final and binding upon the Optionee, the Company and all other interested persons.

Section 2.5Merger, Consolidation, Exchange, Acquisition, Liquidation or Dissolution

The Board may provide by the terms of the Option that the Option cannot be exercised after the merger or consolidation of the Company into another corporation, the exchange of all or substantially all of the assets of the Company for the securities of another corporation, the acquisition by another corporation of 80% or more of the Company’s then outstanding voting stock or the liquidation or dissolution of the Company; or the Board may, in its absolute discretion and on such terms and conditions as it deems appropriate, also provide that the Option shall be assumed or an equivalent option substituted by any successor corporation of the Company, or the Board may, in its absolute discretion and upon such terms and conditions as it deems appropriate, provided by resolution adopted prior to the occurrence of such merger, consolidation, exchange, acquisition, liquidation or dissolution, that, for some period of time prior to such event, that such Option shall be exercisable as to all shares covered thereby, notwithstanding anything to the contrary in Sections 3.1(a) or 3.1(b) below.  Any determinations made by the Board pursuant to this Section shall be applied uniformly to all Options outstanding on the date of such determination.

ARTICLE III.

PERIOD OF EXERCISABILITY

Section 3.1Commencement of Exercisability

(a)The Option may not be exercised in whole or in part during the first year after the date of grant of the Option.

(b)Subject to the provisions of Sections 3.1(a) and 3.1(c), the Option shall become exercisable in two (2) cumulative installments as follows:

(i)The first installment shall consist of fifty percent (50%) of the shares covered by the Option and shall become exercisable on the first anniversary of the date the Option is granted.

(ii)The second installment shall consist of fifty percent (50%) of the shares covered by the Option and shall become exercisable on the second anniversary of the date the Option is granted.

(c)Subject to Section 3.1(a), the portion, if any, of an Option which is unexercisable on the date of Termination as a Non-Employee Director shall become immediately exercisable.

Section 3.2Duration of Exercisability

The installments provided for in Section 3.1 are cumulative.  Each such installment which becomes exercisable pursuant to Section 3.1 shall remain exercisable until it becomes unexercisable under Section 3.3.

Section 3.3Expiration of Option

The Option may not be exercised to any extent by anyone after the first to occur of the following events:

(a)The expiration of a period of seven years and one day from the date the Option was granted; or

(b)The expiration of one year from the date of the Optionee’s Termination as a Non-Employee Director for any reason, unless the Optionee dies within said one year period; or

(c)The expiration of one year from the date of the Optionee’s death.

ARTICLE IV.

EXERCISE OF OPTION

Section 4.1Person Eligible to Exercise

During the lifetime of the Optionee, only the Optionee may exercise the Option or any portion thereof; provided, however, that nothing in this Section 4.1 shall prevent the exercise of the Option by a person to whom the Option was lawfully transferred, in whole or in part, pursuant to a qualified domestic relations order (as defined in the Code).  After the death of the Optionee, any exercisable portion of the Option may, prior to the time when the Option becomes unexercisable under Section 3.3, be exercised by his personal representative or by any person empowered to do so under the Optionee’s will or under the then applicable laws of descent and distribution or if the Optionee has made a permitted transfer pursuant to Section 5.2(ii) to a family member the Option may be exercised by such family member.

Section 4.2Partial Exercise

Any exercisable portion of the Option or the entire Option, if then wholly exercisable, may be exercised in whole or in part at any time and from time to time prior to the time when the Option or portion thereof becomes unexercisable under Section 3.3; provided, however, that each partial exercise shall be for not less than one hundred (100) shares and shall be for whole shares only.

Section 4.3Manner of Exercise

The Option, or any exercisable portion thereof, shall be exercised solely by delivery to the Secretary or his office of all of the following prior to the time when the Option or such portion becomes unexercisable under Section 3.3:

(a)Notice in writing signed by the Optionee or the other person then entitled to exercise the Option or portion, stating that the Option or portion is thereby exercised, such notice complying with all applicable rules established by the Board;

(b)The payment to the Company of the aggregate Option exercise price for the shares with respect to which such Option or portion is exercised in:

(i)Cash;

(ii)With the consent of the Board, (A) shares of the Company’s Common Stock owned by the Optionee duly endorsed for transfer to the Company or (B) shares of the Company’s Common Stock issuable to the Optionee upon exercise of the Option, with a Fair Market Value on the date of Option exercise equal to the aggregate purchase price of the shares with respect to which such Option or portion is exercised;

(iii)With the consent of the Board, a full recourse promissory note bearing interest (at no less than such rate as shall then preclude the imputation of interest under the Code or successor provision) and payable upon such terms as may be prescribed by the Board.  The Board may also prescribe the form of such note and the security to be given for such note.  The Option may not be exercised, however, by delivery of a promissory note or by a loan from the Company when or where such loan or other extension of credit is prohibited by law; or

(iv)With the consent of the Board, any combination of the consideration provided in the foregoing subparagraphs (i), (ii) and (iii);

(c)Full payment to the Company (or other employer corporation) of all amounts which, under federal, state or local law, it is required to withhold in connection with the exercise of the Option or a portion thereof; all or any part of such payment may be made, with the consent of the Board, (i) with shares of the Company’s Common Stock owned by the Optionee duly endorsed for transfer, or (ii) with shares of the Company’s Common Stock issuable to the Optionee upon exercise of the Option, in each case, having a Fair Market Value at the date of Option exercise equal to the sums required to be withheld;

(d)Such representations and documents as the Board, in its absolute discretion, deems necessary or advisable to effect compliance with all applicable provisions of the Securities Act and any other Federal or state securities laws or regulations.  The Board may, in its absolute discretion, also take whatever additional actions it deems appropriate to effect such compliance including, without limitation, placing legends on share certificates and issuing stop-transfer orders to transfer agents and registrars; and

(e)In the event the Option or portion thereof shall be exercised pursuant to Section 4.1 by any person or persons other than the Optionee, appropriate proof of the right of such person or persons to exercise the Option.

(f)Notwithstanding anything herein to the contrary, the Optionee may satisfy the requirements of subsections (b) and (c) of this Section 4.3 concerning payment for the shares and all applicable withholding taxes, with the consent of the Board, through the delivery to the Secretary or his office of (i) an irrevocable written exercise notice containing instructions to the Company to deliver to Optionee’s broker the certificate(s) representing the shares with respect to which the Option or portion is thereby exercised and (ii) a copy of Optionee’s irrevocable written instructions to such broker to deliver to the Company, within five business days from the date of the Company’s receipt of such exercise notice, full payment (in cash or by check) for the shares with respect to which such Option or portion is thereby exercised and all amounts which the Company is required to withhold under federal, state or local law in connection with the exercise of the Option or portion thereof.  Provided the Optionee complies with clauses (i) and (ii) above and the Company receives such full payment the Optionee shall be deemed to have such exercised such Option on the date of the Company’s receipt of the deliveries specified in clauses (i) and (ii) above.  Notwithstanding anything to the contrary in this Section 4.3, the Board shall not take any discretionary action which will result in the failure of the Plan to satisfy any exemptive condition imposed by Rule 16b-3 of the code with respect to the effected Option.

Section 4.4Conditions to Issuance of Stock Certificates

The shares of stock issuable and deliverable upon the exercise of the Option, or any portion thereof, may be either previously authorized but unissued shares or issued shares which have then been reacquired by the Company.  Such shares shall be fully paid and nonassessable.  The Company shall not be required to issue or deliver any certificate or certificates for shares of stock purchased upon the exercise of the Option or portion thereof prior to fulfillment of all of the following conditions:

(a)The admission of such shares to listing on all stock exchanges on which such class of stock is then listed;

(b)The completion of any registration or other qualification of such shares under any state or federal law or under rulings or regulations of the Securities and Exchange Commission or of any other governmental regulatory body, which the Board shall, in its absolute discretion, deem necessary or advisable;

(c)The obtaining of any approval or other clearance from any state or federal governmental agency which the Board shall, in its absolute discretion, determine to be necessary or advisable;

(d)The receipt by the Company of full payment for such shares, including payment of all amounts which, under federal, state or local tax law, it is required to withhold upon exercise of the Option; and

(e)The lapse of such reasonable period of time following the exercise of the Option as the Board may establish from time to time for reasons of administrative convenience.

Section 4.5Rights as Stockholder

The holder of the Option shall not be, nor have any of the rights or privileges of, a stockholder of the Company in respect of any shares purchasable upon the exercise of any part of the Option unless and until certificates representing such shares shall have been issued by the Company to such holder.

ARTICLE V.

OTHER PROVISIONS

Section 5.1Administration

With respect to this Option, the full Board, acting by a majority of its members in office, shall have the power to interpret the Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Plan as are consistent therewith and to interpret or revoke any such rules.  All actions taken and all interpretations and determinations made by the Board in good faith shall be final and binding upon the Optionee, the Company and all other interested persons.  No member of the Board shall be personally liable for any action, determination or interpretation made in good faith with respect to the Plan or the Option.

Section 5.2Option Not Transferable

Neither the Option nor any interest or right therein or part thereof shall be liable for the debts, contracts or engagements of the Optionee or his successors in interest or shall be subject to disposition by transfer, alienation, anticipation, pledge, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any attempted disposition thereof shall be null and void and of no effect; provided, however, that nothing in this Section 5.2 shall prevent (i) transfers by will or by the applicable laws of descent and distribution, or, to the extent not prohibited by the Code, pursuant to a qualified domestic relations order (as defined in the Code) or (ii) with the prior written consent of the Board, by gift or as a contribution, to a family member of the Optionee, (as defined under the instructions to use of Form S-8), provided, that an Option that has been so transferred shall continue to be subject to all of the terms and conditions as applicable to the original Optionee, and the transferee shall execute any and all such documents requested by the Board in connection with the transfer, including without limitation to evidence the transfer and to satisfy any requirements for an exemption for the transfer under applicable federal and state securities laws.

Section 5.3Shares to Be Reserved

The Company shall at all times during the term of the Option reserve and keep available such number of shares of stock as will be sufficient to satisfy the requirements of this Agreement.

Section 5.4Notices

Any notice to be given under the terms of this Agreement to the Company shall be addressed to the Company in care of its Secretary, and any notice to be given to the Optionee shall be addressed to him at the address given beneath his signature hereto.  By a notice given pursuant to this Section 5.4, either party may hereafter designate a different address for notices to be given to him.  Any notice which is required to be given to the Optionee shall, if the Optionee is then deceased, be given to the Optionee’s personal representative if such representative has previously informed the Company of his status and address by written notice under this Section 5.4.  Any notice shall be deemed duly given when enclosed in a properly sealed envelope or wrapper addressed as aforesaid, deposited (with postage prepaid) in a post office or branch post office regularly maintained by the United States Postal Service.

Section 5.5Titles

Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of this Agreement.

Section 5.6Construction

This Agreement shall be administered, interpreted and enforced under the laws of the State of California.

Section 5.7Conformity to Securities Laws

The Optionee acknowledges that the Plan and this Option grant are intended to conform to the extent necessary with all provisions of the Securities Act and the Exchange Act and any and all regulations and rules promulgated by the Securities and Exchange Commission thereunder, including without limitation Rule 16b-3.  Notwithstanding anything herein to the contrary, the Plan shall be administered, and the Option is granted and may be exercised, only in such a manner as to conform to such laws, rules and regulations.  To the extent permitted by applicable law, the Plan and this Agreement shall be deemed amended to the extent necessary to conform to such laws, rules and regulations.

IN WITNESS WHEREOF, this Agreement has been executed and delivered by the parties hereto.

SOUTHWEST WATER COMPANY,
a Delaware corporation
By:
	Anton C. Garnier, President & CEO
By:
	Peter J. Moerbeek, EVP & Secretary

«Name_», Director Optionee

Optionee’s Taxpayer

Identification Number:

Shares Awarded:

Award Date:

Exercise Price:

EX-10.1(C)(1)

Exhibit 10.1(c)(1)

FORM OF

NONQUALIFIED STOCK OPTION AGREEMENT

FOR NON-EMPLOYEE DIRECTORS

THIS AGREEMENT, dated, is made by and between Southwest Water Company, a Delaware corporation hereinafter referred to as the “Company,” and                      , a non-employee director of the Company or Subsidiary of the Company, hereinafter referred to as “Optionee”:

WHEREAS, the Company wishes to afford the Optionee the opportunity to purchase shares of its $.01 par value Common Stock;

WHEREAS, the Company wishes to carry out its Amended and Restated Stock Option Plan for Non-Employee Directors (the “Plan”) (the terms of which are hereby incorporated by reference and made a part of this Agreement); and

WHEREAS, the Plan provides for the grant of the Non-Qualified Stock Option set forth herein to the Optionee as an inducement to enter into or remain in the service of the Company or its Subsidiaries and as an incentive for increased efforts during such service, and has advised the Company thereof and instructed the undersigned officers to issue said Option;

NOW, THEREFORE, in consideration of the mutual covenants herein contained and other good and valuable consideration, receipt of which is hereby acknowledged, the parties hereto do hereby agree as follows:

ARTICLE I.
DEFINITIONS

Whenever the following terms are used in this Agreement, they shall have the meaning specified below unless the context clearly indicates to the contrary.  The masculine pronoun shall include the feminine and neuter, and the singular the plural, where the context so indicates.

Section 1.1Board

“Board” shall mean the Board of Directors of the Company as constituted from time to time.

Section 1.2Code

“Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

Section 1.3Common Stock

“Common Stock” shall mean the common stock of the Company, par value $.01 per share, of the Company.

Section 1.4Company

“Company” shall mean Southwest Water Company, a Delaware corporation, or any successor entity.

Section 1.5Director

“Director” shall mean a person who is a member of the Board as constituted at that time.

Section 1.6Employee

“Employee” shall mean any employee (as defined in accordance with the Regulations and Revenue Rulings then applicable under Section 3401(c) of the Code) of the Company, or of any corporation which is then a Subsidiary or a Parent Corporation, whether such employee is so employed at the time the Plan is adopted or becomes so employed subsequent to the adoption of the Plan.

Section 1.7Exchange Act

“Exchange Act” shall mean the Securities Exchange Act of 1934, as amended.

Section 1.8Fair Market Value

“Fair Market Value” of a share of Common Stock as of a given date shall be (i) the closing price of a share of Common Stock on the principal exchange on which shares of Common Stock are then trading, if any (or as reported on any composite index which includes such principal exchange), on the trading day preceding such date, or if shares were not traded on the trading day preceding such date, then on the next preceding trading day during which a sale occurred, or (ii) if the Common Stock is not traded on an exchange (x) the last sales price of a share of the Common Stock on The Nasdaq Stock Market (if the stock is then traded on The Nasdaq Stock Market) on the trading day preceding such date, or, if shares were not traded on the day preceding such date, then on the next preceding trading day during which a sale occurred; or (y) the mean between the closing representative bid and asked prices for the Common Stock on the trading day next preceding such date as reported by the National Association of Securities Dealers, Inc. through NASDAQ or a successor quotation system or, if shares were not quoted on the day immediately preceding such date, then on the next preceding trading day during which a quote occurred, or (iii) if the Common Stock is not publicly traded on an exchange and prices are not provided through The Nasdaq Stock Market, NASDAQ or a successor quotation system, the mean between the closing bid and asked prices for the Common Stock on the trading day next preceding such date as determined in good faith by the Board; or (iv) if the Common Stock is not publicly traded, the fair market value of the Common Stock established by the Board acting in good faith.

Section 1.9Non-Employee Director

“Non-Employee Director” shall mean any Director who is not at the same time an Employee.

Section 1.10Option

“Option” shall mean a non-qualified stock option to purchase Common Stock of the Company granted under this Agreement and Article 3 of the Plan.

Section 1.11Optionee

“Optionee” shall mean a Non-Employee Director to whom an Option is granted under this Agreement and the Plan.

Section 1.12Parent Corporation

“Parent Corporation” shall have the meaning given in Section 424(e) of the Code.

Section 1.13Plan

“Plan” shall mean the Amended and Restated Stock Option Plan for Non-Employee Directors of Southwest Water Company, as the same may be amended or restated from time to time.

Section 1.14Rule 16b-3

“Rule 16b-3” shall mean that certain Rule 16b-3 under the Exchange Act, as such Rule may be amended from time to time.

Section 1.15Secretary

“Secretary” shall mean the Secretary of the Company.

Section 1.16Securities Act

“Securities Act” shall mean the Securities Act of 1933, as amended.

Section 1.17Subsidiary

“Subsidiary” shall mean any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

Section 1.18Termination as a Non-Employee Director

“Termination as a Non-Employee Director” shall mean the time when the Optionee who is a Non-Employee Director ceases to be a member of the Board by reason of such Optionee’s death or disability (within the meaning of Section 22(e)(3) of the Code), retirement, resignation or for any other reason.

ARTICLE II.
GRANT OF OPTION

Section 2.1Grant of Option

In consideration of the Optionee’s agreement to serve as a Non-Employee Director of the Company or its Subsidiaries until the next annual meeting of stockholders of the Company and for other good and valuable consideration, effective as of «Award_Date», the Company irrevocably grants to the Optionee the option to purchase any part or all of an aggregate of «Shares» shares of its $.01 par value Common Stock upon the terms and conditions set forth in this Agreement.

Section 2.2Purchase Price

The price per share of the Common Stock subject to each Option shall be «Exercise_Price_» per share (which is the Fair Market Value of a share of Common Stock on the date of the granting of this Option) without commission or other charge.

Section 2.3Consideration to Company

In consideration of the granting of this Option by the Company, the Optionee agrees to render faithful and efficient services to the Company or a Subsidiary, with such duties and responsibilities as the Company shall from time to time prescribe, until the next annual meeting of stockholders of the Company.  Nothing in the Plan or this Agreement shall confer upon any Optionee any right to continue as a director of the Company, or shall interfere with or restrict in any way the rights of the Company and any Subsidiary, which are hereby expressly reserved, to discharge the Optionee at any time for any reason whatsoever, with or without good cause.

Section 2.4Adjustments in Option

In the event that the outstanding shares of the Common Stock subject to the Option are changed into or exchanged for a different number or kind of shares of the Company or other securities of the Company by reason of merger (including reincorporation by means of merger), consolidation, recapitalization, reclassification, stock split-up, stock dividend or combination of shares (a “Recapitalization”), the Board shall make an appropriate and equitable adjustment in the number and kind of shares as to which the Option, or portions thereof then unexercised, shall be exercisable, to the end that after such event the Optionee’s proportionate interest shall be maintained as before the occurrence of such event.  Such adjustment in the Option may include any necessary corresponding

adjustment in the Option price per share, but shall be made without change in the total price applicable to the Option or the unexercised portion of the Option (except for any change in the aggregate price resulting from rounding-off of share quantities or prices).  Any such adjustment made by the Board shall be final and binding upon the Optionee, the Company and all other interested persons.

Section 2.5Merger, Consolidation, Exchange, Acquisition, Liquidation or Dissolution

The Board may provide by the terms of the Option that the Option cannot be exercised after the merger or consolidation of the Company into another corporation, the exchange of all or substantially all of the assets of the Company for the securities of another corporation, the acquisition by another corporation of 80% or more of the Company’s then outstanding voting stock or the liquidation or dissolution of the Company; or the Board may, in its absolute discretion and on such terms and conditions as it deems appropriate, also provide that the Option shall be assumed or an equivalent option substituted by any successor corporation of the Company, or the Board may, in its absolute discretion and upon such terms and conditions as it deems appropriate, provided by resolution adopted prior to the occurrence of such merger, consolidation, exchange, acquisition, liquidation or dissolution, that, for some period of time prior to such event, that such Option shall be exercisable as to all shares covered thereby, notwithstanding anything to the contrary in Sections 3.1(a) or 3.1(b) below.  Any determinations made by the Board pursuant to this Section shall be applied uniformly to all Options outstanding on the date of such determination.

ARTICLE III.
PERIOD OF EXERCISABILITY

Section 3.1Commencement of Exercisability

(a)The Option may not be exercised in whole or in part during the first year after the date of grant of the Option.

(b)Subject to the provisions of Sections 3.1(a) and 3.1(c), the Option shall become exercisable in two (2) cumulative installments as follows:

(i)The first installment shall consist of fifty percent (50%) of the shares covered by the Option and shall become exercisable on the first anniversary of the date the Option is granted.

(ii)The second installment shall consist of fifty percent (50%) of the shares covered by the Option and shall become exercisable on the second anniversary of the date the Option is granted.

(c)Subject to Section 3.1(a), the portion, if any, of an Option which is unexercisable on the date of Termination as a Non-Employee Director shall become immediately exercisable.

Section 3.2Duration of Exercisability

The installments provided for in Section 3.1 are cumulative.  Each such installment which becomes exercisable pursuant to Section 3.1 shall remain exercisable until it becomes unexercisable under Section 3.3.

Section 3.3Expiration of Option

The Option may not be exercised to any extent by anyone after the first to occur of the following events:

(a)The expiration of a period of seven years and one day from the date the Option was granted; or

(b)The expiration of one year from the date of the Optionee’s Termination as a Non-Employee Director for any reason, unless the Optionee dies within said one year period; or

(c)The expiration of one year from the date of the Optionee’s death.

ARTICLE IV.
EXERCISE OF OPTION

Section 4.1Person Eligible to Exercise

During the lifetime of the Optionee, only the Optionee may exercise the Option or any portion thereof; provided, however, that nothing in this Section 4.1 shall prevent the exercise of the Option by a person to whom the Option was lawfully transferred, in whole or in part, pursuant to a qualified domestic relations order (as defined in the Code).  After the death of the Optionee, any exercisable portion of the Option may, prior to the time when the Option becomes unexercisable under Section 3.3, be exercised by his personal representative or by any person empowered to do so under the Optionee’s will or under the then applicable laws of descent and distribution or if the Optionee has made a permitted transfer pursuant to Section 5.2(ii) to a family member the Option may be exercised by such family member.

Section 4.2Partial Exercise

Any exercisable portion of the Option or the entire Option, if then wholly exercisable, may be exercised in whole or in part at any time and from time to time prior to the time when the Option or portion thereof becomes unexercisable under Section 3.3; provided, however, that each partial exercise shall be for not less than one hundred (100) shares and shall be for whole shares only.

Section 4.3Manner of Exercise

The Option, or any exercisable portion thereof, shall be exercised solely by delivery to the Secretary or his office of all of the following prior to the time when the Option or such portion becomes unexercisable under Section 3.3:

(a)Notice in writing signed by the Optionee or the other person then entitled to exercise the Option or portion, stating that the Option or portion is thereby exercised, such notice complying with all applicable rules established by the Board;

(b)The payment to the Company of the aggregate Option exercise price for the shares with respect to which such Option or portion is exercised in:

(i)Cash;

(ii)With the consent of the Board, (A) shares of the Company’s Common Stock owned by the Optionee duly endorsed for transfer to the Company or (B) shares of the Company’s Common Stock issuable to the Optionee upon exercise of the Option, with a Fair Market Value on the date of Option exercise equal to the aggregate purchase price of the shares with respect to which such Option or portion is exercised;

(iii)With the consent of the Board, a full recourse promissory note bearing interest (at no less than such rate as shall then preclude the imputation of interest under the Code or successor provision) and payable upon such terms as may be prescribed by the Board.  The Board may also prescribe the form of such note and the security to be given for such note.  The Option may not be exercised, however, by delivery of a promissory note or by a loan from the Company when or where such loan or other extension of credit is prohibited by law; or

(iv)With the consent of the Board, any combination of the consideration provided in the foregoing subparagraphs (i), (ii) and (iii);

(c)Full payment to the Company (or other employer corporation) of all amounts which, under federal, state or local law, it is required to withhold in connection with the exercise of the Option or a portion thereof; all or any part of such payment may be made, with the consent of the Board, (i) with shares of the Company’s Common Stock owned by the Optionee duly endorsed for transfer, or (ii) with shares of the Company’s Common Stock issuable to the Optionee upon exercise of the Option, in each case, having a Fair Market Value at the date of Option exercise equal to the sums required to be withheld;

(d)Such representations and documents as the Board, in its absolute discretion, deems necessary or advisable to effect compliance with all applicable provisions of the Securities Act and any other Federal or state securities laws or regulations.  The Board may, in its absolute discretion, also take whatever additional actions it deems appropriate to effect such compliance including, without limitation, placing legends on share certificates and issuing stop-transfer orders to transfer agents and registrars; and

(e)In the event the Option or portion thereof shall be exercised pursuant to Section 4.1 by any person or persons other than the Optionee, appropriate proof of the right of such person or persons to exercise the Option.

(f)Notwithstanding anything herein to the contrary, the Optionee may satisfy the requirements of subsections (b) and (c) of this Section 4.3 concerning payment for the shares and all applicable withholding taxes, with the consent of the Board, through the delivery to the Secretary or his office of (i) an irrevocable written exercise notice containing instructions to the Company to deliver to Optionee’s broker the certificate(s) representing the shares with respect to which the Option or portion is thereby exercised and (ii) a copy of Optionee’s irrevocable written instructions to such broker to deliver to the Company, within five business days from the date of the Company’s receipt of such exercise notice, full payment (in cash or by check) for the shares with respect to which such Option or portion is thereby exercised and all amounts which the Company is required to withhold under federal, state or local law in connection with the exercise of the Option or portion thereof.  Provided the Optionee complies with clauses (i) and (ii) above and the Company receives such full payment the Optionee shall be deemed to have such exercised such Option on the date of the Company’s receipt of the deliveries specified in clauses (i) and (ii) above.  Notwithstanding anything to the contrary in this Section 4.3, the Board shall not take any discretionary action which will result in the failure of the Plan to satisfy any exemptive condition imposed by Rule 16b-3 of the code with respect to the effected Option.

Section 4.4Conditions to Issuance of Stock Certificates

The shares of stock issuable and deliverable upon the exercise of the Option, or any portion thereof, may be either previously authorized but unissued shares or issued shares which have then been reacquired by the Company.  Such shares shall be fully paid and nonassessable.  The Company shall not be required to issue or deliver any certificate or certificates for shares of stock purchased upon the exercise of the Option or portion thereof prior to fulfillment of all of the following conditions:

(a)The admission of such shares to listing on all stock exchanges on which such class of stock is then listed;

(b)The completion of any registration or other qualification of such shares under any state or federal law or under rulings or regulations of the Securities and Exchange Commission or of any other governmental regulatory body, which the Board shall, in its absolute discretion, deem necessary or advisable;

(c)The obtaining of any approval or other clearance from any state or federal governmental agency which the Board shall, in its absolute discretion, determine to be necessary or advisable;

(d)The receipt by the Company of full payment for such shares, including payment of all amounts which, under federal, state or local tax law, it is required to withhold upon exercise of the Option; and

(e)The lapse of such reasonable period of time following the exercise of the Option as the Board may establish from time to time for reasons of administrative convenience.

Section 4.5Rights as Stockholder

The holder of the Option shall not be, nor have any of the rights or privileges of, a stockholder of the Company in respect of any shares purchasable upon the exercise of any part of the Option unless and until certificates representing such shares shall have been issued by the Company to such holder.

ARTICLE V.
OTHER PROVISIONS

Section 5.1Administration

With respect to this Option, the full Board, acting by a majority of its members in office, shall have the power to interpret the Plan and this Agreement and to adopt such rules for the administration, interpretation and application of the Plan as are consistent therewith and to interpret or revoke any such rules.  All actions taken and all interpretations and determinations made by the Board in good faith shall be final and binding upon the Optionee, the Company and all other interested persons.  No member of the Board shall be personally liable for any action, determination or interpretation made in good faith with respect to the Plan or the Option.

Section 5.2Option Not Transferable

Neither the Option nor any interest or right therein or part thereof shall be liable for the debts, contracts or engagements of the Optionee or his successors in interest or shall be subject to disposition by transfer, alienation, anticipation, pledge, encumbrance, assignment or any other means whether such disposition be voluntary or involuntary or by operation of law by judgment, levy, attachment, garnishment or any other legal or equitable proceedings (including bankruptcy), and any attempted disposition thereof shall be null and void and of no effect; provided, however, that nothing in this Section 5.2 shall prevent (i) transfers by will or by the applicable laws of descent and distribution, or, to the extent not prohibited by the Code, pursuant to a qualified domestic relations order (as defined in the Code) or (ii) with the prior written consent of the Board, by gift or as a contribution, to a family member of the Optionee, (as defined under the instructions to use of Form S-8), provided, that an Option that has been so transferred shall continue to be subject to all of the terms and conditions as applicable to the original Optionee, and the transferee shall execute any and all such documents requested by the Board in connection with the transfer, including without limitation to evidence the transfer and to satisfy any requirements for an exemption for the transfer under applicable federal and state securities laws.

Section 5.3Shares to Be Reserved

The Company shall at all times during the term of the Option reserve and keep available such number of shares of stock as will be sufficient to satisfy the requirements of this Agreement.

Section 5.4Notices

Any notice to be given under the terms of this Agreement to the Company shall be addressed to the Company in care of its Secretary, and any notice to be given to the Optionee shall be addressed to him at the address given beneath his signature hereto.  By a notice given pursuant to this Section 5.4, either party may hereafter designate a different address for notices to be given to him.  Any notice which is required to be given to the Optionee shall, if the Optionee is then deceased, be given to the Optionee’s personal representative if such representative has previously informed the Company of his status and address by written notice under this Section 5.4.  Any notice shall be deemed duly given when enclosed in a properly sealed envelope or wrapper addressed as aforesaid, deposited (with postage prepaid) in a post office or branch post office regularly maintained by the United States Postal Service.

Section 5.5Titles

Titles are provided herein for convenience only and are not to serve as a basis for interpretation or construction of this Agreement.

Section 5.6Construction

This Agreement shall be administered, interpreted and enforced under the laws of the State of California.

Section 5.7Conformity to Securities Laws

The Optionee acknowledges that the Plan and this Option grant are intended to conform to the extent necessary with all provisions of the Securities Act and the Exchange Act and any and all regulations and rules promulgated by the Securities and Exchange Commission thereunder, including without limitation Rule 16b-3.  Notwithstanding anything herein to the contrary, the Plan shall be administered, and the Option is granted and may be exercised, only in such a manner as to conform to such laws, rules and regulations.  To the extent permitted by applicable law, the Plan and this Agreement shall be deemed amended to the extent necessary to conform to such laws, rules and regulations.

IN WITNESS WHEREOF, this Agreement has been executed and delivered by the parties hereto.

SOUTHWEST WATER COMPANY,
a Delaware corporation
By:
	Anton C. Garnier, President & CEO
By:
	Peter J. Moerbeek, EVP & Secretary

«Name_», Director Optionee

Optionee’s Taxpayer

Identification Number:

Shares Awarded:

Award Date:

Exercise Price:

EX-10.7

Exhibit 10.7

CREDIT AGREEMENT

between

SOUTHWEST WATER COMPANY

and

BANK OF AMERICA, N.A.

October 6, 2003

TABLE OF CONTENTS

ARTICLE I DEFINITIONS
	SECTION 1.01. Defined Terms.
	SECTION 1.02. Other Definitional Provisions.
ARTICLE II THE CREDIT
	SECTION 2.01. The Revolving Loans.
		(a)	The Revolving Commitment.
		(b)	Making the Revolving Loans.
		(c)	Reduction of the Revolving Commitment.
		(d)	Revolving Note.
		(e)	Standby Letters of Credit.
	SECTION 2.02. Mandatory Repayment.
	SECTION 2.03. Interest Computation and Payment; Fee Computation.
	SECTION 2.04. Unused commitment fee.
	SECTION 2.05. Annual Credit Facility Fee.
ARTICLE III GENERAL PROVISIONS CONCERNING THE LOANS
	SECTION 3.01. Use of Proceeds.
	SECTION 3.02. Payment on Non-Business Days.
	SECTION 3.03. Reduced Return.
	SECTION 3.04. Indemnities.
	SECTION 3.05. Funding Sources.
ARTICLE IV CONDITIONS OF LENDING
	SECTION 4.01. Conditions Precedent to Initial Revolving Loan.
	SECTION 4.02. Conditions Precedent to Each Revolving Loan.
ARTICLE V REPRESENTATIONS AND WARRANTIES
	SECTION 5.01. Representations and Warranties.
		(a)	Organization.
		(b)	Authorization; No Conflict.
		(c)	Governmental Consents.
		(d)	Validity.
		(e)	Financial Condition.
		(f)	Litigation.
		(g)	Employee Benefit Plans.
		(h)	Disclosure.
		(i)	Environmental Matters.
		(j)	Employee Matters.
		(k)	Solvency.
		(l)	Title to Properties.
		(m)	Tax Returns.
		(n)	Compliance with Other Agreements and Applicable Laws.
		(o)	No Default.
		(p)	Regulation U; Investment Company Act.
		(q)	Intangible Assets.
ARTICLE VI COVENANTS
	SECTION 6.01. Affirmative Covenants.
		(a)	Financial Information.

i

		(b)	Notices and Information.
		(c)	Corporate Existence, Etc.
		(d)	Payment of Taxes and Claims.
		(e)	Maintenance of Properties; Insurance.
		(f)	Inspection.
		(g)	Compliance with Laws Etc.
		(h)	Hazardous Waste Studies.
	SECTION 6.02. Negative Covenants.
		(a)	Consolidated Tangible Net Worth.
		(b)	Consolidated Net Profit.
		(c)	EBITDA Coverage Ratio.
		(d)	Liens Etc.
		(e)	Debt.
		(f)	Consolidation, Merger or Dissolution.
		(g)	Loans, Investments, Acquisitions, Secondary Liabilities.
		(h)	Asset Sales.
		(i)	Hostile Tender Offers.
		(j)	Distributions.
		(k)	Transactions with Affiliates.
		(l)	Books and Records.
		(m)	Restructure.
ARTICLE VII EVENTS OF DEFAULT
	SECTION 7.01. Events of Default.
ARTICLE VIII MISCELLANEOUS
	SECTION 8.01. Amendments, Etc.
	SECTION 8.02. Notices, Etc.
	SECTION 8.03. Right of Setoff:  Security Interest in Deposit Accounts.
	SECTION 8.04. No Waiver; Remedies.
	SECTION 8.05. Costs and Expenses.
	SECTION 8.06. Participations.
	SECTION 8.07. Effectiveness: Binding Effect.
	SECTION 8.08. Governing Law.
	SECTION 8.09. Dispute Resolution.
	SECTION 8.10. Waiver of Notices.
	SECTION 8.11. Entire Agreement.
	SECTION 8.12. Severability of Provisions.
	SECTION 8.13. Execution in Counterparts.
	SECTION 8.14. Further Assurances.

ii

Schedules

Exhibits

A - Form of Note

iii

CREDIT AGREEMENT

This Credit Agreement (“Agreement”) dated as of October 6, 2003 is entered into between SOUTHWEST WATER COMPANY, a Delaware corporation (the “Borrower”) and BANK OF AMERICA, N.A. (the “Bank”).

RECITALS

A.WHEREAS, Borrower and Bank have previously entered into that certain Credit Agreement dated as of July 30, 1999, as amended by that certain First Amendment to Credit Agreement dated as of June 30, 2000, that certain Second Amendment to Credit Agreement dated as of September 29, 2000, that certain Third Amendment to Credit Agreement dated as of March 9, 2001, that certain Fourth Amendment to Credit Agreement dated as of July 13, 2001, that certain Fifth Amendment to Credit Agreement dated as of October 22, 2001, that certain Sixth Amendment to Credit Agreement dated as of November 9, 2001, and that certain Seventh Amendment to Credit Agreement dated as of November 1, 2002, and that certain Eighth Amendment to Credit Agreement dated as of March 14, 2003 (collectively “Credit Agreement”);

B.WHEREAS, Bank and Borrower wish to amend and completely restate the Credit Agreement under the terms and conditions set forth in this Agreement.

NOW THEREFORE, in consideration of the premises and of the mutual covenants and agreements contained herein, the parties hereto agree as follows:

ARTICLE I
DEFINITIONS

SECTION 1.01.  Defined Terms.  As used in this Agreement, the following terms have the following meanings:

“Acquisition”: Any transaction, or any series of related transactions, by which Borrower and/or any of its Subsidiaries directly or indirectly (a) acquires the ongoing business or all or substantially all of the assets of any firm, partnership, joint venture, limited liability company, corporation or division thereof, (b) acquires in one transaction or as the most recent transaction in a series of transactions control of securities of a Person engaged in an ongoing business representing more than 50% of the ordinary voting power for the election of directors or other governing position if the business affairs of such Person are managed by a board of directors or other governing body or (c) acquires control of more than 50% of the ownership interest in any partnership, joint venture, limited liability company, business trust or other Person that is not managed by a board of directors or other governing body.

1

“Agreement”:  This Agreement, as amended, supplemented or modified from time to time.

“Aqua”: Aqua Services LP, a Texas limited partnership.

“Bank”:  As set forth in the introductory paragraph of this Agreement.

“Borrower”:  As set forth in the introductory paragraph of this Agreement.

“Business Day”:  Has the meaning set forth in the Revolving Note.

“Capistrano Letter of Credit”: The standby letter of credit issued by Bank of America, N.A., for the account of Borrower in the face amount of $3,430,000 for the benefit of Capistrano Valley Water District.

“Capital Leases”:  As applied to any Person, any lease of any property (whether real, personal or mixed) by that Person as lessee which would, in accordance with GAAP, be required to be accounted for as a capital lease on the balance sheet of that Person.

“CDC”: CDC Maintenance, Inc., a Texas corporation.

“Change of Control”:  Shall be deemed to have occurred at such times as:  (a) a “person” or “group” (within the meaning of Sections 13(d) and 14(d)(2) of the Securities Act of 1934), becomes the “beneficial owner” (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of more than thirty percent (30%) of the total voting power of all classes of stock then outstanding of Borrower normally entitled to vote in the election of directors; or (b)the Borrower shall fail to own directly one hundred percent (100%) of the issued and outstanding common stock or other equity interest of Aqua, Suburban, SWUC, NMUI or ECO or shall lose voting control of Aqua’s, Suburban’s, SWUC’s, NMUI’s or ECO’s issued and outstanding common stock or other equity interest; or (c) the Borrower shall fail to own directly 50.1% of the issued and outstanding common stock or other equity interest of Metro, MTI or OpTech or shall lose voting control of 50.1% of the issued and outstanding common stock or other equity interest of Metro, MTI or OpTech; or (d) the Borrower shall fail to own directly 67% of the issued and outstanding common stock of WRI or shall lose voting control of 67% of the issued and outstanding common stock of WRI; or (e) ECO shall fail to own directly one hundred percent (100%) of the issued and outstanding common stock of CDC or shall lose voting control of CDC’s issued and outstanding common stock; or (f) SWUC shall fail to own directly one hundred percent (100%) of the issued and outstanding common stock of Hornsby or shall lose voting control of Hornsby’s issued and outstanding common stock; or (g) SWUC shall fail to own directly 80% of the issued and outstanding common stock of Windermere or shall lose voting control of 80% of the issued and outstanding common stock of Windermere.  A change of control shall not include a transfer of NMUI’s operating assets through a condemnation or sale in lieu of condemnation.

2

“Closing Date”:  The Business Day on which the conditions set forth in Section 4.01 are satisfied or waived.

“Commitment”:  The Bank’s obligation to make Revolving Loans to the Borrower pursuant to Article II in the amount or amounts referred to therein.

“Consolidated EBITDA” means, for any period of Borrower and its Subsidiaries on a consolidated basis, Consolidated Net Profit for such period, plus interest expense (net of capitalized interest expense) and provision for income taxes for such period, plus depreciation and amortization for such period, plus the non-cash expense of Borrower and its Subsidiaries recognized during such period for any stock options granted by Borrower and its Subsidiaries permitted hereunder.

“Consolidated Net Profit” means, in respect of any period of the Borrower and its Subsidiaries, the consolidated net profit after taxes of the Borrower and its Subsidiaries as such would appear on the consolidated statement of earnings of Borrower and its Subsidiaries prepared in accordance with GAAP, consistently applied, minus nonrecurring or extraordinary income.

“Consolidated Tangible Net Worth”:  At any date of determination, the sum of the capital stock and additional paid-in capital plus retained earnings (or minus accumulated deficit) of the Borrower and its consolidated subsidiaries plus the outstanding principal amount of the Convertible Subordinate Debentures Due 2021 of Borrower (the “Convertible Debentures”) minus (i) treasury stock, (ii) intangible assets (including, without limitation, franchises, patents, patent applications, trademarks, brand names, goodwill, purchased contracts, deferred charges (including unamortized debt discount and expense and organization costs) and research and development expenses, provided, however that water rights shall not be considered an intangible asset) and (iii) receivables, advances, loans and all other amounts due from employees, officers, shareholders and/or affiliates (excluding those Subsidiaries of which Borrower owns at least 80% of the outstanding equity), on a consolidated basis determined in conformity with GAAP.

“Debt”:  As applied to any Person, (i) all indebtedness for borrowed money, (ii) that portion of obligations with respect to Capital Leases which is properly classified as a liability on a balance sheet in conformity with GAAP, (iii) notes payable and drafts accepted representing extensions of credit whether or not representing obligations for borrowed money, (iv) any obligation owed for all or any part of the deferred purchase price of property or services which purchase price is (y) due more than six months from the date of incurrence of the obligation in respect thereof, or (z) evidenced by a note or similar written instrument; (v) all indebtedness secured by any Lien on any property or asset owned or held by that Person regardless of whether the indebtedness secured thereby shall have been assumed by that Person or is non-recourse to the credit of that person; (vi) reimbursement obligations under letters of credit; and (vii) other contingent liabilities.

“Default Rate”:  As defined in the Revolving Note.

3

“Distribution”:  With respect to any Person shall mean that such Person has paid any dividend or returned any capital to, its stockholders or equity holders as such or authorized or made any other distribution, payment or delivery of property or cash to its stockholders or equity holders as such, or redeemed, retired, purchased, or otherwise acquired, directly or indirectly, for consideration, any shares of any class of its capital stock or equity interests (or any options, warrants or rights issued by such Person with respect to its capital stock or equity interests), or set aside any funds for any of the foregoing purposes, or shall have permitted any of its Subsidiaries to purchase or otherwise acquire for a consideration any shares of any class of the capital stock or any equity interests of such Person (or any options, warrants or rights issued by such Person with respect to its capital stock or equity interests). Without limiting the foregoing, “Distributions” with respect to any Person shall also include all payments made or required to be made by such Person with respect to any stock appreciation rights plans, equity incentive or the setting aside of any funds for the foregoing purposes.

“Dividend Reinvestment Plan”:  Borrower’s Dividend Reinvestment and Stock Purchase Plan dated September 26, 2001.

“Dollars and $”:  Dollars in lawful currency of the United States of America.

“EBITDA Coverage Ratio”: For any period of Borrower and its Subsidiaries on a consolidated basis, Consolidated EBITDA divided by the sum of the total interest expense plus current portion of long-term Debtplus current portion of advances for construction plus cash Distributions.

“ECO”:  ECO Resources, Inc., a Texas corporation.

“Employee Benefit Plan”:  Any Pension Plan, any employee welfare benefit plan, or any other employee benefit plan which is described in Section 3(3) of ERISA and which is maintained for employees of the Borrower or any ERISA Affiliate of the Borrower.

“Employee Stock Purchase Plan”:  Borrower’s Amended and Restated Employee Stock Purchase Plan dated May 28, 1998.

“ERISA”:  The Employee Retirement Income Security Act of 1974, as amended to the date hereof and from time to time hereafter.

“ERISA Affiliate”:  As applied to any Person, any trade or business (whether or not incorporated) which is a member of a group of which that Person is a member and which is under common control within the meaning of Section 414(b) and (c) of the Internal Revenue Code.

“Event of Default”: As defined in Section 7.01.

4

“GAAP”:  Generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as may be approved by a significant segment of the accounting profession or any public commission having regulatory responsibility over the Borrower or any Subsidiary.

“Hornsby”:  Hornsby Bend Utility Company, a Texas corporation.

“Internal Revenue Code”:  The Internal Revenue Code of 1986, as amended to the date hereof and from time to time hereafter and any successor statute.

“Lien”:  Any lien, mortgage, deed of trust, pledge, security interest, charge or encumbrance of any kind (including any conditional sale or other title retention agreement, any lease in the nature thereof, and any agreement to give any security interest).

“Loan Documents”:  This Agreement, the Revolving Note, each alternative dispute resolution agreement entered into by Borrower and Bank in connection with this Agreement, and each other agreement, document, instrument and guarantee required by the Bank in connection with this Agreement and/or the credit extended hereunder.

“Maturity Date”:  September 30, 2005.

“Metro”: Metro-H20 Utilities, Limited, a Texas limited partnership.

“MTI”:  Master Tek International, Inc., a Colorado corporation.

“Multiemployer Plan”:  A “multiemployer plan” as defined in Section 4001(a)(3) of ERISA which is maintained for employees of the Borrower or any ERISA Affiliate of the Borrower.

“NMUI”: New Mexico Utilities, Inc., a New Mexico corporation.

“OpTech”: Operations Technologies, Inc., a Georgia corporation.

“Pension Plan”: any employee plan which is subject to Section 412 of the Internal Revenue Code and which is maintained for employees of the Borrower or any ERISA Affiliate of the Borrower, other than a Multiemployer Plan.

“Permitted Acquisition”:  An Acquisition by Borrower or any of its Subsidiaries of all or substantially all of the assets of, or 80% or more of the capital stock or other equity interests of, a Person (the “Acquired Person”) engaged in the same line of business as Borrower or such Subsidiary, provided that (a) if such Acquisition is of all of the capital stock or other equity interests of the Acquired Person, such Acquired Person is merged with and into Borrower or such Subsidiary substantially simultaneously with Borrower’s or such Subsidiary’s acquisition of such capital stock or other equity interests or becomes a wholly-owned Subsidiary, (b) no Potential Event of Default or Event of Default shall have occurred or be continuing or would result after giving effect to such Permitted Acquisition, (c) the Acquisition shall have been

5

consummated in compliance with all applicable laws, and (d) Borrower shall be in compliance with all covenants on a pro forma basis having given effect to the Acquisition both prior to and upon consummation of such Acquisition.

“Person”:  An individual, partnership, corporation, limited liability company, business trust, joint stock company, trust, unincorporated association, joint venture, governmental authority or other entity of whatever nature.

“Potential Event of Default”:  A condition or event which, after notice or lapse of time or both, would constitute an Event of Default if that condition or event were not cured or removed within any applicable grace or cure period.

“Regulations T, U and X”:  Regulations T, U and X, respectively, promulgated by the Board of Governors of the Federal Reserve System, as amended from time to time, and any successors thereto.

“Revolving Commitment”: The amount of $15,000,000, as such amount may be reduced pursuant to Section 2.01(c).

“Revolving Loans”:  As defined in Section 2.01(a).

“Revolving Note”:  As defined in Section 2.01(d).

“S.E.C.”:  The United States Securities and Exchange Commission and any successor institution or body which performs the functions or substantially all of the functions thereof.

“Solvent”:  When used with respect to any Person, that as of the date as to which the Person’s solvency is to be measured:

(i)the fair saleable value of its assets is in excess of the total amount of its liabilities (including contingent liabilities) as they become absolute and matured;

(ii)it has sufficient capital to conduct its business; and

(iii)it is able to meet its debts as they mature.

“Subsidiary”:  Any corporation, limited liability company or partnership (whether or not, in any case, characterized as such or as a “joint venture”): (i) in the case of a corporation or limited liability company, of which a majority of the securities having ordinary voting power for the election of directors or other governing body (other than securities having such power only by reason of the happening of a contingency) are at the time owned directly, or indirectly through one or more intermediaries, or both, by the Borrower, or (ii) in the case of a partnership or limited liability company, of which a majority of the partnership or limited liability company or other ownership interest are at the time owned directly, or indirectly through one or more intermediaries, or both, by the Borrower.

6

“Suburban”:  Suburban Water Systems, a California corporation.

“Suburban Loan Documents”:  That Credit Agreement dated as of July 30, 1999 between Bank and Suburban, and each agreement, document, instrument and guarantee required by Bank in connection with such Credit Agreement and/or the credit extended thereunder, in each case as amended.

“SWUC”: SW Utility Company, a Texas corporation.

“Termination Event”:  (i) a “Reportable Event” described in Section 4043 of ERISA and the regulations issued thereunder (other than a “Reportable Event” not subject to the provision for 30-day notice to the Pension Benefit Guaranty Corporation under such regulations) with respect to any Pension Plan, or (ii) the withdrawal of the Borrower or any of its ERISA Affiliates from a Pension Plan during a plan year in which it was a “substantial employer” as defined in Section 4001(a)(2) of ERISA, or (iii) the filing of a notice of intent to terminate a Pension Plan or the treatment of a Pension Plan amendment as a termination under Section 4041 of ERISA, or (iv) the institution of proceedings to terminate a Pension Plan by the Pension Benefit Guaranty Corporation under Section 4042 of ERISA, or (v) any other event or condition which might constitute grounds under ERISA for the termination of, or the appointment of a trustee to administer, any Pension Plan under Section 4042 of ERISA, or (vi) the imposition of a lien with respect to any Pension Plan pursuant to Section 412(n) of the Internal Revenue Code.

“Union”:  Union Bank of California

“Union Loan Documents”:  That Credit Agreement dated as of June 6, 2003 between Union Bank of California, N.A. and Borrower, and each agreement, document, instrument and guarantee required by Union Bank of California, N.A., in connection with such Credit Agreement and/or the credit extended thereunder, in each case as amended.

“Windermere”: Windermere Utility Co., Inc., a Texas corporation.

“WRI”: Wastewater Rehabilitation, Inc., a Texas corporation.

SECTION 1.02.  Other Definitional Provisions.  All terms defined in this Agreement shall have the defined meanings when used in the Revolving Note or any certificate or other document made or delivered pursuant hereto.

(b)As used herein and in the Revolving Note, and any certificate or other document made or delivered pursuant hereto, accounting terms not defined in Section 1.01, and accounting terms partly defined in Section 1.01 to the extent not defined, shall have the respective meanings given to them under GAAP.

(c)The words “hereof”, “herein” and “hereunder” and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement, and section, subsection, schedule and exhibit references are to this Agreement unless otherwise specified.

7

(d)So long as the Borrower does not have any Subsidiaries, references to a Subsidiary or Subsidiaries in this Agreement shall be deemed to be deleted.

ARTICLE II
THE CREDIT

SECTION 2.01.  The Revolving Loans. 

(a) The Revolving Commitment.  The Bank agrees, on the terms and conditions hereinafter set forth, to make loans (“Revolving Loans”) to the Borrower from time to time during the period from the date hereof to and including the Maturity Date in an aggregate amount not to exceed the Revolving Commitment, as such amount may be reduced pursuant to Section 2.01(c).  Within the limits of the Revolving Commitment and prior to the Maturity Date, the Borrower may borrow, repay, and reborrow subject to the terms of this Agreement and the Revolving Note.

(b) Making the Revolving Loans.  The Borrower may borrow under the Revolving Commitment on any Business Day, provided that the Borrower shall give the Bank notice pursuant to the terms of the Revolving Note specifying (i) the amount of the proposed Revolving Loan and (ii) the requested date of the Revolving Loan.  Upon satisfaction of the applicable conditions set forth in Article IV, the proceeds of all such Revolving Loans will then be made available to the Borrower by the Bank by crediting the account of the Borrower on the books of the Bank, or as otherwise directed by the Borrower.

(c) Reduction of the Revolving Commitment.  The Borrower shall have the right, upon at least two Business Days’ notice to the Bank, to terminate in whole or reduce in part the unused portion of the Revolving Commitment, without premium or penalty, provided that each partial reduction shall be in the aggregate amount of $100,000 or an integral multiple thereof and that such reduction shall not reduce the Revolving Commitment to an amount less than the amount outstanding hereunder on the effective date of the reduction.  Such notice shall be irrevocable and such reduction shall not be reinstated.

(d) Revolving Note.  The Revolving Loans made by the Bank pursuant hereto shall be evidenced by a promissory note of the Borrower, substantially in the form of Exhibit A, with any appropriate insertions (as amended from time to time, the “Revolving Note”), payable to the order of the Bank and representing the obligation of the Borrower to pay the aggregate unpaid principal amount of all Revolving Loans made by the Bank, with interest thereon as prescribed in Section 2.03. The Bank is hereby authorized to record in its books and records and on any schedule annexed to the Revolving Note, the date and amount of each Revolving Loan made by the Bank, the date and amount of each payment of principal thereof, and the applicable interest rate, and any such recordation shall constitute prima facie evidence of the accuracy of the information so recorded; provided that failure by the Bank to effect such recordation shall not affect the Borrower’s obligations hereunder.  Prior to the transfer of the Revolving Note, the Bank shall record such information on any schedule annexed to and forming a part of the Revolving Note.

8

(e) Standby Letters of Credit.  The Revolving Commitment may be used for financing standby letters of credit with a maximum maturity of 365 days but not to extend more than 365 days beyond the Maturity Date. The standby letters of credit may include a provision providing that the maturity date will be automatically extended each year for an additional year unless the Bank gives written notice to the contrary. The amount of standby letters of credit outstanding at any one time (including amounts drawn on letters of credit and not yet reimbursed) may not exceed Three Million Dollars($3,000,000). Each standby letter of credit must be requested by the Borrower at least three (3) Business Days prior to the proposed date of issuance of such standby letter of credit, and any such request may be submitted by telecopy, rapidfax or other telecommunication method (other than telephonic or oral advice).  The Borrower agrees:

(i)to pay the Bank an amount equal to any payment made by the Bank with respect to each letter of credit within one (1) Business Day after demand made by the Bank therefor, together with interest on such amount from the date of any payment made by the Bank at the rate applicable to advances bearing interest with reference to the Reference Rate for the period commencing on the date of any such payment and continuing through the first Business Day following such demand and thereafter at the Default Rate.  The Borrower also agrees that any sum drawn under a letter of credit may, without further action of the Bank, upon the Borrower’s failure to make the payment referred to in the preceding sentence, be added to the principal amount outstanding under the Revolving Commitment. The amount will bear interest and be due as described elsewhere in this Agreement.

(ii)if there is a default under this Agreement, to immediately prepay and make the Bank whole for any outstanding letters of credit.

(iii)the issuance of any letter of credit and any amendment to a letter of credit is subject to the Bank’s written approval and must be in form and content satisfactory to the Bank and in favor of a beneficiary acceptable to the Bank.

(iv)to sign the Bank’s form application and agreement for standby letters of credit with respect to each letter of credit, which must be submitted to the Bank concurrently with the Borrower’s request for any standby letter of credit.

(v)to pay any issuance and/or other fees that the Bank notifies the Borrower will be charged for issuing and processing letters of credit for the Borrower.

(vi)to allow the Bank to automatically charge its checking account for applicable fees, discounts, and other charges.

(vii)to pay the Bank a non-refundable fee equal to 1.25% per annum of the outstanding undrawn amount of each standby letter of credit, provided that the minimum amount per annum of such fee with respect to each standby letter of credit shall be $500.  This fee shall be calculated in advance as of the first day of each calendar quarter on the basis of such amount in effect on the day the fee is calculated, and is payable on the 14^th day after each such date of calculation. If there is a default under this

9

Agreement, at the Bank’s option, the amount of the fee shall be increased to 3.25% per annum, effective starting on the day the Bank provides notice of the increase to the Borrower.

SECTION 2.02.  Mandatory Repayment.  The aggregate principal amount of the Revolving Loans outstanding on the Maturity Date, together with accrued interest thereon, shall be due and payable in full on the Maturity Date.  If at any time the aggregate outstanding Revolving Loans exceed the Revolving Commitment then in effect, the Borrower shall immediately repay the excess to the Bank without penalty or premium.

SECTION 2.03.  Interest Computation and Payment; Fee Computation.  The outstanding principal balance of the Revolving Loans shall bear interest as set forth in the Revolving Note.  Interest shall be computed on the basis of a 360-day year, actual days elapsed.  Interest shall be payable at the times and place set forth in the Revolving Note.  All fees under this Agreement shall be computed on the basis of a 360-day year, actual days elapsed.

SECTION 2.04.  Unused commitment fee.  The Borrower agrees to pay a fee on any difference between the Revolving Commitment and the amount of credit it actually uses, determined by the weighted average credit outstanding during the specified period. The fee will be calculated at 0.25% per year. The calculation of credit outstanding shall include the Revolving Loans and the undrawn amount of outstanding letters of credit. This fee shall be calculated in arrears as of the end of each calendar quarter, and is payable on the 15^th day of the calendar month beginning immediately after each calendar quarter end.  Each such fee shall be fully earned when paid and shall be non-refundable.

SECTION 2.05.  Annual Credit Facility Fee.  The Borrower agrees to pay, on the Closing Date and on each anniversary thereof, an annual credit facility fee in the amount of $25,000.  Each such fee shall be fully earned when paid and shall be non-refundable.Borrower shall pay to Bank an amendment fee of $          for the processing and approval of this Agreement, which fee will be fully earned on the date of this Agreement.

ARTICLE III
GENERAL PROVISIONS CONCERNING THE LOANS

SECTION 3.01.  Use of Proceeds.  The proceeds of Revolving Loans hereunder shall be used by the Borrower (i) for general corporate purposes, working capital and acquisitions permitted hereunder of the Borrower and those Subsidiaries of Borrower as to which Borrower owns at least 80% of the outstanding equity, and (ii) to finance capital additions to the water utility and other operations of the Borrower and those Subsidiaries of Borrower as to which Borrower owns at least 80% of the outstanding equity.

SECTION 3.02.  Payment on Non-Business Days.  Whenever any payment to be made hereunder or under the Revolving Note shall be stated to be due on a day which is not a Business Day, such payment may be made on the next succeeding Business Day, and with respect to payments of principal, interest thereon shall be payable at the then applicable rate during such extension.

10

SECTION 3.03.  Reduced Return.  If the Bank shall have determined that any applicable law, regulation, rule or regulatory requirement generally applicable to banks located in California and (collectively in this Section 3.03, “Requirement”) regarding capital adequacy, or any change therein, or any change in the interpretation or administration thereof by any United States federal or state governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by the Bank with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on the Bank’s capital as a consequence of its Commitment and obligations hereunder to a level below that which would have been achieved but for such Requirement, change or compliance (taking into consideration the Bank’s policies with respect to capital adequacy) by an amount deemed by the Bank to be material (which amount shall be determined by the Bank’s reasonable allocation of the aggregate of such reductions resulting from such events), then from time to time, within five (5) Business Days after demand by the Bank, the Borrower shall pay to the Bank such additional amount or amounts as will compensate the Bank for such reduction.  The Bank does not presently have knowledge of any new Requirement or any pending change in any existing Requirement which would result in such additional amounts being owed.

SECTION 3.04.  Indemnities.  The Borrower agrees to indemnify, pay and hold the Bank, and the shareholders, officers, directors, employees and agents of the Bank (“Indemnified Persons”), harmless from and against any and all claims, liabilities, losses, damages, costs and expenses (whether or not any of the foregoing Indemnified Persons is a party to any litigation), including, without limitation, reasonable attorneys’ fees and costs (including, without limitation, the reasonable estimate of the allocated cost of in-house legal counsel and staff) and costs of investigation, document production, attendance at a deposition, or other discovery, prior to the assumption of defense by the Borrower, with respect to or arising out of any proposed acquisition by the Borrower or any of its Subsidiaries of any Person or any securities (including a self-tender), this Agreement or any use of proceeds hereunder, or any claim, demand, action or cause of action being asserted against the Borrower or any of its Subsidiaries (collectively, the “Indemnified Liabilities”), provided that the Borrower shall have no obligation hereunder with respect to Indemnified Liabilities arising from the gross negligence or willful misconduct of any such Indemnified Persons. If any claim is made, or any action, suit or proceeding is brought, against any Indemnified Person with respect to Indemnified Liabilities, the Indemnified Person shall notify the Borrower within thirty (30) days of the Bank being notified in writing of any such claim or the commencement of such action, suit or proceeding, and the Borrower will assume the defense of such action, suit or proceeding, employing counsel selected by Borrower’s insurance carrier, or selected by the Borrower and reasonably satisfactory to the Indemnified Person, and pay the fees and expenses of such counsel. This covenant shall survive termination of this Agreement and payment of the amounts outstanding under the Revolving Note for a period of six (6) years.

SECTION 3.05.  Funding Sources.  Nothing in this Agreement shall be deemed to obligate the Bank to obtain the funds for any Revolving Loan in any particular place or manner or to constitute a representation by the Bank that it has obtained or will obtain the funds for any Revolving Loan in any particular place or manner.

11

ARTICLE IV
CONDITIONS OF LENDING

SECTION 4.01.  Conditions Precedent to Initial Revolving Loan.  The obligation of the Bank to make its initial Revolving Loan is subject to the conditions precedent that:

(a)The Bank shall have received on or before the day of the initial Revolving Loan the following, each dated prior to or as of such day, in form and substance satisfactory to the Bank:

(i)The Revolving Note issued by the Borrower to the order of the Bank;

(ii)Copies of the Articles of Incorporation or Certificate of Incorporation of the Borrower, certified as of a recent date by the Secretary of State of Delaware;

(iii)Copies of the Bylaws, if any, of the Borrower, certified by the Secretary or an Assistant Secretary of the Borrower;

(iv)Copies of resolutions of the Board of Directors or other authorizing documents of the Borrower, in form and substance satisfactory to the Bank, approving the Loan Documents and the Revolving Loans hereunder;

(v)An incumbency certificate executed by the Secretary or an Assistant Secretary of the Borrower or equivalent document, certifying the names and signatures of the officers of the Borrower or other Persons authorized to sign the Loan Documents and the other documents to be delivered hereunder;

(vi)Executed copies of all other Loan Documents;

(b)The Bank shall have completed its due diligence review of the Borrower, and the scope and results thereof shall be satisfactory to Bank in its discretion;

(c)All information previously furnished by Borrower to Bank shall be true and correct in all material respects;

(d)All fees and expenses required to be paid on the Closing Date shall have been paid or arrangements satisfactory to Bank shall have been made with respect to the payment thereof;

(e)Borrower shall be in compliance with the Loan Documents, and after giving effect to the initial Revolving Loan, no Potential Event of Default or Event of Default shall have occurred and be continuing;

(f)The representations and warranties of Borrower contained in Article V shall be true and correct in all respects;

12

(g)Bank shall have received evidence of the insurance policies required by Section 6.01(e);

(h)All corporate and legal proceedings and all instruments and documents in connection with the transactions contemplated by this Agreement shall be reasonably satisfactory in content, form and substance to the Bank and its counsel, and the Bank and such counsel shall have received any and all further information and documents which the Bank or such counsel may reasonably have requested in connection therewith, such documents where appropriate to be certified by proper corporate or governmental authorities;

(i)Nothing shall have occurred and the Bank shall not have become aware of any fact or condition not previously known, which the Bank shall determine has, or could reasonably be expected to have, a material adverse effect on the rights or remedies of the Bank, or on the ability of the Borrower to perform its obligations to the Bank or which has, or could reasonably be expected to have, a materially adverse effect on the performance, business, property, assets, condition (financial or otherwise) or prospects of Borrower and its Subsidiaries taken as a whole;

(j)Suburban shall have reduced the outstanding principal balance of the credit facility provided to Suburban pursuant to the Suburban Loan Documents to $0; the commitment represented by the Suburban Loan Documents hereby being deemed terminated.

SECTION 4.02.  Conditions Precedent to Each Revolving Loan.  The obligation of the Bank to make a Revolving Loan on the occasion of each Revolving Loan (including the initial Revolving Loan) shall be subject to the further conditions precedent that on the date of such Revolving Loan (a) the following statements shall be true and the Bank shall have received the notice required by Section 2.01(b), which notice shall be deemed to be a certification by the Borrower that:

(i)The representations and warranties contained in Section 5.01 are correct on and as of the date of such Revolving Loan as though made on and as of such date,

(ii)No event has occurred and is continuing, or would result from such Revolving Loan, which constitutes an Event of Default or Potential Event of Default; and

(iii)Nothing shall have occurred and the Bank shall not have become aware of any fact or condition not previously known, which the Bank shall determine has, or could reasonably be expected to have, a material adverse effect on the rights or remedies of the Bank, or on the ability of the Borrower to perform its obligations to the Bank or which has, or could reasonably be expected to have, a material adverse effect on the performance, business, property, assets, condition (financial or otherwise) or prospects of Borrower and its Subsidiaries taken as a whole; and

(iv)All Loan Documents are in full force and effect,

and (b) the Bank shall have received such other approvals, opinions or documents as the Bank may reasonably request.

13

ARTICLE V
REPRESENTATIONS AND WARRANTIES

SECTION 5.01.  Representations and Warranties.  The Borrower represents and warrants as follows:

(a) Organization.  The Borrower and each of its Subsidiaries is duly organized, validly existing and in good standing under the laws of the state of its incorporation. The Borrower and each of its Subsidiaries is also duly authorized, qualified and licensed in all applicable jurisdictions, and under all applicable laws, regulations, ordinances or orders of public authorities, to carry on its business in the locations and in the manner presently conducted, and the Borrower and each of its Subsidiaries has all requisite power and authority to conduct its business and to own and lease its properties.  Schedule 5.01(a) attached hereto correctly sets forth the names, form of legal entity, number of shares of capital stock or membership or other equity interests, as applicable, issued and outstanding, number of shares of capital stock or membership or other equity interests, as applicable, owned by the Borrower or any of its Subsidiaries (specifying such owner) and jurisdictions of organization of all Subsidiaries of the Borrower.  Except as set forth on Schedule 5.01(a), there are no outstanding options, warrants or other rights to purchase any capital stock, membership interests or units of other equity interest of any Subsidiary other than in favor of the Borrower, and all shares, membership interests or other equity interests issued by the Subsidiaries arefree and clear of all liens, except for liens permitted under Section 6.02(d).

(b) Authorization; No Conflict.  The execution, delivery and performance by the Borrower of the Loan Documents, and the borrowing of Revolving Loans hereunder, are within the Borrower’s corporate powers, have been duly authorized by all necessary corporate action, do not contravene (i) the Borrower’s charter, by-laws or other organizational document or (ii) any law or regulation (including, without limitation, Regulations T, U and X and regulations of public utility commissions or similar regulatory authorities) binding on or affecting the Borrower or its properties, and will not constitute an event of default under any material agreement to which Borrower is a party or by which its assets or properties may be bound.

(c) Governmental Consents.  No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body (except routine reports required pursuant to the Securities Exchange Act of 1934, as amended (if such act is applicable to the Borrower), which reports will be made in the ordinary course of business) is required for the due execution, delivery and performance by the Borrower of the Loan Documents.

(d) Validity.  The Loan Documents are the binding obligations of the Borrower or other executing Person, if any, enforceable in accordance with their respective terms; except in each case as such enforceability may be limited by bankruptcy, insolvency, reorganization, liquidation, moratorium or other similar laws of general application and equitable principles relating to or affecting creditors’ rights.

(e) Financial Condition.  The balance sheets of the Borrower and its consolidated Subsidiaries as at December 31, 2002, and the related consolidated statements of income and changes in common stockholders’ equity of the Borrower and its consolidated Subsidiaries for

14

the fiscal twelve months then ended, copies of which have been furnished to the Bank, fairly present the financial condition of the Borrower and its consolidated Subsidiaries as at such dates and the results of the operations of the Borrower and its consolidated Subsidiaries for the period ended on such date, all in accordance with GAAP, consistently applied, and since December 31, 2002 there has been no material adverse change in the business, operations, properties, assets or condition (financial or otherwise) of the Borrower and its Subsidiaries, taken as a whole.

(f) Litigation.  Except as set forth in the Form 10-K dated December 31, 2002, and on Schedule 5.01(f) hereto, there is no known pending or threatened action or proceeding affecting the Borrower or any of its Subsidiaries before any court, governmental agency or arbitrator, which may materially adversely affect the consolidated financial condition or operations of the Borrower or which may have a material adverse effect on the Borrower’s ability to perform its obligations under the Loan Documents, having regard for its other financial obligations.

(g) Employee Benefit Plans.  The Borrower and each of its ERISA Affiliates is in compliance in all material respects with any applicable provisions of ERISA and the regulations and published interpretations thereunder with respect to all Employee Benefit Plans.  No Termination Event has occurred with respect to any Pension Plan.  The excess of the actuarial present value of all benefit liabilities under all Pension Plans (excluding in such computation Pension Plans with assets greater than benefit liabilities) over the fair market value of the assets allocable to such benefit liabilities are not greater than five percent (5%) of Consolidated Tangible Net Worth.  For purposes of the preceding sentence, the term “benefit liabilities” shall have the meaning specified in Section 4001 of ERISA.

(h) Disclosure.  No representation or warranty of the Borrower contained in this Agreement or any other document, certificate or written statement furnished to the Bank by or on behalf of the Borrower for use in connection with the transactions contemplated by this Agreement contains any known untrue statement of a material fact or omits to state a known material fact (known to the Borrower in the case of any document not furnished by it) necessary in order to make the statements contained herein or therein not misleading. There is no fact known to the Borrower (other than matters of a general economic nature) which materially adversely affects the business, operations, property, assets or condition (financial or otherwise) of the Borrower and its Subsidiaries, taken as a whole, which has not been disclosed herein or in such other documents, certificates and statements furnished to the Bank for use in connection with the transactions contemplated hereby.

(i) Environmental Matters.  Except as set forth in Schedule 5.01(i) hereto, neither the Borrower nor any Subsidiary, nor any of their respective officers, employees, representatives or agents, nor, to the best of their knowledge, any other person, has treated, stored, processed, discharged, spilled, or otherwise disposed of any substance defined as hazardous or toxic by any applicable federal, state or local law, rule, regulation, order or directive, or any waste or by-product thereof, at any real property or any other facility owned, leased or used by the Borrower or any Subsidiary, in violation of any applicable statutes, regulations, ordinances or directives of any governmental authority or court, which violations may result in liability to the Borrower or any Subsidiary or any of their respective officers, employees, representatives, agents or shareholders in an amount exceeding $500,000 for all such violations; and the unresolved

15

violations set forth in said Schedule 5.01(i) will not result in liability to the Borrower or any Subsidiary or any of their respective officers, employees, representatives, agents or shareholders in an amount exceeding $500,000 for all such unresolved violations. Except as set forth in said Schedule, no employee or other person has made a claim or demand against the Borrower or any Subsidiary based on alleged damage to health caused by any such hazardous or toxic substance or by any waste or by-product thereof; and the unsatisfied claims or demands against the Borrower or any Subsidiary set forth in said Schedule 5.01(i) will not result in uninsured liability to the Borrower or any Subsidiary or any of their respective officers, employees, representatives, agents or shareholders in an amount exceeding $250,000 in excess of reserves on the books of the Borrower for all such unsatisfied claims or demands. Except as set forth in said Schedule 5.01(i), neither the Borrower nor any Subsidiary has been charged by any governmental authority with improperly using, handling, storing, discharging or disposing of any such hazardous or toxic substance or waste or by-product thereof or with causing or permitting any pollution of any body of water; and the outstanding related charges set forth in said Schedule 5.01(i) will not result in liability to the Borrower or any Subsidiary or any of their respective officers, employees, representatives, agents or shareholders in an amount exceeding $500,000 for all such outstanding charges.

(j) Employee Matters.  There is no known strike or work stoppage in existence or threatened involving the Borrower or its Subsidiaries that may materially adversely affect the consolidated financial condition or operations of the Borrower or that may have a material adverse effect on the Borrower’s ability to perform its obligations under the Loan Documents, having regard for its other financial obligations.

(k) Solvency.  Borrower and each of its Subsidiaries is Solvent.

(l) Title to Properties.  Borrower and each of its Subsidiaries has good and marketable title to or interests in all of its properties and assets subject to no liens, mortgages, pledges, security interests, encumbrances or charges of any kind, except those granted to Bank and such others as are permitted under Section 6.02(d) hereof.

(m) Tax Returns.  Borrower and each of its Subsidiaries has filed, or caused to be filed, in a timely manner all tax returns, reports and declarations which are required to be filed by it (without requests for extension (other than automatic extensions provided by law) except as previously disclosed in writing to Bank).  All information in such tax returns, reports and declarations is complete and accurate in all material respects.  Borrower and each of its Subsidiaries has paid or caused to be paid all taxes due and payable or claimed due and payable in any assessment received by it, except taxes the validity of which are being contested in good faith by appropriate proceedings diligently pursued and available to Borrower or its Subsidiaries and with respect to which adequate reserves have been set aside on its books.  Adequate provision has been made for the payment of all accrued and unpaid Federal, State, county, local, foreign and other taxes whether or not yet due and payable and whether or not disputed.

(n) Compliance with Other Agreements and Applicable Laws.  Neither Borrower nor any of its Subsidiaries is in default in any material respect under, or in violation in any material respect of any of the terms of, any agreement, contract, instrument, lease or other commitment (including, but not limited to any such agreement involving the debts or

16

investments of Borrower or liens upon its assets) to which it is a party or by which it or any of its assets are bound and Borrower and each of its Subsidiaries is in compliance in all material respects with all applicable provisions of laws, rules, regulations, licenses, permits, approvals and orders of any foreign, Federal, State or local governmental authority.

(o) No Default.  No event has occurred and is continuing that is a Potential Event of Default or an Event of Default.

(p) Regulation U; Investment Company Act.  No part of the proceeds of any Revolving Loan hereunder will be used to purchase or carry, or to extend credit to others for the purpose of purchasing or carrying, any “margin stock” (as defined in Regulation U) in violation of Regulation U.  Borrower is not required to be registered as an “investment company” under the Investment Company Act of 1940.

(q) Intangible Assets.  Borrower owns, or possesses the right to use to the extent necessary in its business, all trademarks, trade names, copyrights, patents, patent rights, computer software, licenses and other intangible assets that are used in the conduct of its business as now operated, and no such intangible asset, to Borrower’s actual knowledge, conflicts with the valid trademark, trade name, copyright, patent, patent right or intangible asset of any other Person.

ARTICLE VI
COVENANTS

SECTION 6.01.  Affirmative Covenants.  So long as any Revolving Loan shall remain unpaid or the Bank shall have any Commitment hereunder, the Borrower will, unless the Bank shall otherwise consent in writing:

(a) Financial Information.  Furnish to the Bank:

(i)as soon as available, but in any event within 120 days after the end of each fiscal year of the Borrower, (1) a copy of the Borrower’s annual report to shareholders containing the audited consolidated balance sheets of itself and its consolidated Subsidiaries as at the end of each fiscal year and the related consolidated statements of income and changes in common stockholders’ equity (or comparable statement) employed in the business and changes in financial position and cash flow for such year, in each case prepared in accordance with GAAP, setting forth in each case in comparative form the figures for the previous year, accompanied by an unqualified report and opinion thereon of independent certified public accountants acceptable to the Bank and, if prepared, such accountants’ letter to management, and (2) a copy of the Borrower-prepared consolidating balance sheets and statements of income prepared in connection with each of the statements provided in subpart (1) above; and

(ii)as soon as available, but in any event within forty-five (45) days after the end of each fiscal quarter, the Borrower’s unaudited consolidated and consolidating balance sheets of itself and its consolidated Subsidiaries as at the end of such period and the related unaudited consolidated and consolidating statements of income and the related unaudited consolidated statement of changes in common

17

stockholders’ equity (or comparable statement) and changes in financial position and cash flow for such period and year to date, setting forth in each case in comparative form the figures as at the end of the previous fiscal year as to the balance sheet and the figures for the previous corresponding period as to the other statements, certified by a duly authorized officer of the Borrower as being fairly stated in all material respects subject to year end adjustments; all such financial statements to be complete and correct in all material respects and to be prepared in reasonable detail acceptable to the Bank and in accordance with GAAP applied consistently throughout the periods reflected therein (except as approved by such accountants and disclosed therein and except for the exclusion of certain information and footnote disclosures omitted pursuant to the rules and regulations of the S.E.C.); and

(iii)as soon as available, copies of all reports which the Borrower sends to any of its security holders, and copies of all reports and registration statements which the Borrower or any Subsidiary files with the S.E.C. or any national securities exchange; and

(iv)(a) together with each delivery of financial statements of Borrower and its Subsidiaries pursuant to subdivision (i) above, a certificate, executed by the Borrower’s chairman of the board (if an officer) or its president or one of its vice presidents or by its chief financial officer stating that the signers have reviewed the terms of this Agreement and have made, or caused to be made under their supervision, a review in reasonable detail of the transactions and condition of Borrower and its Subsidiaries during the accounting period covered by such financial statements and that such review has not disclosed the existence during or at the end of such accounting period, and that the signers do not have knowledge of the existence as at the date of such certificate, of any condition or event that constitutes an Event of Default or Potential Event of Default, or, if any such condition or event existed or exists, specifying the nature and period of existence thereof and what action Borrower has taken, is taking and proposes to take with respect thereto; and (b) together with each delivery of financial statements of Borrower and its Subsidiaries pursuant to subdivision (i) and (ii) above, a certificate demonstrating in reasonable detail compliance during and at the end of the applicable accounting periods with the restrictions contained in Section 6.02 hereof.

(b) Notices and Information.  Deliver to the Bank:

(i)promptly upon any officer of the Borrower obtaining knowledge (a) of any condition or event which constitutes an Event of Default or Potential Event of Default, (b) that any Person has given any notice to the Borrower or any Subsidiary of the Borrower or taken any other action with respect to a claimed default or event or condition of the type referred to in Section 7.01(e) or Section 7.01(f), (c) of the institution of any litigation involving an alleged liability (including possible forfeiture of property) of the Borrower or any of its Subsidiaries equal to or greater than $500,000 which is not, except for deductibles and self insurance reserves, fully covered by insurance maintained by Borrower or any adverse determination in any litigation involving a potential liability of the Borrower or any of its Subsidiaries equal to or greater than $500,000 which is not, except for deductibles and self insurance reserves, fully covered by insurance maintained by

18

Borrower or (d) of a material adverse change in the business, operations, properties, assets or condition (financial or otherwise) of the Borrower and its Subsidiaries, taken as a whole, an officers’ certificate specifying the nature and period of existence of any such condition or event, or specifying the notice given or action taken by such holder or Person and the nature of such claimed default, Event of Default, Potential Event of Default, event or condition, and what action the Borrower has taken, is taking and proposes to take with respect thereto;

(ii)promptly upon becoming aware of the occurrence of any (a) Termination Event, or (b) non-exempt “prohibited transaction”, as such term is defined in Section 4975 of the Internal Revenue Code or a transaction prohibited by Section 406 of ERISA, in connection with any Employee Benefit Plan or any trust created thereunder, a written notice specifying the nature thereof, what action the Borrower has taken, is taking or proposes to take with respect thereto, and, when known, any action taken or threatened by the Internal Revenue Service, the Department of Labor, or the Pension Benefit Guaranty Corporation with respect thereto;

(iii)with reasonable promptness copies of (a) all notices received by the Borrower or any of its ERISA Affiliates of the Pension Benefit Guaranty Corporation’s intent to terminate any Pension Plan or to have a trustee appointed to administer any Pension Plan and (b) all notices received by the Borrower or any of its ERISA Affiliates from a Multiemployer Plan sponsor concerning the imposition or amount of withdrawal liability pursuant to Section 4202 of ERISA;

(iv)promptly, and in any event within 10 days after the effective date thereof, a copy of all amendments to any of the loan documents governing any of the unsecured debt permitted by Section 6.02(e)(iv) (including, without limitation, the Union Loan Documents);

(v)promptly, and in any event within 30 days after receipt thereof, a copy of any notice, summons, citation, directive, letter or other form of communication from any governmental authority or court in any way concerning any action or omission on the part of the Borrower or any of its Subsidiaries in connection with any substance defined as toxic or hazardous by any applicable federal, state or local law, rule, regulation, order or directive or any waste or byproduct thereof, or concerning the filing of a lien upon, against or in connection with the Borrower, its Subsidiaries, or any of their leased or owned real or personal property, in connection with a Hazardous Substance Superfund or a Post-Closure Liability Fund as maintained pursuant to § 9507 of the Internal Revenue Code; and

(vi)promptly, and in any event within 30 days after request, such other information and data with respect to the Borrower or any of its Subsidiaries as from time to time may be reasonably requested by the Bank and is reasonably available to Borrower.

(c) Corporate Existence, Etc.  At all times preserve and keep in full force and effect its and its Subsidiaries’ corporate existence and rights, licenses and franchises material to

19

its business and those of each of its Subsidiaries; provided, however, that the corporate existence of any such Subsidiary may be terminated if such termination is in the best interest of Borrower and does not result in a Change of Control.

(d) Payment of Taxes and Claims.  Pay, and cause each of its Subsidiaries to pay, all taxes, assessments and other governmental charges imposed upon it or any of its properties or assets or in respect of any of its franchises, business, income or property before any penalty which would exceed the Penalty Cap (as defined below) or interest accrues thereon, and all claims (including, without limitation, claims for labor, services, materials and supplies) for sums which have become due and payable and which by law have or may become a lien upon any of its properties or assets, prior to the time when any penalty or fine shall be incurred with respect thereto; provided that no such charge or claim need be paid if being contested in good faith by appropriate proceedings promptly instituted and diligently conducted and if such reserve or other appropriate provision, if any, as shall be required in conformity with GAAP shall have been made therefor.  As used herein, the term “Penalty Cap” means an amount equal to $10,000 in the aggregate for the Borrower and its Subsidiaries for each calendar year.

(e) Maintenance of Properties; Insurance.  Maintain or cause to be maintained in good repair, working order and condition all material properties used or useful in the business of the Borrower and its Subsidiaries and from time to time will make or cause to be made all appropriate repairs, renewals and replacements thereof. The Borrower will maintain or cause to be maintained, with financially sound and reputable insurers, insurance with respect to its properties and business and the properties and business of its Subsidiaries against loss or damage of the kinds customarily insured against by corporations of established reputation engaged in the same or similar businesses and similarly situated, of such types and in such amounts as are customarily carried under similar circumstances by such other corporations.  The Borrower will comply with any other insurance requirement set forth in any other Loan Document.

(f) Inspection.  Permit any authorized representatives designated by the Bank to visit and inspect any of the properties of the Borrower or any of its Subsidiaries, including its and their financial and accounting records, and to make copies and take extracts therefrom, and to discuss its and their affairs, finances and accounts with its and their officers and independent public accountants, all at such reasonable times during normal business hours and as often as may be reasonably requested.

(g) Compliance with Laws Etc.  Exercise, and cause each of its Subsidiaries to exercise, all due diligence in order to comply with the requirements of all applicable laws, rules, regulations and orders of any governmental authority, including, without limitation, all rules and regulations of public utility commissions or similar regulatory authorities, and all environmental laws, rules, regulations and orders, noncompliance with which would materially adversely affect the business, properties, assets, operations or condition (financial or otherwise) of the Borrower and its Subsidiaries, taken as a whole.

(h) Hazardous Waste Studies.  Promptly, and in any event within thirty (30) days after submission, provide the Bank with copies of all such investigations, studies, samplings and testings as may be requested by any governmental or regulatory authority relative to any substance defined as hazardous or toxic by any applicable federal, state or local law, rule,

20

regulation, order or directive, or any waste or by-product thereof, at or affecting any real property or any facility owned, leased or used by the Borrower or any Subsidiary.  The foregoing shall not include sampling and testing of water, waste water and effluent conducted by the Subsidiaries of Borrower on periodic bases as a normal part of their water delivery and wastewater treatment businesses.

SECTION 6.02.  Negative Covenants.  So long as any Revolving Loan shall remain unpaid or the Bank shall have any Commitment hereunder, the Borrower will not, without the written consent of the Bank:

(a) Consolidated Tangible Net Worth.  At any time, permit Consolidated Tangible Net Worth to be less than the sum of (i) $55,500,000 plus (ii) fifty percent (50%) of the cash proceeds received by Borrower or any of its Subsidiaries from the issuance of any capital stock of Borrower or any of its Subsidiaries after the date hereof (net of underwriting discounts and commissions, professional fees and disbursements in each case not paid to an affiliate of Borrower or a Subsidiary of Borrower)(other than any such proceeds received by Borrower in connection with the Employee Stock Purchase Plan or the Dividend Reinvestment Plan).

(b) Consolidated Net Profit.  At the end of any fiscal quarter of the Borrower, permit Consolidated Net Profit, determined on a four quarter rolling basis, to be less than $1.00.

(c) EBITDA Coverage Ratio.  At the end of any fiscal quarter of Borrower, permit the EBITDA Coverage Ratio, determined on a four quarter rolling basis, to be less than 1.50:1.00.

(d) Liens Etc.  Create or suffer to exist, or permit any of its Subsidiaries to create or suffer to exist, any Lien upon or with respect to any of its properties, whether now owned or hereafter acquired, or assign, or permit any of its Subsidiaries to assign, any right to receive income, in each case to secure any Debt of any Person other than (i) Liens in favor of the Bank; (ii) Liens existing on the date hereof and set forth in Schedule 6.02(d) hereto; (iii) purchase money Liens upon or in any equipment acquired or held by the Borrower or any Subsidiary in the ordinary course of business with respect to principal indebtedness up to a maximum of $2,000,000 to secure the purchase price of such equipment or to secure indebtedness incurred solely for the purpose of financing the acquisition of such equipment; (iv) Liens existing on property acquired by the Borrower or any Subsidiary, and all refundings and extensions of any such Liens; (v) Liens, deposits and/or pledges made to secure the performance of operating leases; provided that the principal amount of Debt secured by any such Lien permitted hereunder shall not exceed an amount equal to (x) one hundred percent (100%) of the cost of the real property subject to such lien or security interest or (y) one hundred percent (100%) of the cost of the personal property subject to such lien or security interest, and further provided that none of such liens or security interests shall extend to other assets of the Borrower or its Subsidiaries, (vi) Liens for taxes, assessments or other governmental charges which are not delinquent, and (vii) materialmen’s, mechanics’ or other similar liens arising in the ordinary course of business the underlying claim with respect to which is not delinquent or is being contested in good faith.

(e) Debt.  Create, incur, assume or permit to exist, or permit any Subsidiary to create, incur, assume or permit to exist, any indebtedness or liabilities resulting from borrowings,

21

loans or advances, whether matured or unmatured, liquidated or unliquidated, joint or several, secured or unsecured, except for (i) Debt incurred pursuant to the Convertible Debentures in a principal amount not to exceed $20,000,000 outstanding at any time, (ii) secured indebtedness for purchase money financing of equipment which is permitted under Section 6.02(d)(iii) in a principal amount not to exceed an aggregate of $2,000,000 outstanding at any time, (iii) other secured Debt identified on Schedule 6.02(e) not to exceed the applicable amount indicated on such schedule, (iv) unsecured senior funded bank debt in a principal amount not to exceed $30,000,000 outstanding at any time in the aggregate for the Borrower and its Subsidiaries (including, without limitation, unsecured senior funded bank debt incurred pursuant to the Loan Documents and the Union Loan Documents, and excluding the undrawn face amount of the Capistrano Letter of Credit); provided that (A) the principal amount outstanding under the credit facility provided to Suburban pursuant to the Suburban Loan Documents shall not exceed $0 at any time, and (B) the only unsecured senior funded debt of the Subsidiaries which may be outstanding shall be (I) unsecured bank indebtedness of NMUI in an aggregate principal amount not to exceed at any one time $4,000,000 and (II) other unsecured senior funded debt in a principal amount not to exceed $500,000 outstanding at any time in the aggregate for all Subsidiaries,and (v) intercompany Debt between Borrower and its majority-owned Subsidiaries.  In no event shall funded debt at Suburban exceed Suburban’s bondable capacity at any time, and any and all mortgage bonds issued by Suburban and/or NMUI subsequent to the date of this Agreement shall have an NAIC rating of “1” or “2”.

(f) Consolidation, Merger or Dissolution.  (i) Consolidate with or merge into any other Person, or permit any Subsidiary to consolidate with or merge into any other Person, unless Borrower or the applicable Subsidiary is the surviving entity and no event has occurred and is continuing, or would result from such consolidation or merger, which constitutes an Event of Default or Potential Event of Default, (ii) wind up, liquidate or dissolve (provided, however, that the corporate existence of any Subsidiary may be terminated if such termination is in the best interest of Borrower and does not result in a Change of Control) or (iii) agree to do any of the foregoing or permit any Subsidiary to agree to do any of the foregoing.

(g) Loans, Investments, Acquisitions, Secondary Liabilities.  Make or permit to remain outstanding, or permit any Subsidiary to make or permit to remain outstanding, any loan or advance to, or guarantee, induce or otherwise become contingently liable, directly or indirectly, in connection with the obligations, stock or dividends of, or own, purchase or acquire any stock, obligations or securities of or any other interest in, or make any capital contribution to, any other Person, or make any Acquisition or enter into any agreement to make any Acquisition, except that the Borrower and its Subsidiaries may:

(i)own, purchase or acquire certificates of deposit issued by a bank, commercial paper rated Moody’s P-1, municipal bonds rated Moody’s AA or better, direct obligations of the United States of America or its agencies, obligations guaranteed by the United States of America, and “money market preferred stock” issued by a corporation incorporated under the laws of the United States of America or any state thereof given on the date of such investment a credit rating of at least Moody’s Aa (and having an investment period not exceeding 50 days);

22

(ii)make Permitted Acquisitions, provided that the aggregate consideration paid or payable by Borrower and its Subsidiaries in connection with all Permitted Acquisitions consummated in any fiscal year of Borrower shall not exceed $5,000,000, provided further that such limit on consideration shall be increased to $10,000,000 with respect to each fiscal year of Borrower if all Permitted Acquisitions are made by Borrower in such fiscal year and all purchase price payments to be made by Borrower in connection with such Permitted Acquisitions are payable only in stock of Borrower;

(iii)continue to own the existing capital stock of the Borrower’s Subsidiaries;

(iv)endorse negotiable instruments for deposit or collection or similar transactions in the ordinary course of business;

(v)allow the Borrower’s Subsidiaries to make or permit to remain outstanding advances from the Borrower’s Subsidiaries to the Borrower;

(vi)make or permit to remain outstanding loans or advances to those Subsidiaries of Borrower as to which Borrower owns at least 80% of the outstanding equity;

(vii)with respect to the Borrower only, enter into or permit to remain outstanding (a) a guaranty of the unsecured bank indebtedness of NMUI in an amount not to exceed at any one time $4,000,000 for principal, plus all interest thereon and all costs and expenses pertaining to the enforcement of the guaranty and/or the collection of such indebtedness, (b) a guaranty of the unsecured bank indebtedness of Suburban in an amount not to exceed at any one time $4,000,000 for principal, plus all interest thereon and all costs and expenses pertaining to the enforcement of the guaranty and/or the collection of such indebtedness, (c) a guaranty of the senior secured bank indebtedness provided by Bank of the West to Windermere in an amount not to exceed at any one time $10,000,000 for principal, plus all interest thereon and all costs and expenses pertaining to the enforcement of the guaranty and/or the collection of such indebtedness, (d) guaranties of the obligations of ECO under that certain Service Contract for the Design, Construction, Financing and Operation of the San Juan Basin Desalter Project dated as of September 3, 2002 between the Capistrano Valley Water District and ECO and associated project agreements, and (e) a guaranty of the senior secured bank indebtedness provided by Compass Bank to Metro in an amount not to exceed at any one time $250,000 for principal, plus all interest thereon and all costs and expenses pertaining to the enforcement of the guaranty and/or the collection of such indebtedness;and

(viii)make or permit to remain outstanding loans and advances to any of its officers, shareholders or affiliates or enter into or permit to remain outstanding guarantees in connection with the obligations of its officers, shareholders or affiliates, in an aggregate amount for all such loans, advances and guarantees not exceeding $100,000 in addition to the loans outstanding and reflected on the Borrower’s financial statements dated March 31, 2003.

23

(h) Asset Sales.  Convey, sell, lease, transfer or otherwise dispose of, or permit any Subsidiary to convey, sell, lease, transfer or otherwise dispose of, in one transaction or a series of transactions, all or any part of its or its Subsidiary’s business, property or fixed assets outside the ordinary course of business, whether now owned or hereafter acquired, except that the Borrower and its Subsidiaries may convey, sell, lease, transfer or otherwise dispose of business, property or fixed assets for consideration which in the aggregate does not exceed $1,000,000 per year.  The foregoing covenant shall not extend to any property taken by eminent domain by any governmental authority or other person or entity having the power of eminent domain or to any sale in lieu of condemnation to a governmental authority or other person or entity having the power of eminent domain made after threat of condemnation by such governmental authority or other person or entity.

(i) Hostile Tender Offers.  Make any offer to purchase or acquire, or consummate a purchase or acquisition of, five percent (5%) or more of the capital stock of any publicly held corporation or other publicly held business entity, unless the board of directors of such corporation or business entity has notified the Borrower that it invites or does not oppose such offer or purchase.

(j) Distributions.  Upon the occurrence and during the continuance of an Event of Default or Potential Event of Default, authorize, declare or pay, or permit any of its Subsidiaries to authorize, declare or pay, any Distributions.

(k) Transactions with Affiliates.  Neither Borrower nor any of its Subsidiaries shall enter into any transaction for the purchase, sale or exchange of property or the rendering of any service to or by any affiliate, except in the ordinary course of and pursuant to the reasonable requirements of Borrower’s or its Subsidiary’s business and upon fair and reasonable terms no less favorable to the Borrower or its Subsidiary than Borrower or its Subsidiary would obtain in a comparable arm’s length transaction with an unaffiliated person.

(l) Books and Records.  Borrower will, and will cause each of its Subsidiaries to, keep proper books of record and account in which full, true and correct entries in conformity with GAAP and all requirements of applicable law shall be made of all dealings and transactions in relation to its business and activities.

(m) Restructure.  Make any change in the principal nature of Borrower’s and its Subsidiaries’ business operations (taken as a whole) or the date of its fiscal year.

ARTICLE VII
EVENTS OF DEFAULT

SECTION 7.01.  Events of Default.  If any of the following events (“Events of Default”) shall occur and be continuing:

(a)Borrower shall fail to pay within three (3) days of the date when due, any principal, interest, fees or other amounts payable under any of the Loan Documents; or

24

(b)Any representation or warranty made by the Borrower herein or by the Borrower (or any of its officers)  in connection with the Loan Documents shall prove to have been incorrect in any material respect when made; or

(c)Borrower shall fail to perform or observe any term, any affirmative or negative covenant, including, but not limited to, those covenants set forth in Sections 6.01 and 6.02 hereof, or any other agreement contained in this Agreement on its part to be performed or observed (other than those referred to in subsections (a) and (b) above); and with respect to any such default which by its nature can be cured, such default shall continue for a period of twenty (20) days from its occurrence; or

(d)The Borrower or any of its Subsidiaries shall default in the performance of or compliance with any term contained in any Loan Document other than this Agreement and such default shall not have been remedied or waived within any applicable grace period in such Loan Document or in (c) above; or

(e)The Borrower shall default in the performance of or compliance with any term contained in any Union Loan Document, and such default shall continue after the applicable grace period, if any, specified in the applicable Union Loan Document; or

(f)to the extent not already addressed in this Section 7.01, (i) The Borrower or any of its Subsidiaries shall (A) fail to pay any principal of, or premium or interest on, any Debt the aggregate outstanding principal amount of which is at least $500,000 (excluding Debt evidenced by the Revolving Note), when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such Debt, or (B) fail to perform or observe any term, covenant or condition on its part to be performed or observed under any agreement or instrument relating to any such Debt or material to the performance, business, property, assets, condition (financial or otherwise) or prospects of the Borrower and its Subsidiaries taken as a whole, when required to be performed or observed, and such failure shall continue after the applicable grace period, if any, specified in such agreement or instrument; or

(g)(i) The Borrower or any of its Subsidiaries shall commence any case, proceeding or other action (A) under any existing or future law of any jurisdiction, domestic or foreign, relating to bankruptcy, insolvency, reorganization or relief of debtors, seeking to have an order for relief entered with respect to it, or seeking to adjudicate it a bankrupt or insolvent, or seeking reorganization, arrangement, adjustment, winding-up, liquidation, dissolution, composition or other relief with respect to it or its debts, or (B) seeking appointment of a receiver, trustee, custodian or other similar official for it or for all or any substantial part of its assets, or the Borrower or any of its Subsidiaries shall make a general assignment for the benefit of its creditors; or (ii) there shall be commenced against the Borrower or any of its Subsidiaries any case, proceeding or other action of a nature referred to in clause (i) above which (A) results in the entry of an order for relief or any such adjudication or appointment or (B) remains undismissed, undischarged or unbonded for a period of sixty (60) days (Bank may, in its discretion, cease making Revolving Loans during the pendency of such action or proceeding); or (iii) there shall be commenced against the Borrower or any of its Subsidiaries any case,

25

proceeding or other action seeking issuance of a warrant of attachment, execution, distraint or similar process against all or any substantial part of its assets which results in the entry of an order for any such relief which shall not have been vacated, discharged, or stayed or bonded pending appeal within sixty (60) days from the entry thereof (Bank may, in its discretion, cease making Revolving Loans during the pendency of such action or proceeding); or (iv) the Borrower or any of its Subsidiaries shall take any action in furtherance of, or indicating its consent to, approval of, or acquiescence in, any of the acts set forth in clauses (i), (ii) and (iii) above; or (v) the Borrower or any of its Subsidiaries shall generally not, or shall be unable to, or shall admit in writing its inability to, pay its debts as they become due; or

(h)One or more judgments or decrees shall be entered against the Borrower or any of its Subsidiaries involving in the aggregate a liability (not paid or fully covered by insurance or reserves)  equal to or greater than $500,000 and all such judgments or decrees shall not have been vacated, discharged, or stayed or bonded pending appeal within thirty (30) days from the entry thereof; or

(i)(i)  The Borrower or any of its ERISA Affiliates fails to make full payment when due of all material amounts which, under the provisions of any Pension Plan or Section 412 of the Internal Revenue Code, the Borrower or any of its ERISA Affiliates is required to pay as contributions thereto and such development is not remedied or reversed within fifteen (15) days after the Borrower knows of such development;

(ii)any material accumulated funding deficiency occurs or exists, whether or not waived, with respect to any Pension Plan and such development is not remedied or reversed within fifteen (15) days after the Borrower knows of such development;

(iii)the excess of the actuarial present value of all benefit liabilities under all Pension Plans over the fair market value of the assets of such Pension Plans (excluding in such computation Pension Plans with assets greater than benefit liabilities)  allocable to such benefit liabilities are greater than five percent (5%) of Consolidated Tangible Net Worth and such development is not remedied or reversed within fifteen (15)  days after the Borrower knows of such development;

(iv)the Borrower or any of its ERISA Affiliates enters into any transaction which has as its principal purpose the evasion of liability under Subtitle D of Title IV of ERISA;

(v)(A) Any Pension Plan maintained by the Borrower or any of its ERISA Affiliates shall be terminated within the meaning of Title IV of ERISA in a distress termination, or (B) a trustee shall be appointed by an appropriate United States district court in accordance with Section 4042 of ERISA to administer any Pension Plan, or (C) the Pension Benefit Guaranty Corporation (or any successor thereto) shall institute proceedings to terminate any Pension Plan or to appoint a trustee to administer any Pension Plan in accordance with Section 4042 of ERISA, or (D) the Borrower or any of its ERISA Affiliates shall withdraw (under Section 4063 of ERISA) from a Pension Plan, if as of the date of the event listed in subclauses (A)-(D) above or any subsequent date,

26

either the Borrower or its ERISA Affiliates has any material liability (such liability to include, without limitation, any liability to the Pension Benefit Guaranty Corporation, or any successor thereto, or to any other party under Sections 4062, 4063 or 4064 of ERISA or any other provision of law) resulting from or otherwise associated with the events listed in subclauses (A)-(D) above;

(vi)As used in this subsection 7.01(i) the term “accumulated funding deficiency” has the meaning specified in Section 412 of the Internal Revenue Code, and the term “benefit liabilities” has the meaning specified in Section 4001 of ERISA;

(j)There shall be instituted against the Borrower or any Subsidiary, or against any guarantor, any proceeding for which forfeiture of any property with a value of $500,000 or more is a potential penalty and such proceeding remains undismissed, undischarged or unbonded for a period of thirty (30) days from the date the Borrower knows of such proceeding; or

(k)A Change of Control shall have occurred.

Then, (i) upon the occurrence of any Event of Default described in clause 7.01(g) above, the Commitment shall immediately terminate and all Revolving Loans hereunder with accrued interest thereon, and all other amounts owing under the Loan Documents shall automatically become due and payable, and (ii) upon the occurrence of any other Event of Default, the Bank may, by notice to the Borrower, declare the Commitment to be terminated forthwith, whereupon the Commitment shall immediately terminate; and, by notice to the Borrower, declare the Revolving Loans hereunder, with accrued interest thereon, and all other amounts owing under the Loan Documents to be due and payable forthwith, whereupon the same shall immediately become due and payable.  Bank shall have all rights, powers and remedies available under each of the Loan Documents, or accorded by law, including, without limitation, the right to resort to any or all security for any credit accommodation from the Bank subject hereto and to exercise any or all of the rights of a beneficiary or secured party pursuant to applicable law.  All rights, powers and remedies of Bank in connection with each of the Loan Documents may be exercised at any time by Bank and from time to time after the occurrence of an Event of Default, are cumulative and not exclusive, and shall be in addition to any other rights, powers or remedies provided by law or equity.  Except as expressly provided above in this Section, presentment, demand, protest and all other notices of any kind are hereby expressly waived. Notwithstanding any other provision of this Agreement, including Section 8.02, notices to the Borrower under this Section shall be communicated in writing (including telex or facsimile transmissions).

ARTICLE VIII
MISCELLANEOUS

SECTION 8.01.  Amendments, Etc.  No amendment or waiver of any provision of the Loan Documents nor consent to any departure by the Borrower therefrom, shall in any event be effective unless the same shall be in writing and signed by the Bank, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given.

27

SECTION 8.02.  Notices, Etc.  Except as otherwise set forth in this Agreement, all notices and other communications provided for hereunder shall be in writing (including facsimile communication) and mailed certified mail, return receipt requested or sent by facsimile or delivered, if to the Borrower, at its address set forth on the signature page hereof; and if to the Bank, at its address set forth on the signature page hereof; or, as to each party, at such other address as shall be designated by such party in a written notice to the other parties. All such notices and communications shall be effective upon personal delivery or upon receipt when sent by facsimile, or on the date of receipt or refusal indicated on the return receipt if sent by certified mail, except that notices and communications to the Bank pursuant to Article II or VII shall not be effective until received by the Bank.

SECTION 8.03.  Right of Setoff:  Security Interest in Deposit Accounts.  Upon and only after the occurrence of any Event of Default not cured within any applicable grace period, the Bank is hereby authorized by the Borrower, at any time and from time to time, without notice, (a) to set off against, and to appropriate and apply to the payment of, the obligations and liabilities of the Borrower under the Loan Documents (whether matured or unmatured, fixed or contingent or liquidated or unliquidated) any and all amounts owing by the Bank to the Borrower (whether payable in Dollars or any other currency, whether matured or unmatured, and, in the case of deposits, whether general or special, time or demand and however evidenced) and (b) pending any such action, to the extent necessary, to hold such amounts as collateral to secure such obligations and liabilities and to return as unpaid for insufficient funds any and all checks and other items drawn against any deposits so held as the Bank in its sole discretion may elect. The Borrower hereby grants to the Bank a security interest in all deposits and accounts maintained with the Bank and with any other financial institution. The Bank is authorized to debit any account maintained with it by the Borrower for any amount of principal, interest or fees which are then due and owing to the Bank.

SECTION 8.04.  No Waiver; Remedies.  No failure on the part of either party hereto to exercise, and no delay in exercising, any right under any of the Loan Documents shall operate as a waiver thereof; nor shall any single or partial exercise of any right under any of the Loan Documents preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law.

SECTION 8.05.  Costs and Expenses.  Borrower shall pay to Bank immediately upon demand the full amount of all costs and expenses, including reasonable attorneys’ fees (to include outside counsel fees and all allocated costs of Bank’s in-house counsel), incurred by Bank in connection with (a) the negotiation and preparation of this Agreement and each other of the Loan Documents, and the preparation of any amendments and waivers hereto and thereto, (b) the enforcement of Bank’s rights and/or the collection of any amounts which become due to Bank under any of the Loan Documents (including, without limitation, in appellate, bankruptcy, insolvency, liquidation, reorganization, moratorium or other similar proceedings) or the restructuring of the Loan Documents, and (c) the prosecution or defense of any action in any way related to any of the Loan Documents, including, without limitation, any action for declaratory relief.

SECTION 8.06.  Participations.  The Bank may sell, assign, transfer, negotiate or grant participations to other financial institutions in all or part of the obligations of the Borrower

28

outstanding under the Loan Documents, provided that any such sale, assignment, transfer, negotiation or participation shall be in compliance with the applicable federal and state securities laws; and provided further that any assignee or transferee agrees to be bound by the terms and conditions of this Agreement. The Bank may, in connection with any actual or proposed assignment or participation, disclose to the actual or proposed assignee or participant, any information relating to the Borrower or any of its Subsidiaries.

SECTION 8.07.  Effectiveness: Binding Effect.  This Agreement shall become effective when it shall have been executed by the Borrower and the Bank and thereafter shall be binding upon and inure to the benefit of the Borrower, the Bank and their respective successors and assigns, except that the Borrower shall not have the right to assign its rights hereunder or any interest herein without the prior written consent of the Bank.

SECTION 8.08.  Governing Law.  The validity, interpretation and enforcement of this Agreement and the other Loan Documents (except to the extent otherwise provided in any such Loan Document) and any dispute arising out of the relationship between the parties hereto or thereto, whether in contract, tort, equity or otherwise, shall be governed by the internal laws of the State of California (without giving effect to principles of conflicts of law).

SECTION 8.09.  Dispute Resolution.  This Agreement hereby incorporates any alternative dispute resolution agreement previously, concurrently or hereafter executed between Borrower and Bank.

SECTION 8.10.  Waiver of Notices.  Borrower hereby expressly waives demand, presentment, protest and notice of protest and notice of dishonor with respect to any and all instruments, included in or evidencing any of the obligations, and any and all other demands and notices of any kind or nature whatsoever with respect to the obligations and this Agreement, except such as are expressly provided for herein.  No notice to or demand on Borrower which Bank may elect to give shall entitle Borrower to any other or further notice or demand in the same, similar or other circumstances.

SECTION 8.11.  Entire Agreement.  This Agreement with Exhibits and Schedules and the other Loan Documents embody the entire agreement and understanding between the parties hereto and supersede all prior agreements and understandings relating to the subject matter hereof.  In the event of any conflict between the provisions of this Agreement and those of any other Loan Document, the provisions of this Agreement shall control and govern; provided that the inclusion of supplemental rights or remedies in favor of Bank in any other Loan Document shall not be deemed a conflict with this Agreement.

SECTION 8.12.  Severability of Provisions.  In case any one or more of the provisions contained in this Agreement should be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not in any way be affected or impaired thereby.

SECTION 8.13.  Execution in Counterparts.  This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which

29

when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement.

SECTION 8.14.  Further Assurances.  Without limiting in any manner any other obligation, requirement or agreement hereunder or under any of the other Loan Documents or otherwise, Borrower shall, at its expense and without expense to Bank, do, execute and deliver such further acts and documents as Bank from time to time reasonably requires for the assuring and confirming unto Bank of the rights hereby created or intended now or hereafter so to be, or for carrying out the intention or facilitating the performance of the terms of any Loan Document.

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written.

BANK OF AMERICA, N.A.	SOUTHWEST WATER COMPANY
By:	By:
Name:	Name:
Title:	Title:
Address:	Address:
Bank of America	One Wilshire Building
675 Anton Boulevard, 2nd Floor	624 S. Grand Avenue, Suite 2900
Costa Mesa, California  92626	Los Angeles, California  90017
Attention: Jamie L. Freeman	Attention: Thomas C. Tekulve
Title: Vice President	Vice President and Treasurer
Facsimile: (714) 850-6586	Facsimile: (213) 929-1888

30

SCHEDULE 5.01(f) - LITIGATION

None other than as reported on Form 10-Q of Borrower for the quarter ended June 30, 2003 and Form 10-K of Borrower for the year ended December 31, 2002.

31

SCHEDULE 5.01(i) - ENVIRONMENTAL MATTERS

See Form 10-Q of Borrower for the quarter ended June 30, 2003 and Form 10-K of Borrower for the year ended December 31, 2002.

32

SCHEDULE 6.02(d) - LIENS

None except as disclosed in the audited consolidated financial statements of Borrower for the fiscal year ended 2002.

33

SCHEDULE 6.02(e) – OTHER SECURED DEBT

None other than as reported on Form 10-K of Borrower for the year ended December 31, 2002.

34

EXHIBIT A

REVOLVING NOTE

$15,000,000 October           , 2003

FOR VALUE RECEIVED, the undersigned SOUTHWEST WATER COMPANY, a Delaware corporation (“Borrower”) promises to pay to the order of BANK OF AMERICA, N.A. (“Bank”) at its office at 675 Anton Boulevard, 2^nd Floor, Costa Mesa, California 92626, or at such other place as the holder hereof may designate, in lawful money of the United States of America and in immediately available funds, the principal sum of Fifteen Million Dollars ($15,000,000), or so much thereof as may be advanced and be outstanding, with interest thereon, to be computed on each advance from the date of its disbursement (computed on the basis of a 360-day year and actual days elapsed, which results in more interest than if a 365-day year were used) at a rate per annum equal to the applicable LIBOR Rate plus one and one-quarter percent (1.25%) or the Prime Rate minus one-quarter of one percent (0.25%).  When interest is determined in relation to the Prime Rate, each change in the rate of interest hereunder shall become effective on the opening of business on the day specified in the public announcement of a change in Bank’s Prime Rate. With respect to each LIBOR option selected hereunder, Bank is hereby authorized to note the date, principal amount, interest rate and applicable LIBOR Rate Term thereto and any payments made thereon on Bank’s books and records (either manually or by electronic entry) and/or on any schedule attached to this Note, which notations shall be prima facie evidence of the accuracy of the information noted.

A.DEFINITIONS:

Capitalized terms used and not otherwise defined herein shall have the meanings given such terms in the Credit Agreement referred to below.  As used herein, the following terms shall have the meanings set forth after each:

1.“Agreement” means that certain Credit Agreement between Borrower and Bank dated as of October 6, 2003, as amended from time to time, including, without limitation, those terms relating to arbitration of disputes.

2.“Business Day” means any day except a Saturday, Sunday or any other day designated as a holiday under Federal or California statute or regulation, or for amounts bearing interest based on the LIBOR Rate, any Business Day is any day except a Saturday, Sunday or any other day designated as a holiday under Federal or California statute or regulation on which dealings in Dollar deposits are conducted by and among banks in the Designated LIBOR Market.

3.“Designated LIBOR Market” means the regular established market located in London by and among banks for the solicitation, offer and acceptance of Dollar deposits in such banks.

4.“Dollars” means United States of America dollars.

5.“LIBOR Rate” means the interest rate determined by the following formula, rounded upward, if necessary, to the nearest 1/100 of one percent. (All amounts in the calculation will be determined by Bank as of the first day of the interest period.)

35

LIBOR Rate =	LIBOR Base Rate
	(1.00 - Reserve Percentage)

(a)“LIBOR Base Rate” means, with respect to any Revolving Loan to be made by Bank which is to bear interest in relation to the LIBOR Rate, the interest rate per annum (rounded upward, if necessary, to the nearest 1/100^th of 1%) at which deposits in Dollars are offered by Bank through its London Banking Center, London, Great Britain to prime banks in the Designated LIBOR Market on the first day of the applicable LIBOR Rate Term in an aggregate amount approximately equal to the amount of the Revolving Loan to be made by Bank and for a period of time comparable to the number of days in the applicable LIBOR Rate Term.  The determination of the LIBOR Base Rate by Bank shall be conclusive in the absence of manifest error.

(b)  “Reserve Percentage” means, with respect to any Revolving Loan to be made by Bank which is to bear interest in relation to the LIBOR Rate, the maximum reserve percentage (expressed as a decimal, rounded upward, if necessary, to the nearest 1/100 of one percent) in effect on the date the LIBOR Base Rate for the Revolving Loan is determined (whether or not such reserve percentage is applicable to Bank) under regulations issued from time to time by the Federal Reserve Board for determining the maximum reserve requirement (including any emergency, supplemental or other marginal reserve requirement) with respect to eurocurrency funding (currently referred to as “eurocurrency liabilities”) having a term comparable to the LIBOR Rate Term for such Revolving Loan.  The determination by Bank of any applicable Reserve Percentage shall be conclusive in the absence of manifest error.

6.“LIBOR Rate Portion” means a portion of the principal amount outstanding under this Note which is bearing interest at a rate related to LIBOR. No LIBOR Rate Portion shall be less than Two Hundred Fifty Thousand Dollars ($250,000).

7.“LIBOR Rate Term” means a period commencing on a Business Day and continuing for one (1) month, two (2) months, three (3) months, six (6) months or twelve (12) months, as designated by Borrower, during which all or a portion of the outstanding principal balance of this Note bears interest determined in relation to Bank’s LIBOR; provided however, that no LIBOR Rate Term shall extend beyond the scheduled maturity date hereof. The last day of the interest period will be determined by Bank using the Designated LIBOR Market. If any LIBOR Rate Term would end on a day which is not a Business Day, then such LIBOR Rate Term shall be extended to the next succeeding Business Day.

8.“Prime Rate” means the rate of interest publicly announced from time to time by the Bank as its Prime Rate.  The Prime Rate is set by the Bank based on various factors, including the Bank’s costs and desired return, general economic conditions and other factors, and is used as a reference point for pricing some loans.  The Bank may price loans to its customers at, above or below the Prime Rate.  Any change in the Prime Rate will take effect at the opening of business on the day specified in the public announcement of a change in the Bank’s Prime Rate.

36

B.INTEREST:

1.Payment of Interest. Interest accrued on this Note shall be payable on the fifteenth (15^th) day of each month for the prior month or portion thereof, commencing October 15, 2003.

2.Selection of Interest Rate Options. At any time any portion of this Note bears interest determined in relation to the LIBOR Rate, it may be continued by Borrower at the end of the LIBOR Rate Term applicable thereto so that all or a portion thereof bears interest determined in relation to the Prime Rate or in relation to the LIBOR Rate for a new LIBOR Rate Term designated by Borrower. At any time any portion of this Note bears interest determined in relation to the Prime Rate, Borrower may convert all or a portion thereof so that it bears interest determined in relation to the LIBOR Rate for a LIBOR Rate Term designated by Borrower. At the time each advance is requested hereunder or Borrower wishes to select the LIBOR option for all or a portion of the outstanding principal balance hereof, and at the end of each LIBOR Rate Term, Borrower shall give Bank notice specifying (a) the interest rate option selected by Borrower, (b) the principal amount subject thereto, and (c) if the LIBOR option is selected, the length of the applicable LIBOR Rate Term. Any such notice may be given by telephone so long as, with respect to each LIBOR selection, such notice is given to Bank prior to 10:00 a.m., California time, on the third Business Day prior to the commencement of the LIBOR Rate Term and, with respect to each Prime Rate selection, such notice is given to Bank prior to 11:00 a.m., California time, on the day of the requested advance. For each LIBOR option requested hereunder, Bank will quote the applicable LIBOR Rate to Borrower at approximately 10:00 a.m., California time, on the second Business Day prior to the LIBOR Rate Term. If Borrower does not immediately accept the rate quoted by Bank, any subsequent acceptance by Borrower shall be subject to a re-determination by Bank of the applicable LIBOR Rate; provided however, that if Borrower fails to accept any such rate by 11:00 a.m., California time, on the Business Day such quotation is given, then the quoted rate shall expire and Bank shall have no obligation to permit a LIBOR option to be selected on such day. If no specific designation of interest is made at the time any advance is requested hereunder or at the end of any LIBOR Rate Term, Borrower shall be deemed to have made a Prime Rate interest selection for such advance or the principal amount to which such LIBOR Rate Term applied.

3.Additional LIBOR Provisions.

(a)If Bank at any time shall determine that for any reason adequate and reasonable means do not exist for ascertaining the LIBOR Rate, then Bank shall promptly give notice thereof to Borrower. If such notice is given and until such notice has been withdrawn by Bank, then (i) no new LIBOR option may be selected by Borrower, and (ii) any portion of the outstanding principal balance hereof which bears interest determined in relation to the LIBOR Rate, subsequent to the end of the LIBOR Rate Term applicable thereto, shall bear interest determined in relation to the Prime Rate.

(b)If any law, treaty, rule, regulation or determination of a court or governmental authority or any change therein or in the interpretation or application thereof (each, a “Change in Law”) shall make it unlawful for Bank (i) to make LIBOR options available hereunder, or (ii) to maintain interest rates based on the LIBOR Rate, then in the former event, any obligation of Bank to make available such unlawful LIBOR options shall immediately be cancelled, and in the

37

latter event, any such unlawful LIBOR-based interest rates then outstanding shall be converted, at Bank’s option, so that interest on the portion of the outstanding principal balance subject thereto is determined in relation to the Prime Rate; provided however, that if any such Change in Law shall permit any LIBOR-based interest rates to remain in effect until the expiration of the LIBOR Rate Term applicable thereto, then such permitted LIBOR-based interest rates shall continue in effect until the expiration of such LIBOR Rate Term. Upon the occurrence of any of the foregoing events, Borrower shall pay to Bank immediately upon demand such amounts as may be necessary to compensate Bank for any fines, fees, charges, penalties or other costs incurred or payable by Bank as a result thereof and which are attributable to any LIBOR options made available to Borrower hereunder, and any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower.

(c)If any Change in Law or compliance by Bank with any request or directive (whether or not having the force of law) from any central bank or other governmental authority shall:

(i)subject Bank to any tax, duty or other charge with respect to any LIBOR options, or change the basis of taxation of payments to Bank of principal, interest, fees or any other amount payable hereunder (except for changes in the rate of tax on the overall net income of Bank); or

(ii)impose, modify or hold applicable any reserve, special deposit, compulsory loan or similar requirement against assets held by, deposits or other liabilities in or for the account of advances or loans by, or any other acquisition of funds by any office of Bank; or

(iii)impose on Bank any other condition; and the result of any of the foregoing is to increase the cost to Bank of making, renewing or maintaining any LIBOR options hereunder and/or to reduce any amount receivable by Bank in connection therewith, then in any such case, Borrower shall pay to Bank immediately upon demand such amounts as may be necessary to compensate Bank for any additional costs incurred by Bank and/or reductions in amounts received by Bank which are attributable to such LIBOR options. In determining which costs incurred by Bank and/or reductions in amounts received by Bank are attributable to any LIBOR options made available to Borrower hereunder, any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower.

(d)Bank will have no obligation to accept an election of Borrower for the LIBOR option if any of the following described events has occurred and is continuing:

(i)  Dollar deposits in the principal amount, and for periods equal to the LIBOR Rate Term, of any Revolving Loan which bears interest in relation to the LIBOR Rate are not available in the Designated LIBOR Market; or

(ii)  an Event of Default has occurred and is continuing; or

(iii) the LIBOR Rate does not accurately reflect the cost of any Revolving Loan which bears interest in relation to the LIBOR Rate.

38

4.Default Interest. During the continuance of an Event of Default, the outstanding principal balance of this Note shall bear interest until paid in full at an increased rate per annum (computed on the basis of a 360-day year and actual days elapsed, which results in more interest than if a 365-day year were used) equal to two percent (2.00%) above the rate of interest from time to time applicable to this Note (the “Default Rate”).

C.BORROWING AND REPAYMENT:

1.Loan and Repayment. Borrower may from time to time during the term of this Note borrow, partially or wholly repay its outstanding borrowings, and re-borrow, subject to all of the limitations, terms and conditions of this Note and of any document executed in connection with or governing this Note, including the Credit Agreement; provided however, that the total outstanding borrowings under this Note shall not at any time exceed the principal amount stated above. The unpaid principal balance of this obligation at any time shall be the total amounts advanced hereunder by the holder hereof less the amount of principal payments made hereon by or for Borrower, which balance may be endorsed hereon from time to time by the holder.  The outstanding principal balance of this Note shall be due and payable in full on the “Maturity Date” (as defined in the Credit Agreement).

2.Advances. Advances hereunder, to the total amount of the principal sum stated above, may be made by the holder at the oral or written request of (a) Thomas C. Tekulve, Richard Shields, or Leslie-Ward Cline, any one acting alone, who are authorized to request advances and direct the disposition of any advances until written notice of the revocation of such authority is received by the holder at the office designated above, or (b) any person, with respect to advances deposited to the credit of any account of Borrower with the holder, which advances, when so deposited, shall be conclusively presumed to have been made to or for the benefit of Borrower regardless of the fact that persons other than those authorized to request advances may have authority to draw against such account. The holder shall have no obligation to determine whether any person requesting an advance is or has been authorized by Borrower.

3.Application of Payments. Each payment made on this Note shall be credited first, to any interest then due and second, to the outstanding principal balance hereof. Unless instructed otherwise by Borrower, all payments credited to principal shall be applied first, to the outstanding principal balance of this Note which bears interest determined in relation to the Prime Rate, if any, and second, to the outstanding principal balance of this Note which bears interest determined in relation to the LIBOR Rate, with such payments applied to the oldest LIBOR Rate Term first.

4.Prepayment.

(a)Prime Rate. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to the Prime Rate at any time, in any amount and without penalty.

(b)LIBOR. Each prepayment of a LIBOR Rate Portion shall be not less than $250,000 and shall be in an integral multiple of $100,000, and Bank shall have received notice of each such prepayment on the date that is five (5) Business Days before the date of such

39

prepayment (which notice shall identify the date and amount of the prepayment).  Each prepayment of a LIBOR Rate Portion, whether voluntary, by reason of acceleration or otherwise, will be accompanied by the amount of accrued interest on the amount prepaid, and a prepayment fee as described below. A “prepayment” is a payment on a date earlier than the last day of the applicable LIBOR Rate Term. The prepayment fee shall be equal to the amount (if any) by which:

(i)the additional interest which would have been payable during the applicable LIBOR Rate Term on the amount prepaid had it not been prepaid, exceeds

(ii)the interest which would have been recoverable by Bank by placing the amount prepaid on deposit in the domestic certificate of deposit market, the eurodollar deposit market, or other appropriate money market selected by Bank for a period starting on the date on which it was prepaid and ending on the last day of the applicable LIBOR Rate Term.

Borrower acknowledges that prepayment of such amount may result in Bank incurring additional costs, expenses and/or liabilities, and that it is difficult to ascertain the full extent of such costs, expenses and/or liabilities. Borrower, therefore, agrees to pay the above-described prepayment fee and agrees that said amount represents a reasonable estimate of the prepayment costs, expenses and/or liabilities of Bank. If Borrower fails to pay any prepayment fee when due, the amount of such prepayment fee shall thereafter bear interest until paid at a rate per annum two percent (2.00%)above the Prime Rate in effect from time to time (computed on the basis of a 360-day year, actual days elapsed).

D.EVENTS OF DEFAULT:

This Note is made pursuant to and is subject to the terms and conditions of the Credit Agreement.  Any default in the payment or performance of any obligation under this Note, or any defined event of default under the Credit Agreement, shall constitute an “Event of Default” under this Note.

E.MISCELLANEOUS:

1.Remedies.  Upon the occurrence of any Event of Default, the holder of this Note, at the holder’s option, without notice upon the occurrence of an Event of Default pursuant to Section 7.01(g) of the Credit Agreement, and with notice upon the occurrence of any other Event of Default, may declare all sums of principal and interest outstanding hereunder to be immediately due and payable without presentment, demand, protest or notice of dishonor, all of which are expressly waived by Borrower, and the obligation, if any, of the holder to extend any further credit hereunder shall immediately cease and terminate. Borrower shall pay to the holder immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys’ fees (to include outside counsel fees and all allocated costs of the holder’s in-house counsel), incurred by the holder in connection with the enforcement of the holder’s rights and/or the collection of any amounts which become due to the holder under this Note, and the prosecution or defense of any action in any way related to this

40

Note, including without limitation, any action for declaratory relief, and including any of the foregoing incurred in connection with any bankruptcy proceeding relating to Borrower.

2.Obligations Joint and Several. Should more than one person or entity sign this Note as a Borrower, the obligations of each such Borrower shall be joint and several.

3.Governing Law. This Note shall be governed by and construed in accordance with the laws of the State of California, except to the extent Bank has greater rights or remedies under Federal law, whether as a national bank or otherwise, in which case such choice of California law shall not be deemed to deprive Bank of any such rights and remedies as may be available under Federal law.

“Borrower”

SOUTHWEST WATER COMPANY,

a Delaware corporation

By:

Name:

Title:

41

EX-10.11(B)

Exhibit 10.11(b)

CHANGE IN TERMS AGREEMENT

Principal		Loan Date	Maturity	Loan No.	call/coll	Account	Officer	Initials
$	4,000,000.00	04-10-2002	04-10-2004	1000137188-18		SWEEP	***

References in the shaded area are for Lender’s use only and do not limit the applicability of this document to any particular loan or item.  Any item above containing “***” has been omitted due to text length limitations.

Borrower: NEW MEXICO UTILITIES, INC.
4700 Irving Boulevard NW, Suite 2O1
Albuquerque, NM 87114 Lender: BANK OF THE WEST
New Mexico Business Banking #223M
500 Marquette, 14th Floor
Albuquerque, NM 87102
(888) 457-2892

Principal Amount:   $4,000,000.00 Date of Agreement: July 10, 2003

DESCRIPTION OF EXISTING INDEBTEDNESS.  The Promissory Note dated April 10, 2002 in the original principal amount of $4,000,000.00 and Business Loan Agreement dated April 10, 2002.

DESCRIPTION OF COLLATERAL. Unsecured.

DESCRIPTION OF CHANGE IN TERMS.

1.     Extension of Maturity Date.  The Maturity Date provided for in the Promissory Note shall be extended from April 10, 2004 to April 30, 2005.

2.     Modification of MONTHLY LOAN FEE.  Heading captioned “MONTHLY LOAN FEE” of the Promissory Note is deleted in its entirety and the following is substituted in lieu thereof:

MONTHLY LOAN FEE.  Borrower will pay to Lender a monthly loan fee in the amount of $400.00, which fee shall be payable on a monthly basis and represent an unconditional and non-refundable payment to Lender in consideration of Lender’s agreement to enter in to this Note.

3.     Deleting GUARANTOR(S) AGREE TO FURNISH LENDER WITH THE FOLLOWING.  Heading captioned “GUARANTOR(S) AGREE TO FURNISH LENDER WITH THE FOLLOWING” of the Business Loan Agreement is deleted in its entirety.

4.     Conditions Precedent.  As a condition precedent to the effectiveness of this Change in Terms Agreement, (a) Borrower agrees to provide a commercial guaranty executed by Southwest Water Company; (b) Borrower agrees to pay to Lender a renewal fee of $250.00.

CONTINUING VALIDITY.  Except as expressly changed by this Agreement, the terms of the original obligation or obligations, including all agreements evidenced or securing the obligations(s), remain unchanged and in full force and effect.  Consent by Lender to this Agreement does not waive Lender’s right to strict performance of the obligation(s) as changed, nor obligate Lender to make any future change in terms.  Nothing in this Agreement will constitute a satisfaction of the obligations(s).  It is the intention of Lender to retain as liable parties all makers and endorsers of the original obligations(s), including accommodation parties, unless a party is expressly released by Lender in writing, Any maker or endorser, including accommodation makers, will not be released by virtue of this Agreement.  If any person who signed the original obligation does not sign this Agreement below, then all persons signing below acknowledge that this Agreement is given conditionally, based on the representation to Lender that the non-signing party consents to the changes and provisions of this Agreement or otherwise will not be released by it.  This waiver applies not only to any initial extension, modification or release, but also all such subsequent actions.

PRIOR TO SIGNING THIS AGREEMENT, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF THIS AGREEMENT, INCLUDING THE VARIABLE INTEREST RATE PROVISIONS.  BORROWER AGREES TO THE TERMS OF THE AGREEMENT.

CIT SIGNERS:

NEW MEXICO UTILITIES, INC.

By:	/s/ [ILLEGIBLE]	By:	/s/ [ILLEGIBLE]
	Bobby L. Gay, V.P. & General Manager of NEW MEXICO UTILITIES, INC.		Michael O. Quinn, Secretary & Treasure of NEW MEXICO UTILITIES. INC.

BANK OF THE WEST

By:	/s/  Elizabeth R. Allbright
	Elizabeth R. Allbright, Vice President of BANK OF THE WEST

COMMERCIAL GUARANTY

Principal	Loan Date	Maturity	Loan No.	call/coll	Account	Officer	Initials
						***

References in the shaded area are for Lender’s use only and do not limit the applicability of this document to any particular loan or item.  Any item above containing “***” has been omitted due to text length limitations.

Borrower:	NEW MEXICO UTILITIES, INC. 4700 Irving Boulevard NW, Suite 201 Albuquerque NM  87114	Lender:	BANK OF THE WEST New Mexico Business Banking #223J 5501 Jefferson NE Albuquerque, NM 87109 (888) 457-2692
Guarantor:	SOUTHWEST WATER COMPANY 225 N. Barranca Avenue, Suite 200 West Covina, CA 91791

AMOUNT OF GUARANTY.  The amount of this Guaranty is Unlimited.

CONTINUING UNLIMITED GUARANTY.  For good and valuable consideration, SOUTHWEST WATER COMPANY (“Guarantor”) absolutely and unconditionally guarantees and promises to pay to BANK OF THE WEST (“Lender”) or its order, in legal tender of the United States of America, the Indebtedness (as that term is defined below) of NEW MEXICO UTILITIES, INC. (“Borrower”) to Lender on the terms and conditions set forth in this Guaranty.  Under this Guaranty, the liability of Guarantor is unlimited and the obligations of Guarantor are continuing.

INDEBTEDNESS GUARANTEED.  The Indebtedness guaranteed by this Guaranty includes and any and all of Borrower’s Indebtedness to Lender and is used in the most comprehensive sense and means and includes any and all of Borrower’s liabilities, obligations and debts to Lender, now  existing or hereinafter incurred or created, including, without limitation, all loans, advances, interest, costs, debts, overdraft indebtedness, credit card indebtedness, lease obligations, other obligations, and liabilities of Borrower, or any of them, and any present or future judgments against Borrower, or any of them; and whether any such Indebtedness is voluntarily or involuntarily incurred, due or not due, absolute or contingent, liquidate or unliquidated, determined or undetermined; whether Borrower may be liable individually or jointly with others, or primarily or secondarily, or as guarantor or surety; whether recovery on the Indebtedness may be or may become barred or unenforceable against Borrower for any reason whatsoever; and whether the Indebtedness arises from transactions which may be voidable on account of infancy, insanity, ultra vires, or otherwise.

DURATION OF GUARANTY.  This Guaranty will take effect when received by Lender without the necessity of any acceptance by Lender, or any notice to Guarantor or to Borrower, and will continue in full force until all Indebtedness incurred or contracted before receipt by Lender of any notice of revocation shall have been fully and finally paid and satisfied and all of Guarantor’s other obligations under this Guaranty shall have been performed in full.  If Guarantor elects to revoke this Guaranty, Guarantor may only do so in writing.  Guarantor’s written notice of revocation must be mailed to Lender, by certified mail, at Lender’s address listed above or such other place as Lender may designate in writing Written revocation of this Guaranty will apply only to advances or new Indebtedness created after actual receipt by Lender of Guarantor’s written revocation.  For this purpose and without limitation, the term “new indebtedness” does not include Indebtedness which at the time of notice of revocation is contingent, unliquidated, undetermined or not due and which later becomes absolute, liquidated, determined or due.  This Guaranty will continue to bind Guarantor for all Indebtedness incurred by Borrower or committed by Lender prior to receipt of Guarantor’s written notice of revocation, including any extensions, renewals, substitutions or modifications of the indebtedness.  All renewals, extensions, substitutions, and modifications of the Indebtedness granted after Guarantor’s revocation, are contemplated under this Guaranty and, specifically will not be considered to be new Indebtedness.  This Guaranty shall bind Guarantor’s estate as to Indebtedness created both before and after Guarantor’s death or incapacity, regardless of Lender’s actual notice of Guarantor’s death Subject to the foregoing, Guarantor’s executor or administrator or other legal representative may terminate this Guaranty in the same manner in which Guarantor might have terminated it and with the same effect.  Release of any other guarantor or termination of any other guaranty of the Indebtedness shall not affect the liability of Guarantor under this Guaranty.  A revocation Lender receives from any one or more Guarantors shall not affect the liability of any remaining Guarantors under this Guaranty.  It is anticipated that fluctuations may occur in the aggregate amount of Indebtedness covered by this Guaranty, and Guarantor specifically acknowledges and agrees that reductions in the amount of Indebtedness, even to zero dollars ($0.00), prior to Guarantor’s written revocation of this Guaranty shall not constitute a termination of this Guaranty. This Guaranty is binding upon Guarantor and Guarantor’s written revocation of this Guaranty shall not constitute a termination of this Guaranty.  This Guaranty is binding upon Guarantor and Guarantor’s heirs, successors and assigns so long as any of the guaranteed Indebtedness remains unpaid and even though the Indebtedness guaranteed may from time to be zero dollars ($0.00).

GUARANTOR’S AUTHORIZATION TO LENDER.  Guarantor authorizes Lender, either before or after any revocation hereof, without notice or demand and without lessening Guarantor’s liability under this Guaranty, from time to time: (A) prior to revocation as set forth above, to make one or more additional secured or unsecured loans to Borrower, to lease equipment or other goods to Borrower, or otherwise to extend additional credit to Borrower; (B) to alter, compromise, renew, extend, accelerate or otherwise change one or more times the time for payment or other terms of the Indebtedness or any part of the Indebtedness, including increases and decreases of the rate of interest on the Indebtedness; extensions may be repeated and may be for longer than the original loan term; (C) to take and hold security for the payment of this Guaranty or the Indebtedness, and exchange, enforce, waive, subordinate, fail or decide not to perfect, and release any such security, with or without the substitution of new collateral; (D) to release, substitute, agree not to sue, or deal with any one or more of Borrower’s sureties, endorsers, or other guarantors on any terms or in any manner Lender may choose; (E) to determine how, when and what application of payments and credits shall be made on the Indebtedness; (F) to apply such security and direct the order or manner of sale thereof, including without limitation, any nonjudicial sale permitted by the terms of the controlling security agreement or deed of trust, as Lender in its discretion may determine; (G) to sell, transfer, assign or grant participations in all or any part of the Indebtedness; and (H) to assign or transfer this Guaranty in whole or in part.

GUARANTOR’S REPRESENTATIONS AND WARRANTIES. Guarantor represents and warrants to Lender that (A) no representations or agreements of any kind have been made to Guarantor which would limit or qualify in any way the terms of this Guaranty; (B) this Guaranty is executed at Borrower’s request and not at the request of Lender; (C) Guarantor has full power, right and authority to enter into this Guaranty; (D) the provisions of this Guaranty to do not conflict with or result in a default under any agreement or other instrument binding upon Guarantor and do not result in a violation of any law, regulation, court decree or order applicable to Guarantor; (E) Guarantor has not and will not, without the prior written consent of Lender, sell, lease, assign, encumber, hypothecate, transfer, or otherwise dispose of all or substantially all of Guarantor’s assets, or any interest therein; (F) upon Lender’s request, Guarantor will provide to Lender financial and credit information in form acceptable to Lender, and all such financial information which currently has been, and all future financial information which will be provided to Lender is and will be true and correct in all material respects and fairly present Guarantor’s financial condition as of the dates the financial information is provided; (G) no material adverse change has occurred in Guarantor’s financial condition since the date of the most recent financial statements provided to Lender and no event has occurred which may materially adversely affect Guarantor’s financial condition; (H) no litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Guarantor is pending or threatened; (I) Lender has made no representation to Guarantor as to the creditworthiness of Borrower; and (J) Guarantor has established

adequate means of obtaining from Borrower on a continuing basis information regarding Borrower’s financial condition.  Guarantor agrees to keep adequately informed from such means of any facts, events, or circumstances which might in any way affect Guarantor’s risks under this Guaranty, and Guarantor further agrees that, absent a request for information, Lender shall have no obligation to disclose to Guarantor any information or documents acquired by Lender in the course of its relationship with Borrower.

GUARANTOR’S FINANCIAL STATEMENTS.  Guarantor agrees to furnish Lender with the following:

Additional Requirements.  Annual Statements.  Not later than April 15th of each year, a copy of the annual financial report of the Guarantor for such year, audited by a firm or certified public accountants acceptable to Lender.

All financial reports required to be provided under this Guaranty shall be prepared in accordance with GAAP, applied on a consistent basis, and certified by Guarantor as being true and correct.

GUARANTOR’S WAIVERS.  Except as prohibited by applicable law, Guarantor waives any right to require Lender (A) to continue lending money or to extend other credit to Borrower; (B) to make any presentment, protest, demand, or notice of any kind, including notice of any nonpayment of the Indebtedness or of any nonpayment related to any nonpayment of the Indebtedness or of any nonpayment related to any collateral, or notice of any action or nonaction on the part of Borrower, Lender, any surety, endorser, or other guarantor in connection with the Indebtedness or in connection with the creation of new of additional Lender, any surety, endorser, or other guarantor in connection with the Indebtedness or in connection with the creation of new or additional loans or obligations; (C) to resort for payment or to proceed directly or at once against any person, including Borrower or any other guarantor; (D) to proceed directly against or exhaust any collateral held by Lender from Borrower, any other guarantor, or any other person; (E) to give notice of the terms, time, and place of any public or private sale of personal property security held by Lender from Borrower or to comply with any other applicable provisions of the Uniform Commercial Code; (F) to pursue any other remedy with Lender’s power; or (G) to commit any act or omission of any kind, or at any time, with respect to any matter whatsoever.

Guarantor also waives any and all rights or defenses arising by reason of (A) any “one action” or “anti-deficiency” law or any other law which may prevent Lender from bringing any action, including a claim for deficiency, against Guarantor, before or after Lender’s commencement or completion of any foreclosure action, either judicially or by exercise of a power of sale; (B) any election of remedies by Lender with destroys or otherwise adversely affects Guarantor’s subrogation rights or Guarantor’s rights to proceed against Borrower for reimbursement, including without limitation, any loss of rights Guarantor may suffer by reason of any law limiting qualifying, or discharging the Indebtedness; (C) any disability or other defense of Borrower, of any other guarantor, or of any other person, or by reason of the cessation of Borrower’s liability form any cause whatsoever, other than payment in full in legal tender, of the Indebtedness; (D) any right to claim discharge of the Indebtedness on the basis of unjustified impairment of any collateral for the Indebtedness; (E) any statute of limitations, if at any time any action or suit brought by Lender against Guarantor is commenced, there is outstanding Indebtedness of Borrower to Lender with is not barred by any applicable statute of limitations; or (F) any defenses given to guarantors at law or in equity other than actual payment and performance of the Indebtedness.  If payment is made by Borrower, whether voluntarily or otherwise, or by any third party, on the Indebtedness and thereafter Lender is forced to remit the amount of that payment to Borrower’s trustee in bankruptcy or to any similar person under any federal or state bankruptcy law or law for the relief of debtors, the Indebtedness shall be considered unpaid for the purpose of the enforcement of this Guaranty.

Guarantor further waives and agrees not to asset or claim at any time any deductions to the amount guaranteed under this Guaranty for any claim of setoff, counterclaim, counter demand, recoupment or similar right, whether such claim, demand or right may be asserted by the Borrower, the Guarantor, or both.

GUARANTOR’S UNDERSTANDING WITH RESPECT TO WAIVERS.  Guarantor warrants and agrees that each of the waivers set forth above is made with Guarantor’s full knowledge of its significance and consequences and that, under the circumstances, the waivers are reasonable and not contrary to public policy or law.  If any such waiver is determined to be contrary to any applicable law of public policy, such waiver shall be effective only to the extent permitted by law or public policy.

SUBORDINATION OF BORROWER’S DEBTS TO GUARANTOR.  Guarantor agrees that the Indebtedness of Borrower to Lender, whether now existing or hereafter created, shall be superior to any claim that Guarantor may now have or hereafter acquire against Borrower, whether or not Borrower becomes insolvent.  Guarantor hereby expressly subordinates any claim Guarantor may have against Borrower, upon any account whatsoever, to any claim that Lender may now or hereafter have against Borrower.  In the event of insolvency and consequent liquidation of the assets of Borrower, through bankruptcy, by an assignment for the benefit of creditors.  By voluntary liquidation, or otherwise, the assets of Borrower applicable to the payment of the claims of both Lender and Guarantor shall be paid to Lender and shall be first applied by Lender to the Indebtedness of Borrower to Lender.  Guarantor does hereby assign to Lender all claims which it may have or acquire against Borrower or against any assignee or trustee in bankruptcy of Borrower; provided however, that such assignment shall be effective only for the purpose of assuring to Lender full payment in legal tender of the Indebtedness.  If Lender so requests, any notes or credit agreements now or hereafter evidencing any debts or obligations of Borrower to Guarantor shall be marked with a legend that the same are subject to this Guaranty and shall be delivered to Lender.  Guarantor agrees, and Lender is hereby authorized, in the name of Guarantor, from time to time to execute and file financing statements and continuation statements and to execute such other documents and to take such other actions as Lender deems necessary or appropriate to perfect, preserve and enforce its rights under this Guaranty.

MISCELLANEOUS PROVISIONS.  The following miscellaneous provision are a part of this Guaranty:

Amendments.       This Guaranty, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Guaranty.  No alteration of or amendment to this Guaranty shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment.

Attorneys’ Fees; Expenses.   Guarantor agrees to pay upon demand all of Lender’s costs and expenses, including Lender’s reasonable attorneys’ fees and Lender’s legal expenses, incurred in connection with the enforcement of this Guaranty.  Lender may hire or pay someone else to help enforce this Guaranty, and Guarantor shall pay the costs and expenses of such enforcement Costs and expenses include Lender’s reasonable attorneys fees and legal expenses whether or not there is a lawsuit, including reasonable attorneys fees and legal expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services.  Lender may also recover from Guarantor all court, alternative dispute resolution or other collection costs (including, without limitation, fees and charges of collection agencies) actually incurred by Lender

Caption Headings.   Caption headings in this Guaranty are for convenience purposes only and are not to be used to interpret or define the provisions of this Guaranty.

Governing Law.   This Guaranty will be governed by, construed and enforced in accordance with federal law and the laws of the State of New Mexico.  However, in the event that the enforceability or validity of any provision of this Guaranty is challenged or questioned, such provision shall be governed by whichever applicable state or federal law would uphold or would enforce such challenged or questioned provision.  The loan transaction which is evidence by the Note and this Guaranty has been applied for, considered, approved and made, and all necessary loan documents have been accepted by Lender in the State of New Mexico.

Choice of Venue.   If there is a lawsuit, Guarantor agrees upon Lender’s request to submit to the jurisdiction of the courts of the State of New Mexico, in the county in which Borrower’s following address is located:  4700 Irving Boulevard NW.  Suite 201, Albuquerque.  NM

2

87114.

Integration.   Guarantor further agrees that Guarantor has read and fully understands the terms of this Guaranty; Guarantor has had the opportunity to be advised by Guarantor’s attorney with respect to this Guaranty; the Guaranty fully reflects Guarantor’s intentions and parol evidence is not required to interpret the terms of this Guaranty. Guarantor hereby indemnifies and holds Lender harmless from all losses, claims, damages, and costs (including Lender’s attorneys’ fees) suffered or incurred by Lender as a result of any breach by Guarantor of the warranties, representations and agreements of this paragraph.

interpretation.      In all cases where there is more than one Borrower or Guarantor, then all words used in this Guaranty in the singular shall be deemed to have been used in the plural where the context and construction so require; and where there is more than one Borrower named in this Guaranty or when this Guaranty is executed by more than one Guarantor, the words “Borrower” and “Guarantor” respectively shall mean all and any one or more of them.  The words “Guarantor,” “Borrower,” and “Lender” include the heirs, successors, assigns, and transferees of each of them.  If a court finds that any provision of this Guaranty is not valid or should not be enforced, that fact by itself will not mean that the rest of this Guaranty will not be valid or enforced.  Therefore, a court will enforce the rest of the provisions of this Guaranty even if a provision of this Guaranty may be found to be invalid or unenforceable.  If any one or more of Borrower of Guarantor are corporations, partnerships, limited liability companies, or similar entities, it is not necessary for lender to inquire into the powers of Borrower or Guarantor or of the officers, directors, partners, managers, or other agents acting or purporting to act on their behalf, and any Loan indebtedness made or created in reliance upon the professed exercise of such powers shall be guaranteed under this Guaranty.

Notices.   Any notice required to be given under this Guaranty shall be given in writing, and, except for revocation notices by Guarantor, shall be effective when actually delivered, when actually received by telefacsimile (unless otherwise required by law), when deposited with a nationally recognized overnight courier, or, if mailed, when deposited in the United States mail, as first class, certified or registered mail postage prepaid, directed to the addresses shown near the beginning of this Guaranty.  All revocation notices by Guarantor shall be in writing and shall be effective upon delivery to Lender as provided in the Section of this Guaranty entitled “DURATION OF GUARANTY.”  Any party may change its address for notices under this Guaranty by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party’s address.  For notice purposes, Guarantor agrees to keep Lender informed at all times of Guarantor’s current address unless otherwise provided or required by law.  if there is more than one Guarantor, any notice given by Lender to any Guarantor is deemed to be notice given to all Guarantors.

No Waiver by Lender.         Lender shall not be deemed to have waived any rights under this Guaranty unless such waiver is given in writing and signed by Lender.  No delay or omission on the part of Lender in exercising any right shall operate us a waiver of such right or any other right.  A waiver by Lender of a provision of this Guaranty shall not prejudice or constitute a waiver of Lender’s right otherwise to demand strict compliance with that provision or any other provision of this Guaranty.  No prior waiver by Lender, nor any cause of dealing between Lender and Guarantor, shall constitute a waiver of any of Lender’s rights or of any of Guarantor’s obligations as to any future transactions.  Whenever the consent of Lender is required under this Guaranty, the granting of such consent by Lender in any instance shall not constitute continuing consent to subsequent instances where such consent is required and in all cases such consent may be granted or withheld in the sole discretion of Lender.

Successors and Assigns.   Subject to any limitations stated in this Guaranty on transfer of Guarantor’s interest, this Guaranty shall be binding upon and inure to the benefit of the parties, their successors and assigns.

DEFINITIONS.     The following capitalized words and terms shall have the following meaning when used in this Guaranty.  Unless specifically stated to the contrary, all references to dollar amounts shall mean amounts in lawful money of the United States of America.  Words and terms used in the singular shall include the plural, and the plural shall include the singular, as the context may require.  Words and terms not otherwise defined in this Guaranty shall have the meanings attributed to such terms in the Uniform Commercial Code:

Borrower   The word “Borrower” means NEW MEXICO UTILITIES, INC, and includes all co-signers and co-makers signing the Note.

GAAP    The word “GAAP” means generally accepted accounting principles.

Guarantor.   The word “Guarantor” means each and every person or entity signing this Guaranty, including without limitation SOUTHWEST WATER COMPANY.

Guaranty.   The word “Guaranty” means the guaranty from Guarantor to Lender, including without limitation a guaranty of all or part of the Note.

Indebtedness.        The word “indebtedness” means Borrower’s Indebtedness to Lender as more particularly described in this Guaranty

Lender.   The word “Lender” means BANK OF THE WEST, its successors and assigns.

Note.       The word “Note” means and includes without limitation all of Borrower’s promissory notes and/or credit agreements evidencing Borrower’s loan obligations in favor of Lender, together with all renewals of, extensions of, modifications of, refinancing of, consolidations of and substitutions for promissory notes or credit agreements,

Related Documents.   The words “Related Documents” mean all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, security deeds, collateral mortgages, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the Indebtedness.

3

EACH UNDERSIGNED GUARANTOR ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS GUARANTY AND AGREES TO ITS TERMS.  IN ADDITION, EACH GUARANTOR UNDERSTANDS THAT THIS GUARANTY IS EFFECTIVE UPON GUARANTOR’S EXECUTION AND DELIVERY OF THIS GUARANTY TO LENDER AND THAT THE GUARANTY WILL CONTINUE UNTIL TERMINATED IN THE MANNER SET FORTH IN THE SECTION TITLED “DURATION OF GUARANTY”.  NO FORMAL ACCEPTANCE BY LENDER IS NECESSARY TO MAKE THIS GUARANTY EFFECTIVE.  THIS GUARANTY IS DATED JULY 10, 2003.

THIS GUARANTY IS GIVEN UNDER SEAL AND IT IS INTENDED THAT THIS GUARANTY IS AND SHALL CONSTITUTE AND HAVE THE EFFECT OF A SEALED INSTRUMENT ACCORDING TO LAW.

GUARANTOR:
SOUTHWEST WATER COMPANY
By:	/s/ Richard J. Shields	(Seal)	By:	/s/ Thomas C. Tekulve	(Seal)
	Richard J. Shields, Chief Financial Officer of SOUTHWEST WATER COMPANY			Thomas C. Tekulve, Vice President/Treasurer of SOUTHWEST WATER COMPANY

4

CORPORATE RESOLUTION TO GRANT COLLATERAL / GUARANTEE

Principal $4,000,000.00	Loan Date 04-10-2002	Maturity 04-10-2004	Loan No 1000137188-18	Call / Coll	Account	Officer ***	Initials
References in the shaded area are for Lender’s use only and do not limit the applicability of this document to any particular loan or item.  Any item above containing “***” has been omitted due to text length limitations.

Borrower:	NEW MEXICO UTILITIES, INC. 4700 Irving Boulevard NW, Suite 201 Albuquerque, NM 87114	Lender:	BANK OF THE WEST New Mexico Business Banking #223J 5501 Jefferson NE Albuquerque, NM 87109 (888) 457-2692
Corporation:	SOUTHWEST WATER COMPANY 225 N. Barranca Avenue, Suite 200 West Covina, CA 91791

1. THE UNDERSIGNED, DO HERBY CERTIFY THAT:

THE CORPORATION’S EXISTENCE.  The complete and correct name of the Corporation is SOUTHWEST WATER COMPANY (“Corporation”).  The Corporation is a corporation for profit which is, and at all times shall be, duly organized, validly existing, and in good standing under and by virtue of the laws of the State of Delaware.  The Corporation is duly authorized to transact business in all other states in which the Corporation is doing business, having obtained all necessary filings, governmental licenses and approvals for each state in which the Corporation is doing business.  Specifically, the Corporation is, and at all times shall be, duly qualified as a foreign corporation in all states in which the failure to so qualify would have a material adverse effect on its business or financial condition.  The Corporation has the full power and authority to own its properties and to transact the business in which it is presently engaged or presently proposes to engage.  The Corporation maintains an office at 225 N. Barranca Avenue, Suite 200, West Covina, CA 91791.  Unless the Corporation has designated otherwise in writing, the principal office is the office at which the Corporation keeps its books and records.  The Corporation will notify Lender prior to any change in the location of the Corporation’s state of organization or any change in the Corporation’s name.  The Corporation shall do all things necessary to preserve and to keep in full force and effect its existence, rights and privileges, and shall comply with all regulations, rules, ordinances, statutes, orders and decrees of any governmental or quasi-governmental authority or court applicable to the Corporation and the Corporation’s business activities.

RESOLUTIONS ADOPTED.  At a meeting of the Directors of the Corporation, or if the Corporation is a close corporation having no Board of Directors then at a meeting of the Corporation’s shareholders, duly called and held on                                 , at which a quorum was present and voting, or by other duly authorized action in lieu of a meeting, the resolutions set forth in this Resolution were adopted.

OFFICERS.  The following named persons are officers of SOUTHWEST WATER COMPANY:

NAMES	TITLES	AUTHORIZED		ACTUAL SIGNATURES
Richard J. Shields	Chief Financial Officer	Y	X	/s/ Richard J.  Shields
Thomas Tekulve	Vice President/Treasurer	Y	X	/s/ Thomas Tekulve

ACTIONS AUTHORIZED.  Any two (2) of the authorized persons listed above may enter into any agreements of any nature with Lender, and those agreements will bind the Corporation.  Specifically, but without limitation, any two (2) of such authorized persons are authorized, empowered, and directed to do the following for and on behalf of the Corporation:

Guaranty.  To guarantee or act as surety for loans or other financial accommodations to Borrower from Lender on such guarantee or surety terms as may be agreed upon between the officers of the Corporation and Lender and in such sum or sums of money as in their judgment should be guaranteed or assured, (the “Guaranty”).

Grant Security.  To mortgage, pledge, transfer, ondorse, hypothecate, or otherwise encumber and deliver to Lender any property now or hereafter belonging to the Corporation or in which the Corporation now or hereafter may have an interest, including without limitation all of the Corporation’s real property and all of the Corporation’s personal property (tangible or intangible), as security for the Guaranty, and as a security for the payment of any loans, any promissory note, or any other or further indebtedness of NEW MEXICO UTILITIES, INC. to Lender at any time owing, however the same may be evidenced.  Such property may be mortgaged, pledged, transferred, endorsed, hypothecated or encumbered at the time such loans are obtained or such indebtedness is incurred, or at any other time or times, and may be either in addition to or in lieu of any property theretofore mortgaged, pledged, transferred, endorsed, hypothecated or encumbered.  The provisions of this Resolution authorizing or relating to the pledge, mortgage, transfer, endorsement, hypothecation, granting of a security interest in, or in any way encumbering, the assets of the Corporation shall include, without limitation, doing so in order to lend collateral security for the indebtedness, now or hereafter existing, and of any nature whatsoever, of NEW MEXICO UTILITIES, INC. to Lender.  The Corporation has considered the value to itself of lending collateral in support of such indebtedness, and the Corporation represents to Lender that the Corporation is benefited by doing so.

Execute Security Documents.  To execute and deliver to Lender the forms of mortgage, deed of trust, pledge agreement, hypothecation agreement, and other security agreements and financing statements which Lender may require and which shall evidence the terms and conditions under and pursuant to which such liens and encumbrances, or any of them, are given; and also to execute and deliver to Lender any other written instruments, any chattel paper, or any other collateral, of any kind or nature, which Lender may deem necessary or proper in connection with or pertaining to the giving of the liens and encumbrances.  Notwithstanding the foregoing, any one of the above authorized persons may execute, deliver, or record financing statements.

Further Acts.  To do and perform such other acts and things and to execute and deliver such other documents and agreements, including agreements waiving the right to a trial by jury, as the officers may in their discretion deem reasonably necessary or proper in order to carry into effect the provisions of this Resolution.

ASSUMED BUSINESS NAMES.  The Corporation has filed or recorded all documents or filings required by law relating to all assumed business names used by the Corporation.  Excluding the name of the Corporation, the following is a complete list of all assumed business names under which the Corporation does business:  None.

NOTICES TO LENDER.  The Corporation will promptly notify Lender in writing at Lender’s address shown above (or such other addresses as Lender may designate from time to time) prior to any (A) change in the Corporation’s name; (B) change in the Corporation’s assumed business name(s); (C) change in the management of the Corporation; (D) change in the authorized signer(s); (E) change in the Corporation’s principal office address; (F) change in the Corporation’s state of organization: (G) conversion of the Corporation to a new or different type of

business entity; or (H) change in any other aspect of the Corporation that directly or indirectly relates to any agreements between the Corporation and Lender.  No change in the Corporation’s name or state of organization will take effect until after Lender has received notice.

CERTIFICATION CONCERNING OFFICERS AND RESOLUTIONS.  The officers named above are duly elected, appointed, or employed by or for the Corporation, as the case may be, and occupy the positions set opposite their respective names.  This Resolution now stands of record on the books of the Corporation, is in full force and effect, and has not been modified or revoked in any manner whatsover.

NO CORPORATE SEAL.  The Corporation has no corporate seal, and therefore, no seal is affixed to this Resolution.

CONTINUING VALIDITY.  Any and all acts authorized pursuant to this Resolution and performed prior to the passage of this Resolution are hereby ratified and approved.  This Resolution shall be continuing. shall remain in full force and effect and Lender may rely on it until written notice of its revocation shall have been delivered to and received by Lender at Lender’s address shown above (or such addresses as Lender may designate from time to time).  Any such notice shall not affect any of the Corporation’s agreements or commitments in effect at the time notice is given.

IN TESTIMONY WHEREOF, I have hereunto set my hand and attest that the signatures set opposite the names listed above are their genuine signatures.

I have read all the provisions of this Resolution, and I personally and on behalf of the Corporation certify that all statements and representations made in this Resolution are true and correct.  This Corporate Resolution to Grant Collateral / Guarantee is dated 7-30-03.

THIS RESOLUTION IS GIVEN UNDER SEAL AND IT IS INTENDED THAT THIS RESOLUTION IS AND SHALL CONSTITUTE AND HAVE THE EFFECT OF A SEALED INSTRUMENT ACCORDING TO LAW.

	CERTIFIED TO AND ATTESTED BY:
X	/s/ [ILLEGIBLE]	(Seal)
	Secretary

NOTE: If the officers signing the Resolution are designated by the foregoing document as one of the officers authorized to act on the Corporation’s behalf, it is advisable to have this Resolution signed by at least one non-authorized officer of the Corporation.

2

CORPORATE RESOLUTION TO BORROW

Principal	Loan Date	Maturity	Loan No	Call/Coll	Account	Officer	Initials
$4,000,000.00	04-10-2002	04-10-2004	1000137188-18		SWEEP	***

References in the shaded area are for Lender’s use only and do not limit the applicability of this document to any particular loan or item .  Any item above containing “* * *” has been omitted due to text length limitations.

Corporation:	NEW MEXICO UTILITIES, INC.	Lender:	BANK OF THE WEST
	4700 Irving Boulevard NW, Suite 201		New Mexico Business Banking #223M
	Albuquerque, NM 87114		500 Marquette, 14th Floor
			Alburquerque, NM 87102
			(888) 457-2692

I, THE UNDERSIGNED, DO HEREBY CERTIFY THAT:

THE CORPORATION’S EXISTENCE.  The complete and correct name of the Corporation is NEW MEXICO UTILITIES, INC. (“Corporation”).  The Corporation is a corporation for profit which is, and at all times shall be, duly organized, validly existing, and in good standing under and by virtue of the laws of the State of New Mexico.  The Corporation is duly authorized to transact business in all other states in which the Corporation is doing business.  Specifically, the Corporation is, and at all times shall be, duly qualified as a foreign corporation in all states in which the failure to so qualify would have a material adverse effect on its business or financial condition.  The Corporation has the full power and authority to own its properties and to transact the business in which it is presently engaged or presently proposes to engage.  The Corporation maintains an office at 4700 Irving Boulevard NW, Suite 201, Albuquerque,  NM 87114.  Unless the Corporation has designated otherwise in writing, the principal office is the office at which the Corporation keeps its books and records.  The Corporation will notify Lender prior to any change in the location of the Corporation’s state of organization or any change in the Corporation’s name.  The Corporation shall do all things necessary to preserve and to keep in full force and effect its existence, rights and privileges, and shall comply with all regulations, rules, ordinances, statutes, orders and decrees of any governmental or quasi-governmental authority or court applicable to the Corporation and the Corporation’s business activities.

RESOLUTIONS ADOPTED.  At a meeting of the Directors of the Corporation, or if the Corporation is a close corporation having no Board of Directors then at a meeting of the Corporation’s shareholders, duly called and held on Jan 14^th 2003, at which a quorum was present and voting, or by other duly authorized action in lieu of a meeting, the resolutions set forth in this Resolution were adopted.

OFFICERS.  The following named persons are officers of NEW MEXICO UTILITIES, INC:

NAMES	TITLES	AUTHORIZED		ACTUAL SIGNATURES
Bobby L. Gay	V.P. & General Manager	Y	X	/s/ [ILLEGIBLE]
Michael O. Quinn	Secretary & Treasurer	Y	X	/s/ [ILLEGIBLE]

ACTIONS AUTHORIZED.  Any two (2) of the authorized persons listed above may enter into any agreements of any nature with Lender, and those agreements will bind the Corporation.  Specifically but without limitation, any two (2) of such authorized persons are authorized, empowered, and directed to do the following for and on behalf of the Corporation:

Borrow Money.  To borrow, as a cosigner or otherwise, from time to time from Lender, on such terms as may be agreed upon between the Corporation and Lender, such sum or sums of money as in their judgment should be borrowed, without limitation.

Execute Notes.  To execute and deliver to Lender the promissory note or notes, or other evidence of the Corporation’s credit accommodations, on Lender’s forms, at such rates of interest and on such terms as may be agreed upon, evidencing the sums of money so borrowed or any of the Corporation’s indebtedness to Lender, and also to execute and deliver to Lender one or more renewals, extensions, modifications, refinancings, consolidations, or substitutions for one or more of the notes, any portion of the notes, or any other evidence of credit accommodations.

Execute Security Documents.  To execute and deliver to Lender the forms of mortgage, deed of trust, pledge agreement, hypothecation agreement, and other security agreements and financing statements which Lender may require and which shall evidence the terms and conditions under and pursuant to which such liens and encumbrances, or any of them, are given;  and also to execute and deliver to Lender any other written instruments, any chattel paper, or any other collateral, of any kind or nature, which Lender may deem necessary or proper in connection with or pertaining to the giving of the liens and encumbrances.  Notwithstanding the foregoing, any one of the above authorized persons may execute, deliver, or record financing statements.

Other Actions.  (1)  Enter into derivative transactions, including but not limited to.  Interest rate swaps, caps, floors, collars, swap options, and forwards; (2) Apply for letters of credit or seek the issuance of banker’s acceptances under which the Corporation shall be liable to the Lender for repayment.

Negotiate Items.  To draw, endorse, and discount with Lender all drafts, trade acceptances, promissory notes, or other evidences of indebtedness payable to or belonging to the Corporation  or in which the Corporation may have an interest, and either to receive cash for the same or to cause such proceeds to be credited to the Corporation’s account with Lender, or to cause such other disposition of the proceeds derived therefrom as they may deem advisable.

Further Acts.  In the case of lines of credit, to designate additional or alternate individuals as being authorized to request advances under such lines, and in all cases, to do and perform such other acts and things, to pay any and all fees and costs, and to execute and deliver such other documents and agreements, including agreements waiving the right to a trial by jury, as the officers may in their discretion deem reasonably necessary or proper in order to carry into effect the provisions of this Resolution.

ASSUMED BUSINESS NAMES.  The Corporation has filed or record all documents or filings required by law relating to all assumed business names used by the Corporation.  Excluding the name of the Corporation the following is a complete list of all assumed business names under which the Corporation does business: None.

NOTICES TO LENDER.  The Corporation will promptly notify Lender in writing at Lender’s address shown above (or such other addresses as Lender may designate from time to time) prior to any (A) change in the Corporation’s name; (B) change in the Corporation’s assumed business name(s); (C) change in the management of the Corporation; (D) change in the authorized signer(s); (E) change in the Corporation’s principal office address; (F) change in the Corporation’s state of organization; (G) conversion of the Corporation to a new or different type of business entity; or (H) change in any other aspect of the Corporation that directly or indirectly relates to any agreements between the Corporation and Lender.  No change in the Corporation’s name or state of organization will take effect until after Lender has received notice.

CERTIFICATION CONCERNING OFFICERS AND RESOLUTIONS.  The officers named above are duly elected, appointed, or employed by or for the Corporation, as the case may be, and occupy the positions set opposite their respective names.  This Resolution now stands of record on the books of the Corporation, is in full force and effect, and has not been modified or revoked in any manner whatsoever.

NO CORPORATE SEAL.  The Corporation has no corporate seal, and therefore, no seal is affixed to this Resolution.

CONTINUING VALIDITY.  Any and all acts authorized pursuant to this Resolution and performed prior to the passage of this Resolution are hereby ratified and approved.  This Resolution shall be continuing, shall remain in full force and effect and Lender may rely on it until written notice of its revocation shall have been delivered to and received by Lender at Lender’s address shown above (or such addresses as Lender may designate from time to time).  Any such notice shall not affect any of the Corporation’s agreements or commitments in effect at the time notice is given.

IN TESTIMONY WHEREOF, I have hereunto set my hand and attest that the signatures set opposite the names listed above are their genuine signatures.

I have read all the provisions of this Resolution, and I personally and on behalf of the Corporation certify that all statements and representations made in this Resolution are true and correct.  This Corporate Resolution to Borrow is dated July 22, 2003.

CERTIFIED TO AND ATTESTED BY:

/s/ Michael O. Quinn

Michael O. Quinn, Secretary

NOTE: If the officers signing the Resolution are designated by the foregoing document as one of the officers authorized to act on the Corporation’s behalf, it is advisable to have this Resolution signed by at least one non-authorized officer of the Corporation.

2

New Mexico Utilities, Inc.

Phone:(505) 898-2661

Fax:(505) 898-6379

FAX TRANSMISSION

To: Tom T

Fax #:

From: Bob Gay

Date: 12-12-03

Pages: 9 including this cover sheet.

COMMENTS:

EX-21.1

QuickLinks -- Click here to rapidly navigate through this document

EXHIBIT 21.1

SOUTHWEST WATER COMPANY
SUBSIDIARIES OF THE REGISTRANT
As of March 15, 2004

Jurisdiction of Name of Subsidiary Incorporation	Parent
Suburban Water Systems California	Southwest Water Company
Water Suppliers Mobile Communication Service California	Suburban Water Systems
New Mexico Utilities New Mexico	Southwest Water Company
ECO Resources, Inc. Texas	Southwest Water Company
Southwest Environmental Labs Texas	ECO Resources, Inc.
Wastewater Rehabilitation, Inc. Texas	Southwest Water Company
SW Utility Company Texas	Southwest Water Company
Southwest Resource Management Delaware	Southwest Water Company
Master Tek International, Inc. Colorado	Southwest Water Company
Windermere Utility Company Texas	Southwest Water Company
Hornsby Bend Utility Company Texas	Southwest Water Company
Operations Technologies, Inc. Georgia	Southwest Water Company
Aqua Services LP Texas	Southwest Water Company
Lab-tech Corporation Texas	Southwest Water Company
METRO-H2O Utilities, Inc. Texas	Southwest Water Company
Southwest Water Government Services Company Delaware	Southwest Water Company
ECO Capistrano Valley, Inc. California	ECO Resources, Inc.

All above listed subsidiaries have been included in the Registrant's consolidated financial statements.

QuickLinks

EXHIBIT 21.1

SOUTHWEST WATER COMPANY SUBSIDIARIES OF THE REGISTRANT As of March 15, 2004

EX-23.1

QuickLinks -- Click here to rapidly navigate through this document

Exhibit 23.1

Independent Auditors' Consent

To the Board of Directors
Southwest Water Company:

        We consent to incorporation by reference in the registration statements (Nos. 33-21154, 333-77881, 333-35252, 333-63196, 333-69662 and 333-70194, 33-28918, 33-28919, 33-73174, 333-18513, 333-38935, 333-106506, 333-109444 and 333-111586) on Forms S-3 and S-8 of Southwest Water Company of our report dated March 12, 2004, with respect to the consolidated balance sheets of Southwest Water Company and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2003, and the related schedules, which report appears in the December 31, 2003, annual report on Form 10-K of Southwest Water Company.

        Our report refers to a change in accounting for goodwill and other intangible assets in 2002.

Los Angeles, California
March 12, 2004

QuickLinks

Exhibit 23.1

EX-31.1

QuickLinks -- Click here to rapidly navigate through this document

Exhibit 31.1

Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Anton C. Garnier, Chief Executive Officer, certify that:

1.

I have reviewed this annual report on Form 10-K of Southwest Water Company;

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)

evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)

disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Dated: March 12, 2004 Anton C. Garnier
Chief Executive Officer

QuickLinks

Exhibit 31.1

Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

EX-31.2

QuickLinks -- Click here to rapidly navigate through this document

Exhibit 31.2

Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Richard J. Shields, certify that:

1.

I have reviewed this annual report on Form 10-K of Southwest Water Company;

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)

evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)

disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Dated: March 12, 2004 Richard J. Shields
Chief Financial Officer

QuickLinks

Exhibit 31.2

Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

EX-32.1

QuickLinks -- Click here to rapidly navigate through this document

Exhibit 32.1

Certifications of Chief Executive Officer and Chief Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

        Pursuant to 18 U.S.C. §1350, the undersigned Chief Executive Officer of Southwest Water Company (the "Company"), hereby certifies, to such officer's knowledge, that the accompanying Annual Report of Form 10-K of the Company for the year ended December 31, 2003 (the "Report") fully complies with the requirements of Section 13(a) of 15(d) of the Securities Exchange Act of 1934 and that information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 15, 2004 Anton C. Garnier
Chief Executive Officer

        Pursuant to 18 U.S.C. §1350, the undersigned Chief Financial Officer of Southwest Water Company (the "Company"), hereby certifies, to such officer's knowledge, that the accompanying Annual Report of Form 10-K of the Company for the year ended December 31, 2003 (the "Report") fully complies with the requirements of Section 13(a) of 15(d) of the Securities Exchange Act of 1934 and that information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 15, 2004 Richard J. Shields
Chief Financial Officer

        The foregoing certifications are being furnished solely to accompany the Report pursuant to 18 U.S.C. §1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

QuickLinks

Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002