10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 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
(State or other jurisdiction of
incorporation or organization)
95-1840947
(I.R.S. Employer
Identification No.)

225 North Barranca Avenue, Suite
200 West Covina, California
(Address of principal executive offices)

91791-1605
(Zip Code)

(626) 915-1551
(Registrant’s telephone number, including area code)

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 x No o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. On August 11, 2003, there were 10,969,325 common shares outstanding.

SOUTHWEST WATER COMPANY AND SUBSIDIARIES

INDEX

Part I.	Financial Information:		PageNo.
	Item 1.	Financial Statements:
		Condensed Consolidated Statements of Income (unaudited) - Three and Six Months Ended June 30, 2003 and 2002	1
		Condensed Consolidated Balance Sheets (unaudited) - June 30, 2003 and December 31, 2002	2
		Condensed Consolidated Statements of Cash Flows (unaudited) - Six Months Ended June 30, 2003 and 2002	3
		Notes to Condensed Consolidated Financial Statements (unaudited)	4
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
	Item 4.	Controls and Procedures	24
Part II.	Other Information:
	Item 1.	Legal Proceedings	25
	Item 4.	Submission of Matters to a Vote of Security Holders	26
	Item 6.	Exhibits and Reports on Form 8-K	26

Signatures 27

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Southwest Water Company and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)

	ThreeMonthsEnded June30,						SixMonthsEnded June30,
	2003			2002			2003			2002
	(inthousandsexceptpersharedata)
Revenues:
Service operations	$	27,702		$	19,189		$	52,890		$	36,366
Utility operations		13,762			13,557			24,688			24,548
		41,464			32,746			77,578			60,914
Expenses:
Operating expenses - services		24,323			16,321			46,329			30,993
Operating expenses- utilities		8,219			8,578			15,646			15,643
Selling, general and administrative expenses		5,425			5,954			11,185			10,442
		37,967			30,853			73,160			57,078
Operating Income		3,497			1,893			4,418			3,836
Other Income (Expense):
Interest expense		(1,109	)		(1,063	)		(2,306	)		(2,219	)
Interest income		—			12			49			32
Gain on sales of land		720			—			720			119
Other		(110	)		1,780			(119	)		2,641
		(499	)		729			(1,656	)		573
Income Before Income Taxes		2,998			2,622			2,762			4,409
Income Tax Provision		1,109			914			1,022			1,537
Net Income		1,889			1,708			1,740			2,872
Dividends on Preferred Shares		7			7			14			14
Net Income Available for Common Shares	$	1,882		$	1,701		$	1,726		$	2,858
Earnings per Common Share
Basic	$	0.19		$	0.18		$	0.17		$	0.30
Diluted	$	0.18		$	0.16		$	0.17		$	0.28
Weighted Average Outstanding Common Shares
Basic		10,171			9,720			9,971			9,692
Diluted		10,577			10,361			10,380			10,243

See accompanying notes to unaudited condensed consolidated financial statements.

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Southwest Water Company and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)

	June30, 2003		December 31, 2002
	(inthousands)
ASSETS
Current Assets:
Cash and cash equivalents	$	1,868	$	1,606
Customers’ accounts receivable, net		19,792		16,657
Other current assets		10,735		11,573
		32,395		29,836
Property, Plant and Equipment:
Utility group property, plant and equipment – at cost		256,690		245,134
Services group property, plant and equipment – at cost		19,803		20,753
		276,493		265,887
Less accumulated depreciation and amortization		66,053		61,954
		210,440		203,933
Other Assets:
Goodwill		20,212		20,151
Intangible assets, net		2,337		2,497
Other assets		11,288		12,327
		33,837		34,975
	$	276,672	$	268,744
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Current portion of long-term debt	$	2,189	$	1,969
Accounts payable		8,611		11,390
Other current liabilities		16,494		18,264
		27,294		31,623
Long-Term Liabilities and Deferred Credits:
Long-term debt		60,356		60,827
Bank lines of credit		14,224		20,158
Advances for construction		7,234		7,352
Contributions in aid of construction		76,348		70,658
Deferred income taxes		9,271		8,411
Other liabilities and deferred credits		7,359		7,878
Total Liabilities and Deferred Credits		202,086		206,907
Stockholders’ Equity:
Preferred stock		512		513
Common stock		109		98
Paid-in capital		54,948		42,787
Retained earnings		19,017		18,439
Total Stockholders’ Equity		74,586		61,837
	$	276,672	$	268,744

See accompanying notes to unaudited condensed consolidated financial statements.

2

Southwest Water Company and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

	Six Months Ended June 30,
	2003			2002
	(in thousands)
Cash Flows From Operating Activities:
Net income	$	1,740		$	2,872
Depreciation and amortization		4,003			3,681
Stock-based compensation expense		467			459
Deferred income taxes		860			636
Gain on sales of land		(720	)		(119	)
Other changes in operating assets and liabilities		(7,212	)		(701	)
Net cash provided by (used in) operating activities		(862	)		6,828
Cash Flows From Investing Activities:
Additions to property, plant and equipment		(9,139	)		(9,142	)
Proceeds from sale of land		741			165
Other investments, net		(40	)		(1,000	)
Net cash used in investing activities		(8,438	)		(9,977	)
Cash Flows From Financing Activities:
Net proceeds from private placement of common stock		10,988			—
Net repayment on bank lines of credit		(5,934	)		(1,748	)
Capital improvement reimbursements		2,182			—
Contributions in aid of construction and advances for construction		1,975			7,728
Net proceeds from dividend reinvestment plan, employee stock purchase plan and stock option plans		733			581
Proceeds from sale/leaseback of assets		1,102			—
Dividends paid		(1,141	)		(1,043	)
Repayment of long-term debt		(177	)		(2,209	)
Repayments on advance contracts, net of additions		(166	)		(151	)
Net cash provided by financing activities		9,562			3,158
Net increase in cash and cash equivalents		262			9
Cash and cash equivalents at beginning of period		1,606			789
Cash and cash equivalents at end of period	$	1,868		$	798
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest	$	2,555		$	2,544
Income taxes	$	305		$	288
Non-cash contribution in aid of construction	$	3,629		$	1,655

See accompanying notes to unaudited condensed consolidated financial statements.

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SOUTHWEST WATER COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Note 1. – Basis of Presentation

Southwest Water Company was incorporated in California in 1954 and reincorporated in Delaware in 1988. Southwest Water Company and our subsidiaries (collectively referred to in this report as Southwest Water, the Company, “we”, “us” or “our” except where the context otherwise requires) provide a broad range of services including water production and distribution, wastewater collection and treatment, public works services, water and wastewater infrastructure development, customer billing and service, and utility submetering. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. They do not include all information and notes required by US GAAP for complete financial statements. Except as disclosed herein, there have been no material changes in the information disclosed in the notes to the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2002 (the 2002 Annual Report). The unaudited condensed consolidated financial statements reflect all adjustments which, in our opinion, are necessary to present fairly the financial position of Southwest Water as of June 30, 2003, and our results of operations for the three and six months ended June 30, 2003 and 2002 and our cash flows for the six months ended June 30, 2003 and 2002. These adjustments are of a normal recurring nature.

Certain amounts in our prior period financial statements have been reclassified to conform to the current period presentation. In 2002, we retroactively adopted the fair value based method of accounting for stock options as outlined in Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. Accordingly, all prior periods presented have been restated to reflect compensation cost that would have been recognized under the fair value based accounting method for all options granted, modified or settled in fiscal years beginning after December 15, 1994. See Note 5 for detailed information.

Note 2. – Operating Segments

Our operating structure includes two segments: our Utility Group and our Services Group. We have not changed the basis of segmentation or measurement of segment profit or loss from that reported in our 2002 Annual Report.

In our Utility Group, we own and operate 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 operations, as well as establish the rates that we can charge for our water delivery and wastewater services.

In our Services Group, we operate and maintain water supply and wastewater treatment facilities owned by cities, public agencies, municipal utility districts and private entities in Texas, Mississippi, California, Georgia, New Mexico, Colorado and South Dakota. We also provide utility submetering and billing and collection services nationwide. While state and federal agencies issue regulations regarding standards of water quality, safety, environmental and other matters which affect these operations, the pricing of our services by the Services Group is not subject to regulation.

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Information about Southwest Water’s operations by operating segment for the three months ended June 30, 2003 is as follows:

	Services Group		Utility Group		Total Segment information		Other (2)			Consolidated
		(in thousands)
Three Months Ended June 30, 2003
Total revenues(1)	$	27,702	$	13,762	$	41,464	$	—		$	41,464
Operating income		869		4,410		5,279		(1,782	)		3,497
As of June 30, 2003
Assets	$	63,510	$	208,948	$	272,458	$	4,214		$	276,672
Three Months Ended June 30, 2002
Total revenues(1)	$	19,189	$	13,557	$	32,746	$	—		$	32,746
Operating income		516		3,173		3,689		(1,796	)		1,893
As of June 30, 2002
Assets	$	43,061	$	184,768	$	227,829	$	4,378		$	232,207

______________

(1) Total revenues include both revenues from external customers and intersegment transactions. Intersegment revenues were approximately $421,000 and $14,000 for the three months ended June 30, 2003 and 2002, respectively.

(2) Other consists of costs that include any corporate functional departments whose cost is not allocated and headquarter expenses.

Information about our operations by operating segment for the six months ended June 30, 2003 is as follows:

	Services Group		Utility Group		Total Segment Information		Other (2)			Consolidated
	(in thousands)
Six Months Ended June 30, 2003
Total revenues (1)	$	52,890	$	24,688	$	77,578	$	—		$	77,578
Operating income		902		6,614		7,516		(3,098	)		4,418
As of June 30, 2003
Assets	$	63,510	$	208,948	$	272,458	$	4,214		$	276,672
Six Months Ended June 30, 2002
Total revenues (1)	$	36,366	$	24,548	$	60,914	$	—		$	60,914
Operating income		1,007		6,517		7,524		(3,688	)		3,836
As of June 30, 2002
Assets	$	43,061	$	184,768	$	227,829	$	4,378		$	232,207

______________

(1) Total revenues include both revenues from external customers and intersegment transactions. Intersegment revenues were approximately $1,180,000 and $18,000 for the six months ended June 30, 2003 and 2002, respectively.

(2) Other consists of costs that include any corporate functional departments whose cost is not allocated and headquarter expenses.

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Note 3. – Earnings Per Share, Stock Options and Stock Dividends

We record earnings per share (EPS) by computing “basic EPS” and “diluted EPS” in accordance with US GAAP. Basic EPS measures our performance 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 our performance over the reporting period after giving effect to all potentially dilutive common shares that would have been outstanding if the dilutive common shares had been issued. Stock options, convertible debentures and warrants give rise to potentially dilutive common shares. In 2002, our Board of Directors declared a five percent stock dividend to stockholders of record on January 1, 2003. All per share amounts and numbers of shares outstanding reflect this dividend.

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

	Net Income		Dividendson preferred shares			Basic EPS		Effect of Dilutive Options	Diluted EPS
	(in thousands except per share amounts)
For three months ended June 30, 2003
Income (numerator)	$	1,889	$	(7	)	$	1,882		$	1,882
Shares (denominator)							10,171	406		10,577
Per share amount						$	.19		$	.18
For three months ended June 30, 2002
Income (numerator)	$	1,708	$	(7	)	$	1,701		$	1,701
Shares (denominator)							9,720	641		10,361
Per share amount						$	0.18		$	0.16

	Net Income		Dividendson preferred shares			Basic EPS		Effect of Dilutive Options	Diluted EPS
	(in thousands except per share amounts)
For six months ended June 30, 2003
Income (numerator)	$	1,740	$	(14	)	$	1,726		$	1,726
Shares (denominator)							9,971	409		10,380
Per share amount						$	.17		$	.17
For six months ended June 30, 2002
Income (numerator)	$	2,872	$	(14	)	$	2,858		$	2,858
Shares (denominator)							9,692	551		10,243
Per share amount						$	0.30		$	0.28

Note 4. – Balancing Account

Our California water utility has recorded a balancing account receivable in the amount of approximately $2,300,000, representing the difference between actual water production costs incurred and California Public Utilities Commission (CPUC)–adopted water production costs. Historically, the CPUC

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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 $2,300,000 that was 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 expenses are also tracked in a memorandum account and we will attempt to recover these expenses in future rate hearings.

Note 5. – Adoption of New Accounting Policy – Stock-Based Compensation

We currently sponsor two stock option plans: a Stock Option Plan (SOP) and a Director Option Plan (DOP). Prior to 2002, we accounted for those plans under the recognition and measurement provisions of the Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations under whichno stock-based compensation cost was reflected, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. In 2002, we adopted the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires that we 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 accordance with the provisions of SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment to FASB Statement No. 123, we elected to recognize stock-based compensation using the retroactive restatement method. Under this change in accounting method, we restated our financial statements for the prior periods presented in this Report on Form 10-Q for the three and six months ended June 30, 2003 (the June Report) to reflect stock-based compensation expense under a fair value based accounting method for all options granted, modified or settled after December 15, 1994.

The table below sets forth the effect of the retroactive restatement of the prior periods:

	Periods Ended June 30, 2002 (in thousands except per share amounts)
	Three months		Six months
Net Income:
Restated for adoption of SFAS No. 123	$	1,708	$	2,872
Previously reported	$	1,870	$	3,164
Basic Earnings per Common Share:
Restated for adoption of SFAS No. 123	$	.18	$	.30
Previously reported	$	.19	$	.33
Diluted Earnings per Common Share:
Restated for adoption of SFAS No. 123	$	.16	$	.28
Previously reported	$	.18	$	.31

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

7

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.

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 and 2002:

	2003		2002
Dividend yield	1.8	%	1.8	%
Expected volatility	26.6	%	27.3	%
Risk free interest rate	2.7	%	4.6	%
Expected life in years	5.5		5.6

Compensation expense arising from stock option grants as determined using the Black-Scholes fair value option model was approximately $252,000 and $256,000 for the three months ended June 30, 2003 and 2002, respectively, and $467,000 and $459,000 for the six months ended June 30, 2003 and 2002, respectively.

We recorded the following stock-based compensation expense (included in selling, general and administrative expenses) and the related tax benefit recorded to the tax provision under the provisions of SFAS No. 123:

	Three Month Periods Ended (in thousands)
	Jun 30, 2003			Mar 31, 2003			Dec 31, 2002			Sep 30, 2002			Jun 30, 2002			Mar 31, 2002
Compensation recorded	$	252		$	215		$	253		$	251		$	256		$	203
Tax benefit		(93	)		(80	)		(89	)		(88	)		(90	)		(77	)
Net compensation expense	$	159		$	135		$	164		$	163		$	166		$	126

Stock Option Plan: In 1988, the stockholders approved the SOP and in 2000, approved an amendment to the SOP which increased the number of authorized and available shares for issuance by 937,500, 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 750,000. As of June 30, 2003, excluding the issuance of these 750,000 shares, there were 2,430,880 shares (adjusted for stock splits and stock dividends) authorized for issuance under the SOP and 268,914 shares were available for issuance.

Under the SOP, we 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. We 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

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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. Shares attested for purposes of stock options exercised are cancelled. Options are forfeited when they expire or in the event a SOP participant terminates employment with the Company prior to the options vesting.

A summary of the status of the SOP and changes during the six months ended June 30, 2003 and 2002 is presented below:

	SixmonthsendedJune30,
	2003					2002
Fixed Options	Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price
Outstanding at beginning of period		1,492,373		$	8.65		1,196,394		$	7.25
Granted		232,000		$	12.40		247,903		$	13.12
Exercised		(51,471	)	$	7.84		(56,759	)	$	6.62
Cancelled		—			—		—			—
Outstanding options		1,672,902		$	9.19		1,387,538		$	8.32
Options exercisable		865,453		$	7.01		621,682		$	9.18
Weighted average fair value of options granted	$	2.96				$	3.88

The following table summarizes information about fixed stock options outstanding at June 30, 2003:

Options Outstanding						Options Exercisable
Range of Exercise Prices		Number Outstandingat June30,2003	Weighted Average Remaining Contractual LifeinYears	Weighted Average ExercisePrice		Number Exercisable at June30,2003	Weighted Average ExercisePrice
$	2.00 to $5.00	265,091	1.8	$	3.67	265,091	$	3.67
$	5.00 to $ 10.00	440,727	4.6	$	6.93	356,399	$	6.77
$	10.00 to $ 15.00	961,834	5.3	$	11.71	242,913	$	10.97
$	15.00 to $ 20.00	5,250	5.8	$	16.26	1,050	$	16.26
$	2.00 to $ 20.00	1,672,902	4.7	$	9.19	865,453	$	7.01

Director Option Plan: 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 165,375 shares reserved for issuance. As of June 30, 2003, there were 328,166 shares (adjusted for stock splits and stock dividends) authorized for issuance under the DOP and 129,343 shares were available for issuance.

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The DOP provides for an automatic grant of options to purchase 5,000 shares of our 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 our common stock. New directors are granted an initial option to purchase 5,000 shares of our common stock upon appointment to the Board of Directors. DOP options granted subsequent to 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.

A summary of the status of the DOP and changes during the six months ended June 30, 2003 and 2002 is presented below:

	SixmonthsendedJune30,
	2003				2002
Fixed Options		Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
Outstanding at beginning of period		117,632	$	11.20		105,054	$	8.76
Granted		30,000	$	12.12		36,750	$	15.20
Exercised		—		—		—		—
Cancelled		—		—		—		—
Outstanding options		147,632	$	11.39		141,804	$	10.43
Options Exercisable		57,177	$	9.40		33,650	$	11.39
Weighted average fair value of options granted	$	2.89			$	4.50

The following table summarizes information about the director stock options outstanding as of June 30, 2003:

Options Outstanding						Options Exercisable
Range of Exercise Prices		Number Outstanding at June30,2003	Weighted Average Remaining Contractual LifeinYears	Weighted Average ExercisePrice		Number Exercisable at June30,2003	Weighted Average ExercisePrice
$	6.00 to $  9.00	26,024	5.4	$	6.75	23,422	$	6.69
$	9.00 to $15.00	90,108	5.3	$	11.27	27,455	$	10.30
$	15.00 to $20.00	31,500	5.9	$	15.56	6,300	$	15.56
$	6.00 to $20.00	147,632	5.5	$	11.39	57,177	$	9.40

Employee Stock Purchase Plan (ESPP): We have 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, we issued 7,757 shares and

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5,865 shares to employees during the six month periods ended June 30, 2003 and 2002, respectively. At June 30, 2003, 854,649 shares (after adjustment for stock splits and stock dividends) were reserved for issuance under the ESPP and 680,539 shares were available for issuance.

Note 6. – New Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires us to record the fair value of an asset retirement obligation as a liability in the period in which we incur a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development, and/or normal use of the assets. We also record a corresponding asset that is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. We adopted SFAS No. 143 on January 1, 2003. The adoption of SFAS No. 143 did not have a material effect on our consolidated financial statements.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 amends existing guidance on reporting gains and loss on the extinguishment of debt to prohibit the classification of the gain or loss as extraordinary. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provision of SFAS No. 145 related to the rescission of Statement No. 4 applied to fiscal years beginning after May 15, 2002. The provisions of SFAS No. 145 related to Statement No. 13 were effective for transactions occurring after May 15, 2002. The adoption of SFAS No. 145 did not have a material effect on our 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 disposable activities. The provisions of SFAS No. 146 were effective for exit or disposal activities initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a material effect on our 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 were applicable to guarantees issued or modified after December 31, 2002 and the disclosure requirements were effective for financial statements of interim and annual periods ending after December 15, 2002. The adoption of Interpretation No. 45 did not have a material effect on our consolidated financial statements.

In December 2002, the FASB issued SFAS No. 148, which amends FASB No. 123 to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based compensation. In addition, SFAS No. 148 amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. In 2002, we adopted the fair value recognition provisions of SFAS No. 123 and the related provisions of SFAS No. 148 using the retroactive restatement method. See Note 5 for detailed information.

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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. The Interpretation applies immediately to variable interest entities created or obtained after January 31, 2003. For all other variable interest entities the Interpretation applies no later than the end of the first annual reporting period beginning after June 15, 2003. 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. The application of this interpretation is not expected to have a material effect on our consolidated financial statements.

In November 2002, the EITF finalized EITF No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. EITF No. 00-21 is required to be adopted for all new revenue arrangements entered into in fiscal years beginning after June 15, 2003. The EITF also allows application to existing contracts. The adoption of EITF No. 00-21 is not expected to have a material effect on our 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 beginning after June 15, 2003. The application of SFAS No. 150 is not expected to have a material effect on our consolidated financial statements.

Note 7. – Acquisitions

Aqua Services, LP (Aqua Services)

In November 2002, we acquired 100% ownership of certain contract operations primarily in Texas and Colorado of AquaSource, Inc. a provider of contract water and wastewater services. The purchase price consisted of approximately $10,317,000 in cash. Upon closing of the transaction, we began operating a part of this business under the name Aqua Services while the remaining part was incorporated into one of our existing subsidiaries.

Operations Technologies, Inc. (OpTech)

In August 2001, we purchased 90% of the outstanding stock of OpTech, a provider of contract water and wastewater and public works services in the southeastern United States, for a purchase price of $8,248,000. The purchase price consisted of cash payments of $3,948,000, promissory notes of $3,000,000 and 96,580 shares of our common stock with a fair market value of approximately $1,300,000 at the date of acquisition. Under the terms of the purchase agreement, we have the right to acquire the remaining 10% of OpTech after August 31, 2006 based upon a formula incorporating the profitability of OpTech. After August 31, 2003, the minority owner of OpTech has the option to sell the remaining 10% of OpTech to us for $1,000,000 or using the same formula discussed.

Master Tek International, Inc. (Master Tek)

In April 2000, we purchased 80% of the outstanding stock of Master Tek for approximately $4,000,000 consisting of $2,000,000 in cash and a $2,000,000 promissory note. Under the terms of our purchase agreement, the minority owner of Master Tek may require us to purchase his remaining 20% minority interest in 5% increments at a price not to exceed $1,000,000 per year over four years. In April

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2002, we paid $1,000,000 to the minority owner to increase our ownership interest to 85%. In the first quarter of 2003, the minority owner of Master Tek exercised his option to sell to us an additional 5% ownership interest. In April 2003, we paid $1,000,000 into an escrow account as discussed in Part II, Item 1., Legal Proceedings (also see Note 11).

Intangibles

At June 30, 2003, the gross carrying amount of acquired intangible assets was approximately $3,535,000 and accumulated amortization of these assets was approximately $1,198,000. Amortization expense for intangible assets for the six months ended June 30, 2003 was approximately $249,000.

The changes in the carrying amount of goodwill from acquisitions for the six months ended June 30, 2003 are as follows:

	Services Group Segment		Utility Group Segment		Totals
	(in thousands)
Balance as of December 31, 2002	$	20,151	$	—	$	20,151
Goodwill acquired		61		—		61
Impairment losses		—		—		—
Balance as of June 30, 2003	$	20,212	$	—	$	20,212

Note 8. – Non-Recurring Items

Groundwater Settlement

One of the water sources of 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 had to purchase replacement water at a cost substantially higher than the cost of water pumped from our own wells.

In May 2002, a settlement was reached among some of the alleged polluters and a number of water companies, including our water utility in California. As part of the settlement, in the second quarter of 2002, we recorded income of approximately $1,649,000 and received payments, primarily representing reimbursement of certain water and energy costs incurred in 2000 and 2001.

These costs were absorbed by our water utility and not passed to the rate payers. Accordingly the reimbursement offset costs that our utility had previously incurred, resulting in no effect on rate-payers. Additionally, we have received payments in both 2002 and 2003, and we expect to continue to receive payments in future periods until completion of remediation. The 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. We bill and collect this reimbursement each month. These amounts are recorded as a reduction of water costs included in direct operating expenses. The settlement also provides capital contributions to construct new wells and additional interconnections with

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other water sources. Funds from the settlement will also be used to develop long-term solutions that will potentially enable us to use our own less costly groundwater supplies in the future.

Pension Plan Termination

As of December 30, 1999, our non-contributory defined benefit pension plan was terminated. 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 $14,400,000 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 $1,150,000.

In February 2002, our 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. We recognized a net termination gain of approximately $980,000 as income in the first quarter of 2002.

Note 9. – Seasonality

Our Utility Group water operations are seasonal as 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 lower revenue due to consumer conservation efforts and a shortage of water. 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 Group operations. Utility Group wastewater operations are generally not affected by seasonality.

Our Services Group operations can be affected by 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 as we meet the terms of our operations and maintenance contracts. Depending on our specific contractual terms these additional costs may not necessarily be recoverable from the various cities that have operations and maintenance contracts with us.

Note 10. – Private Placement of Equity

In May 2003 we completed a private placement of 1,108,033 shares of newly issued common stock to select institutional investors. Gross proceeds from the private placement were $12,000,000 from which commissions and fees of approximately $1,000,000 were or will be paid. We have filed a registration statement with the Securities and Exchange Commission (SEC) to register the resale of the common stock issued in the private placement.

Note 11. – Legal Proceedings

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 misrepresentations and failure to disclose certain material facts in connection with our purchase of 80% of the stock of Master Tek. We are seeking indemnification for certain costs incurred subsequent to our purchase of the subsidiary in April 2000. In the first quarter of 2003, the minority owner exercised an option to require us to purchase an additional 5% of Master Tek for $1,000,000. In April 2003, due to this lawsuit and as permitted by the purchase agreement, we paid the $1,000,000 into an escrow account. These funds may be used to offset any final

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resolution of our claim. The minority owner has filed a counter claim and the lawsuit is currently in the discovery stage. We cannot predict the outcome of this lawsuit; however, we do not believe this action will have a material adverse effect on our financial position, results of operations or cash flows.

In September 2002, one of our subsidiaries was named as a defendant in a lawsuit in the United States District Court for the Northern District of Mississippi alleging wrongful death as the result of a chlorine gas leak that occurred in July 2000 at one of the facilities that we operate. The decedent who was exposed to the gas leak was treated and released from the hospital on the next day. He subsequently died eleven months later of causes that we believe are unrelated to the chlorine gas exposure. In July 2003, this case was dismissed without prejudice. However, the plaintiff may re-file the action at some future date. We cannot predict the outcome of any future action; however, we do not expect that this matter will have a material adverse effect on our financial position, results of operations or cash flows.

Southwest Water and one of our subsidiaries have been named as defendants in twelve lawsuits, pending in Los Angeles, California, alleging water contamination in the San Gabriel Valley Main Basin. The California Supreme Court (the Court) ruled in February 2002 that the plaintiffs may sue and collect damages from CPUC-regulated water companies only by proving that water delivered did not meet CPUC water quality standards. Our subsidiary believes that it has complied with CPUC water quality standards. The Court directed that the cases be sent to a trial court for further proceedings. At this time twenty-one cases, including the twelve involving the Southwest subsidiary, have been consolidated before a judge in the Superior Court of California for the County of Los Angeles. 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 alleged water contamination. Southwest Water and our subsidiary have requested defense and indemnification from our liability insurance carriers for these lawsuits. Several of the liability insurance carriers are currently covering the costs of defense of the lawsuits. The Company 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.

Southwest Water and its subsidiaries are the subjects of certain 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 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

RESULTS OF OPERATIONS

Revenues and Operating Income

For the second quarter of 2003, we recognized revenues of $41,464,000, an increase of $8,718,000, or 27%, compared to the same period in 2002. In the second quarter of 2003, we recorded operating income of $3,497,000, an increase of $1,604,000, or 85%, compared to the second quarter of 2002.

For the six months ended June 30 for 2003, we recognized revenues of $77,578,000, an increase of $16,664,000, or 27%, compared to the same period in 2002. In the first six months of 2003, we recorded operating income of $4,418,000, an increase of $582,000, or 15%, compared to the same period in 2002.

The increase in total revenue was driven largely by increased Services Group revenues of approximately 45% for both the quarter and year-to-date periods. The revenue increase was due to our Aqua Services acquisition in November 2002, increased construction and operations activities in Texas, and construction revenues from our development of a reverse osmosis water treatment facility in

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California, which we began in December 2002. The Utility Group also expanded revenues over the prior year periods due to increased customer connections in New Mexico, and rate increases in Texas and California.

Operating income increased approximately 85% and 15%, respectively, for the three and six month periods ended June 30, 2003. This increase reflects favorable water production costs and a rate increase at our California utility. Additionally, operating income was bolstered by the increased construction activities related to water distribution facilities in Texas and a reverse osmosis water treatment facility in California. The aforementioned factors were partially offset by increased general and administrative costs for employee health benefits, insurance and compensation expenses. Operating income for the second quarter of 2002 included an increase in our allowance for uncollectible accounts and business development expenses.

Services Group

Services Group revenues for the second quarter of 2003 were $27,702,000, an increase of $8,513,000 or 44%, from the second quarter of 2002. The increase was due primarily to the acquisition of Aqua Services in November 2002. Revenues also increased due to construction activities related to water distribution facilities in Texas and a reverse osmosis water treatment facility in California.

Services Group operating income was $869,000 in the second quarter of 2003, an increase of 68% from $516,000 in the comparable period of 2002. As a percentage of revenues, Services Group operating income increased from 2.7% in the second quarter of 2002 to 3.1% in the comparable period of 2003. Services Group operating income increased due to the operating income contribution from construction activities related to water distribution facilities in Texas and a reverse osmosis water treatment facility in California and continued cost control efforts. Operating income for the second quarter of 2002 included an increase in our allowance for uncollectible accounts and business development expenses.

Services Group revenues for the first six months of 2003 were $52,890,000, an increase of 45% from $36,366,000 in the same period of 2002. The increase was due primarily to the acquisition of Aqua Services in November 2002. Revenues also increased due to construction activities related to water distribution facilities in Texas and a reverse osmosis water treatment facility in California.

Services Group operating income was $902,000 in the first six months of 2003, a decrease of 10%, or $105,000, from the comparable period of 2002. As a percentage of revenues, Services Group operating income decreased from 2.8% in the first six months of 2002 to 1.7% in the first six months of 2003. The decrease is attributable to increased costs of employee health benefits, insurance and compensation expenses, and the integration of Aqua Services.

Utility Group

Utility Group revenues for the second quarter of 2003 increased to $13,762,000, an increase of $205,000, or 2%, from the same period in 2002. In the second quarter of 2003, water usage increased in New Mexico, primarily reflecting an increase in the number of customers. A rate increase at one of our utilities in Texas also contributed to increased revenues. Water usage decreased at our utility in California because of cool, damp weather in 2003 compared to drought-like conditions throughout much of the second quarter of 2002.

In the second quarter of 2003, our Utility Group operating income increased by $1,237,000, or 39%, to $4,410,000 from the same period of 2002. 2003 operating income benefited from lower water-volume-related expenses incurred at our utility in California and increased revenues at our Texas utilities.

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Utility Group revenues for the first six months of 2003 increased to $24,688,000, an increase of $140,000, or 1%, from the same period in 2002. In the first six months of 2003, additional customers at our Texas and New Mexico utilities, combined with a rate increase at one of our Texas utilities, increased revenues. Water usage decreased at our utility in California because of cooler weather in 2003 compared to drought-like conditions throughout much of the first six months of 2002. However, this was mitigated by the rate increase in California that became effective in late May 2003.

In the first six months of 2003, our Utility Group operating income increased 2% to $6,614,000 from $6,517,000 in the same period of 2002. The increase in 2003 year-to-date operating income resulted from the effect of increased revenues due to rate increases in California and Texas and an increase in the number of customers in our New Mexico and Texas utilities.

Selling, General and Administrative Expenses

Selling, general and administrative (SG&A) expenses decreased 9% to $5,425,000 during the second quarter of 2003, compared to $5,954,000 in the same period of 2002. As a percentage of consolidated revenues, SG&A expenses were 13% and 18% in 2003 and 2002, respectively.

SG&A expenses increased 7% to $11,185,000 during the first six months of 2003, compared to $10,442,000 in the same period of 2002. As a percentage of consolidated revenues, SG&A expenses were 14% and 17% in 2003 and 2002, respectively.

SG&A expenses for the second quarter of 2003 include Aqua Services expenses of $407,000 and increased costs company-wide for employee health benefits, insurance and compensation expenses. In 2002 SG&A expenses included approximately $830,000 of marketing and new business development expenses associated potential major new contracts in Florida and California and an increase in our allowance for uncollectible accounts.

SG&A expenses for the six months ended June 30, 2003 include costs for Aqua Services of $936,000 and the increased costs company-wide for employee health benefits, insurance and compensation expenses. In the prior year period SG&A expenses included approximately $830,000 of marketing and new business development expenses associated potential major new contracts in Florida and California and an increase in our allowance for uncollectible accounts.

Other Income and Expense

Interest Expense

Total interest expense increased 4% to $1,109,000 during the second quarter of 2003, compared to $1,063,000 for the same period in 2002. In August 2002, one of our Texas utilities obtained a 10-year $10,000,000 secured bank term loan which increased our interest expense. Total interest expense increased 4% to $2,306,000 during the first six months of 2003, compared to $2,219,000 for the same period in 2002, due to higher average balances outstanding on our lines of credit and additional interest expense from the Texas utility $10,000,000 secured bank loan.

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The major components of interest expense for three and six months ended June 30, 2003 and 2002 are as follows:

For three months ended June 30,	2003	2002
	(in thousands)

Interest expense - convertible subordinate debentures	$	335		$	339
Interest expense - bank lines of credit		124			159
Interest expense - mortgage bonds and bank term loan		579			526
Interest expense – other		187			115
Total interest expense before capitalized interest		1,225			1,139
Capitalized interest		(116	)		(76	)
Total interest expense	$	1,109		$	1,063

For the six months ended June 30,	2003			2002
	(in thousands)
Interest expense - convertible subordinate debentures	$	676		$	681
Interest expense - bank lines of credit		351			310
Interest expense - mortgage bonds and bank term loan		1,161			1,090
Interest expense – other		316			243
Total interest expense before capitalized interest		2,504			2,324
Capitalized interest		(198	)		(105	)
Total interest expense	$	2,306		$	2,219

Other and Land Sale Gains

In the second quarter of 2003, we recognized a $720,000 pretax gain on the sale of surplus land that was no longer used or useful in the operation of the utility. In the second quarter of 2002, we recognized approximately $1,649,000 pretax income from a ground water settlement (see Note 8). In the first quarter of 2002, we recorded a one-time pretax gain on the termination of a pension plan of approximately $980,000, and a $119,000 pretax gain on the sale of surplus land that was no longer used or useful in the operation of the utility.

Income Taxes

Our effective tax rate for the first six months of 2003 was 37% 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.

Net Income and Earnings Per Share

For the second quarter of 2003, we recorded net income of $1,889,000, or diluted EPS of $0.18, compared to net income of $1,708,000, or diluted EPS of $0.16, for the same period in 2002. Our second quarter 2003 net income and EPS reflect the effect of favorable water production costs and a rate increase effective in late May 2003 at our California utility, as well as a gain on sale of land of $454,000, net of tax. Additionally, 2003 net income was bolstered by increased construction activities related to water distribution facilities in Texas and a reverse osmosis water treatment facility in San Juan Capistrano, California. This was offset by increased general and administrative costs for employee health benefits, insurance and compensation expenses. Net income for the second quarter in 2002 also reflects the impact of the ground water settlement.

In the first six months of 2003, we recorded net income of $1,740,000, or diluted EPS of $0.17, compared to net income of $2,872,000, or diluted EPS of $0.28, in the first six months of 2002. Our six month 2003 net income and EPS reflect favorable water production costs as well as continued increases in customers at our Texas and New Mexico utilities and a gain on sale of land of $454,000, net of tax, or

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diluted EPS of $0.07. Additionally, net income was bolstered by the increased construction activities related to water distribution facilities in Texas and a reverse osmosis water treatment facility in San Juan Capistrano, California. These factors were partially offset by increased general and administrative costs for employee health benefits, insurance and compensation expenses.

Net income and diluted EPS in the first six months of 2002 reflects the impact of a one-time gain on the termination of a pension plan of $637,000 net of tax, or diluted EPS of $0.06, a ground water settlement of $1,074,000 net of tax, or diluted EPS of $0.10, and a gain on sale of land of $79,000 net of tax, or diluted EPS of $0.01.

ADJUSTMENTS RELATED TO STOCK OPTION ACCOUNTING

We currently sponsor two stock option plans. Prior to 2002, we accounted for those plans under the recognition and measurement provisions of the APB Opinion No. 25 under which no stock-based compensation cost was reflected, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

Effective in 2002, we adopted the fair value based method of accounting for stock options as outlined in SFAS No. 123. In accordance with the provisions of SFAS No. 148, we elected to recognize stock-based compensation using the retroactive restatement method. Accordingly, all prior periods presented have been restated to reflect compensation cost that would have been recognized under the fair value based accounting method for all options granted, modified or settled in fiscal years beginning after December 15, 1994.

FINANCIAL CONDITION

Liquidity and Financial Position

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 contracts.

On June 30, 2003, we had working capital of approximately $5,101,000 with cash and cash-equivalent balances totaling approximately $1,868,000, as well as aggregate lines of credit totaling $28,000,000 consisting of three separate unsecured lines of credit from three commercial banks. One of the lines of credit for $4,000,000 expires in April 2005. The other two lines totaling $20,000,000 expire in September 2004. In March 2003, we amended one of these lines of credit to increase our line of credit capacity by $4,000,000 to $28,000,000 through December 31, 2003. Our total borrowing availability under our lines of credit on June 30, 2003, including the amendment to extend the additional $4,000,000, was approximately $13,676,000.

As of December 31, 2002, we had approximately $20,158,000 outstanding on our lines of credit and $3,842,000 borrowing availability.

In January 2003, we expanded one of our lines of credit from one of our commercial banks by $3,430,000. This facility was utilized to issue a standby letter of credit in that amount as collateral for performance under the service contract for the Capistrano Valley Water District (CVWD) to design and construct a reverse osmosis water treatment facility and associated wells. This standby letter of credit is

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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 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 $69,000,000 as of June 30, 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 the six months ended June 30, 2003, we were in compliance with all applicable covenants under each of the line of credit agreements.

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.

In the first six months of 2003, net cash used by operations totaled $862,000 compared to net cash provided by operations of $6,828,000 for the same period in 2002.

Investing Activities

Our investing activities include company-funded development and purchase of plant and equipment as well as acquisitions.

The following table summarizes our activity for additions to property, plant and equipment during the six months ended June 30, 2003 and 2002:

	2003		2002
	(in thousands)
Company financed additions	$	4,982	$	1,414
Capital improvement reimbursements		2,182		—
Developer paid contributions in aid of construction (CIAC), advances for construction and living unit equivalent (LUE) fees		1,975		7,728
Total cash additions to property, plant and equipment		9,139		9,142
Non-cash property contributed by developers		3,629		1,655
Total additions to property, plant and equipment	$	12,768	$	10,797

During the first six months of 2003, additions to property, plant and equipment were primarily for regulated water system assets for our Utility Group, including new wells and transmission lines in New Mexico, and the construction of a lift station and water line in Texas.

Financing Activities

Our financing activities include reimbursements of capital improvement costs, CIAC, LUE fees, advances for construction, net borrowings on our lines of credit, dividend payments, payments on long-term debt, and issuing equity among other items.

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In May 2003 we completed a private placement of 1,108,033 shares of newly issued common stock to select institutional investors. Gross proceeds from the private placement were $12,000,000 from which commissions and fees of approximately $1,000,000 were or will be paid. We have filed a registration statement with the SEC to register the resale of the common stock issued in the private placement.

CRITICAL ACCOUNTING POLICIES

The accounting policies described below are those we consider critical in preparing our consolidated financial statements. Certain of these policies require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of certain contingent assets and liabilities at the date of the consolidated financial statements, as well as amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

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 usually 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 on the project based on the expected total project costs and the expected total project revenues. The method is based on an estimate of the revenue and income earned to date, less the revenue and income recognized in earlier periods.

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.

Water utility revenues are recognized when amounts are billed to customers. An estimated amount for unbilled revenues is also recognized for water used toward the end of the accounting period.

Impairment ofGoodwill: 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 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 to their estimated residual values. SFAS No. 142 became effective for fiscal years beginning after December 15, 2001. At June 30, 2003, other assets include approximately $20,212,000 of net goodwill, which was no longer subject to amortization beginning in 2002. There were no impairment charges to goodwill as of June 30, 2003 as no triggering events had occurred.

Under the provisions of SFAS No. 141, Business Combinations, we identified approximately $204,000 of intangible contract costs in connection with our acquisition of Aqua Services and approximately $1,100,000 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.

Utility Accounting: 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, which specifies certain revenue, expense and balance sheet treatment as required by each state regulatory agency. Each state

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agency 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.

One of the companies in our Services Group has contracted with our utilities in Texas and New Mexico to perform operating services, maintenance, and construction work, and, in addition, 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 entities. In accordance with SFAS No. 71, our Services Group recognizes profit from contract and operations work performed and does not eliminate the intercompany profit on the work performed when the contract sales price is reasonable and it is probable that the costs and capital will be recoverable through the rate making process. Accordingly, the intercompany profit on such work has not been eliminated in the accompanying condensed consolidated financial statements. However, all revenue in excess of profits has been eliminated in consolidation, consisting of $2,217,000 and $4,233,000 for the three and six months ended June 30, 2003, respectively.

Balancing Account: Our California water utility has recorded a balancing account receivable in the amount of approximately $2,300,000, representing the difference between actual water production costs incurred and California Public Utilities Commission (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 $2,300,000 that was 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 expenses are also tracked in a memorandum account and we will attempt to recover these expenses in future rate hearings.

Collectibility of Customer Receivables: We periodically evaluate the collectibility of our customer receivables, and provide an allowance for uncollectible receivables based upon an estimate by management of the amount of receivables that might not be collectible. This estimate is predicated upon a number of factors, including historical receivable write-off experience, a review of customer accounts with past due uncollected balances, probable costs of collection and the general credit worthiness of our customers. We believe that our allowance for doubtful accounts is adequate as of June 30, 2003.

Stock-Based Compensation: In 2002, we adopted the fair value recognition provisions of SFAS No. 123. SFAS No. 123 requires that we 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 accordance with the provisions of SFAS No. 148, we have elected to recognize stock-based compensation using the retroactive restatement method. Under this change in accounting method, we have restated our accompanying condensed consolidated financial statements for the prior period presented in the June Report 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

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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.

FORWARD-LOOKING STATEMENTS

Certain statements contained in this report may constitute “forward-looking statements” as defined under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), and such statements as made pursuant to the safe harbor provisions of the Reform Act. Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will,” and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future are forward-looking statements. Forward-looking statements are subject to risks and uncertainties including those risks described under the caption “Risk Factors” in our 2002 Annual Report, that could cause actual results to differ materially from our historical experience and our present expectations or projections. When made, we believe that these forward-looking statements are reasonable. However, 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. We undertake no obligation to publicly update or revise any forward-looking statements.

RISK FACTORS

The following factors, which are described more fully in our 2002 Annual Report, could cause our actual results to differ materially from our forward-looking statements (see our 2002 Annual Report):

Risk factors that affect our Utility Group operations:

• Weather conditions can impact the financial results of our Utility Group;

• Rates that we are allowed to charge customers are set by regulatory agencies;

• We own assets in areas subject to natural disasters;

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

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

Risk factors that affect our Services Group operations:

• We operate in a competitive market with low operating margins;

• We market our services in a political environment;

• We may be unableto renew Services Group contracts;

• Our business depends on trained, qualified employees;

• Risks of events such as hurricanes, tornadoes and floods may impact our results of operations;

• Our Services Group contracts have certain performance risks;

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

• We use third party equipment and subcontractors;

• Our Services Group is subject to environmental and water quality risks;

• We have risks associated with a large fleet of vehicles;

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• Our operating costs may rise faster than our revenues;

• Our operating contracts may be cancelled by a municipality, impacting our revenue backlog.

Other risk factors that impact our operations:

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

• If we continue to grow we may fail to effectively manage our growth;

• Our business may be impacted by the general economic conditions of real estate development in the United States;

• We are subject to the increasing costs of producing products and services;

• Our operations are subject to certain risks due to their location;

• The uncertainties of litigation as well as other risks and uncertainties may affect us.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We have certain indebtedness that is subject to variable interest rates. 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 $20,000,000, 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 our 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 a certain market price, our debentures will become dilutive in our computation of earnings per share.

Item 4. Controls and Procedures

Our principal executive officer and principal financial officer are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Southwest Water, and we have designed such disclosure controls and procedures to ensure that material information relating to Southwest Water, including its consolidated subsidiaries, is made known to us by management within these entities, particularly during the period in which this quarterly report is being prepared. In designing and evaluating the disclosure controls and procedures, management recognized 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 was required to apply its judgement in evaluating the cost-benefit relationship of possible controls and procedures. As required by the SEC Rule 13a-15(b), Southwest Water carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of June 30, 2003, the end of the quarter covered by this report. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the disclosure controls and procedures were effective at the reasonable assurance level.

There has been no change in Southwest Water’s internal controls over financial reporting during Southwest Water’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Southwest Water’s internal controls over financial reporting.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

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 misrepresentations and failure to disclose certain material facts in connection with our purchase of 80% of the stock of Master Tek. We are seeking indemnification for certain costs incurred subsequent to our purchase of the subsidiary in April 2000. In the first quarter of 2003, the minority owner exercised an option to require us to purchase an additional 5% of Master Tek for $1,000,000. On April 3, 2003, due to this lawsuit and as permitted by the purchase agreement, we paid the $1,000,000 into an escrow account. These funds may be used to offset any final resolution of our claim. The minority owner has filed a counter claim and the lawsuit is currently in the discovery stage. We cannot predict the outcome of this lawsuit; however, we do not believe this action will have a material adverse effect on our financial position, results of operations or cash flows.

In September, 2002, one of our subsidiaries was named as a defendant in a lawsuit in the United States District Court for the Northern District of Mississippi alleging wrongful death as the result of a chlorine gas leak that occurred in July 2000 at one of the facilities that we operate. The decedent who was exposed to the gas leak was treated and released from the hospital on the next day. He subsequently died eleven months later of causes that we believe are unrelated to the chlorine gas exposure. In July 2003, this case was dismissed without prejudice. However, the plaintiff may re-file the action at some future date. We cannot predict the outcome of any future action;, however, we do not expect that this matter will have a material adverse effect on our financial position, results of operations or cash flows.

Southwest Water and one of our subsidiaries have been named as defendants in twelve lawsuits, pending in Los Angeles, California, alleging water contamination in the San Gabriel Valley Main Basin. The California Supreme Court (the Court) ruled in February 2002 that the plaintiffs may sue and collect damages from CPUC-regulated water companies only by proving that water delivered did not meet CPUC water quality standards. Our subsidiary believes that it has complied with CPUC water quality standards. The Court directed that the cases be sent to a trial court for further proceedings. At this time twenty-one cases, including the twelve involving the Southwest subsidiary, have been consolidated before a judge in the Superior Court of California for the County of Los Angeles. 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 alleged water contamination. Southwest Water and our subsidiary have requested defense and indemnification from our liability insurance carriers for these lawsuits. Several of the liability insurance carriers are currently covering the costs of defense of the lawsuits. The Company 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.

Southwest Water and its subsidiaries are the subjects of certain 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.

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Item 4. Submission of Matters to a Vote of Security Holders

At the Annual Meeting of Stockholders held on May 8, 2003, the following proposals were voted on:

Proposal One

Linda Griego, Donovan D. Huennekens and Richard G. Newman, members of the Board of Directors, were reelected by the following votes:

Ms. Griego: votes for – 8,550,359; and votes abstaining – 489,857.

Mr. Huennekens: votes for – 8,553,674; and votes abstaining – 506,542.

Mr. Newman: votes for – 8,547,049; and votes abstaining – 493,167.

No votes were cast against the election of any of these individuals. The following are the names of each of our other directors whose term of office continued after the meeting:

Directors Holding Office Until 2004: H. Frederick Christie, Anton C. Garnier, Peter J. Moerbeek

Directors Holding Office Until 2005: James C. Castle, Maureen A. Kindel

Proposal Two

Approval was received for the authorization to increase by 750,000 the number of shares available for issuance under the Stock Option Plan.

Votes for	3,473,375
Votes against	2,053,562
Votes abstaining	351,477
Broker Non-Vote	3,161,802

Item 6. Exhibits and Reports on Form 8-K

(a)Exhibits:

4.1	Form of Securities Purchase Agreement dated May 28, 2003 among Southwest Water Company and the purchasers identified therein (incorporated by reference from Registration Statement on Form S-3, File No. 333-106506, filed June 25, 2003 by Southwest Water Company).
10.1	Eighth Amendment to Credit Agreement between Bank of America, N.A. and Southwest Water Company dated as of March 14, 2003.
10.2	Credit Agreement between Southwest Water and Union Bank of California, NA, dated June 6, 2003.
31	Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code).

(b)Reports on Form 8-K:

We filed a report on Form 8-K, dated May 30, 2003, under Item 5. Other Events, announcing the issuance of 1,108,033 shares of newly issued common stock in a private placement.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	SOUTHWEST WATER COMPANY (Registrant)
Dated:  August 13, 2003	/s/ RICHARD J. SHIELDS
	Richard J. Shields Chief Financial Officer (Principal Accounting and Financial Officer)

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EX-10.1

Exhibit 10.1

EIGHTH AMENDMENT TO
CREDIT AGREEMENT

THIS EIGHTH AMENDMENT TO CREDIT AGREEMENT (the “Amendment,”), dated for reference purposes only as of March 14, 2003, is entered into between BANK OF AMERICA, N.A., a national association (“Bank”), and SOUTHWEST WATER COMPANY, a Delaware corporation (“Borrower”).

RECITALS

A.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, (collectively, the “Credit Agreement”), pursuant to which Bank has made certain loans and financial accommodations available to Borrower. Terms used herein without definition shall have the meanings ascribed to them in the Credit Agreement.

B.Bank and Borrower wish to amend the Credit Agreement under the terms and conditions set forth in this Amendment. Borrower is entering into this Amendment with the understanding and agreement that, except as specifically provided herein, none of Bank’s rights or remedies as set forth in the Credit Agreement is being waived or modified by the terms of this Amendment.

NOW, THEREFORE, in consideration of the foregoing and the mutual covenants herein contained, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows:

1.Amendments to Credit Agreement.

(a)The definition of “Revolving Commitment” set forth in Section 1.01 of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

“‘Revolving Commitment’: The amount of $10,000,000 from the date hereof to December 31, 2003, and $6,000,000 thereafter as such amount may be reduced pursuant to Section 2.01 (c).”

(b)Section 6.02 (a) of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

1

“(a) Leverage Ratio. Permit the ratio of the amount of Consolidated Liabilities less the outstanding principal amount of the Debentures to Consolidated Tangible Net Worth to be more than 2.10:1.00 between the date hereof and December 31, 2003, and 2.00:1.00 thereafter.”

(c)Section 6.02 (1) of the Credit Agreement is hereby amended and restated in its entirety to read as follows:

“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, loans or advances, whether matured or unmatured, liquidated or unliquidated, joint or several, secured or unsecured, except for (i) Debt incurred pursuant to the Agreement and the other Loan Documents, (ii) Debt incurred pursuant to the Suburban Loan Documents; (iii) Debts, revolving lines of credit and lease obligations of Borrower existing as of, and disclosed to Bank prior to, the date of the Agreement (including $6,000,000 of unsecured debt of the Borrower to Mellon, $4,000,000 of unsecured debt of Suburban to Mellon, and $4,000,000 of unsecured debt of NMUI to First Security Bank (or successors), (iv) secured indebtedness for purchase money financing of equipment which is permitted under Section 6.02 (e)(iii) not to exceed an aggregate of $500,000, (v) unsecured funded bank debt not to exceed aggregate of $28,000,000 between the date hereof and December 31, 2003, and $24,000,000 thereafter (including, without limitation, unsecured funded bank debt incurred pursuant to the Loan Documents and the Suburban Loan Documents and unsecured funded bank debt to Mellon as described in clause (iii) above), (vi) Debt incurred pursuant to the Debentures not to exceed $20,000,000, (vii) secured term Debt incurred by Windermere Utility Company not to exceed $10,000,000 and Borrower’s guaranty of such Debt, (viii) obligations owing to Bank by Borrower in respect of a standby letter of credit issued for the benefit of Capistrano Valley Water District, and (ix) intercompany Debt between Borrower and its majority-owned Subsidiaries.”

2.Effectiveness of this Amendment. Bank must have received the following items, in form and content acceptable to Bank, before this Amendment is effective and before Bank is required to extend any credit to Borrower as provided for by this Amendment.

(a)Amendment. This Amendment fully executed in a sufficient number of counterparts for distribution to Bank and Borrower.

(b)Amendment Fee. Receipt by Bank of the amendment fee set forth in Paragraph 3 below.

(c)Note. The Fifth Amended and Restated Revolving Note, the form of which is attached hereto as Exhibit A, fully executed by the Borrower.

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(d) Authorizations. Evidence that the execution, delivery and performance by Borrower and each guarantor or subordinating creditor of this Amendment and any instrument or agreement required under this Amendment have been duly authorized.

(e)Representations and Warranties. The representations and warranties set forth in the Credit Agreement must be true and correct.

(f)Other Required Documentation. All other documents and legal matters in connection with the transactions contemplated by this Amendment shall have been delivered or executed or recorded and shall be in form and substance satisfactory to Bank.

3.Amendment Fee. Borrower shall pay to Bank an amendment fee in the amount of _________ for the processing and approval of this Amendment, which fee will be fully earned on the date of this Amendment.

4.Representations and Warranties. The Borrower represents and warrants as follows:

(a)Authority. The Borrower has the requisite corporate power and authority to execute and deliver this Amendment and to perform its obligations hereunder and under the Loan Documents (as amended or modified hereby) to which it is a party. The execution, delivery and performance by the Borrower of this Amendment and the performance by Borrower of each Loan Document (as amended or modified hereby) to which it is a party have been duly approved by all necessary corporate action of Borrower and no other corporate proceedings on the part of Borrower are necessary to consummate such transactions.

(b)Enforceability. This Amendment has been duly executed and delivered by the Borrower. This Amendment and each Loan Document (as amended or modified hereby) is the legal, valid and binding obligation of Borrower, enforceable against Borrower in accordance with its terms, and is in full force and effect.

(c)Representations and Warranties. The representations and warranties contained in each Loan Document (other than any such representations or warranties that, by their terms, are specifically made as of a date other than the date hereof) are correct on and as of the date hereof as though made on and as of the date hereof.

(d)No Default. No event has occurred and is continuing that constitutes an Event of Default.

5.Choice of Law. The validity of this Amendment, its construction, interpretation and enforcement, the rights of the parties hereunder, shall be determined under, governed by, and construed in accordance with the internal laws of the State of California governing contracts only to be performed in that State.

6.Counterparts. This Amendment may be executed in any number of counterparts and by different parties in separate counterparts, each of which when so executed and delivered, shall be deemed an original, and all of which, when taken together, shall constitute

3

one and the same instrument. Delivery of an executed counterpart of a signature page to this Amendment by telefacsimile shall be effective as delivery of a manually executed counterpart of this Amendment.

7.Due Execution. The execution, delivery and performance of this Amendment are within the power of Borrower, have been duly authorized by all necessary corporate action, have received all necessary governmental approvals, if any, and do not contravene any law or any contractual restrictions binding on Borrower.

8.Reference to and Effect on the Loan Documents.

(a)Upon and after the effectiveness of this Amendment, each reference in the Credit Agreement to “this Agreement”, “hereunder”, “hereof” or words of like import referring to the Credit Agreement, and each reference in the other Loan Documents to “the Credit Agreement”, “thereof” or words of like import referring to the Credit Agreement, shall mean and be a reference to the Credit Agreement as modified and amended hereby.

(b)Except as specifically amended above, the Credit Agreement and all other Loan Documents, are and shall continue to be in full force and effect and are hereby in all respects ratified and confirmed and shall constitute the legal, valid, binding and enforceable obligations of Borrower to Bank.

(c)The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of Bank under any of the Loan Documents, nor constitute a waiver of any provision of any of the Loan Documents.

(d)To the extent that any terms and conditions in any of the Loan Documents shall contradict or be in conflict with any terms or conditions of the Credit Agreement, after giving effect to this Amendment, such terms and conditions are hereby deemed modified or amended accordingly to reflect the terms and conditions of the Credit Agreement as modified or amended hereby.

9.Ratification. Borrower hereby restates, ratifies and reaffirms each and every term and condition set forth in the Credit Agreement, as amended hereby, and the Loan Documents effective as of the date hereof.

10.Estoppel. To induce Bank to enter into this Amendment and to continue to make advances to Borrower under the Credit Agreement, Borrower hereby acknowledges and agrees that, after giving effect to this Amendment, as of the date hereof, there exists no Event of Default and no right of offset, defense, counterclaim or objection in favor of Borrower as against Bank with respect to the Obligations.

(SIGNATURES ON NEXT PAGE)

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IN WITNESS WHEREOF, the parties have entered into this Amendment as of the date first above written.

“Bank” BANK OF AMERICA, N.A. a national association	“Borrower” SOUTHWEST WATER COMPANY, a Delaware corporation
By:	By:
Name:	Name:	Thomas C. Tekulve
Title:	Title:	Vice President - Finance

By:
Name:	Anton C. Garnier
Title:	President

5

FIFTH AMENDED AND RESTATED REVOLVING NOTE

$10,000,000 Costa Mesa, California
March 14, 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 Blvd., Costa Mesa, California, 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 Ten Million Dollars ($10,000,000), 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 IBOR Rate plus the Applicable Margin or Prime Rate plus the Applicable Margin. 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 IBOR option selected hereunder, Bank is hereby authorized to note the date, principal amount, interest rate and applicable IBOR 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. This Note amends, restates in its entirety, and replaces that certain Fourth Amended and Restated Revolving Note dated as of September 30, 2001 in the original amount of Six Million Dollars ($6,000,000), made by Borrower payable to the order of Bank, pursuant to that certain Credit Agreement (as defined in Section D below).

A. DEFINITIONS:

As used herein, the following terms shall have the meanings set forth after each:

1. “Applicable Margin” means the following amounts per annum, based upon the Leverage Ratio as set forth in the certificate received pursuant to Section 6.01 (a) (iv) of the Credit Agreement (“Compliance Certificate”):

		(in basis points per annum)	(in basis points per annum)
Pricing Level	Leverage Ratio	Applicable Margin for IBOR Rate loans	Applicable Margin for Prime Rate loans
1	<1.50x	125.0 bps	(25) bps
2	>=1.50x but <1.75x	150.0 bps	00 bps
3	>=1.75x	200.0 bps	25 bps

During the period from the date of this Note to the date on which the Bank receives the first Compliance Certificate after the date of this Note, the Applicable Margin shall be based on a pricing level 1 set forth in the above table. Thereafter, the Applicable Margin shall be in effect from the date the most recent Compliance Certificate is received by the Bank, provided however, that if the

Exhibit A
1

Borrower fails to timely deliver the next certificate, the Applicable Margin from the date such Compliance Certificate was due shall be that indicated for the pricing level 3 set forth in the above table, and thereafter, the pricing level indicated by such Compliance Certificate when received.

2. “Bus iness 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 at an offshore rate, a 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 Bank is open for business in California and dealing in offshore dollars.

3. “IBOR Rate Portion” means a portion of the principal amount outstanding under this Note which is bearing interest at a rate related to IBOR. No IBOR Rate Portion shall be less than Two Hundred Fifty Thousand Dollars ($250,000).

4. “IBOR Rate Term” means a period commencing on a Business Day and continuing for no shorter than one (1) month and no longer than six (6) 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 IBOR; provided however, that no IBOR Rate Term shall extend beyond the scheduled maturity date hereof. The last day of the interest period will be determined by Bank using the offshore dollar inter-bank market. If any IBOR Rate Term would end on a day which is not a Business Day, then such IBOR Rate Term shall be extended to the next succeeding Business Day.

5. “IBOR 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.)

IBOR Rate =	IBOR Base Rate
	(1.00 - Reserve Percentage)

(a)“IBOR Base Rate” means the interest rate at which Bank’s Grand Cayman Branch, Grand Cayman, British West Indies, would offer U.S. dollar deposits for the applicable interest period to other major banks in the offshore dollar inter-bank market.

(b)“Reserve Percentage” means the total of the maximum reserve percentages for determining the reserves to be maintained by member banks of the Federal Reserve System for Eurocurrency Liabilities, as defined in Federal Reserve Board Regulation D, rounded upward to the nearest 1/100 of one percent. The percentage will be expressed as a decimal, and will include, but not be limited to, marginal, emergency, supplemental, special, and other reserve percentages.

6. “Prime Rate” means the rate of interest publicly announced from time to time by Bank in San Francisco, California, as its Prime Rate. The Prime Rate is set by Bank based on various factors, including Bank’s costs and desired return,

Exhibit A
2

general economic conditions and other factors, and is used as a reference point for pricing some loans. Bank may price loans to its customers at, above or below the Prime Rate.

B. INTEREST:

1. Payment of Interest. Interest accrued on this Note shall be payable on the first day of each month, commencing April 1, 2003.

2. Selection of Interest Rate Options. At any time any portion of this Note bears interest determined in relation to Bank’s IBOR, it may be continued by Borrower at the end of the IBOR Rate Term applicable thereto so that all or a portion thereof bears interest determined in relation to the Prime Rate or in relation to Bank’s 1BOR for a new IBOR 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 Bank’s IBOR for an IBOR Rate Term designated by Borrower. At the time each advance is requested hereunder or Borrower wishes to select the IBOR option for all or a portion of the outstanding principal balance hereof, and at the end of each 1BOR 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 IBOR option is selected, the length of the applicable IBOR Rate Term. Any such notice may be given by telephone so long as, with respect to each IBOR selection, such notice is given to Bank prior to 10:00 a.m., California time, on the first day of the IBOR Rate Term. For each IBOR option requested hereunder, Bank will quote the applicable IBOR Rate to Borrower at approximately 10:00 a.m,, California time, on the first day of the IBOR 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 IBOR 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 IBOR 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 IBOR Rate Term, Borrower shall be deemed to have made a Prime Rate interest selection for such advance or the principal amount to which such IBOR Rate Term applied.

3. Additional IBOR Provisions.

(a)If Bank at any time shall determine that for any reason adequate and reasonable means do not exist for ascertaining Bank’s IBOR, then Bank shall promptly give notice thereof to Borrower. If such notice is given and until such notice has been withdrawn by Bank, than (i) no new IBOR option may be selected by Borrower, and (ii) any portion of the outstanding principal balance hereof which bears interest determined in relation to Bank’s IBOR, subsequent to the end of the IBOR 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)

Exhibit A
3

to make IBOR options available hereunder, or (ii) to maintain interest rates based on Bank’s IBOR, then in the former event, any obligation of Bank to make available such unlawful IBOR options shall immediately be cancelled, and in the latter event, any such unlawful IBOR-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 IBOR-based interest rates to remain in effect until the expiration of the IBOR Rate Term applicable thereto, then such permitted IBOR-based interest rates shall continue in effect until the expiration of such IBOR 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 IBOR 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 IBOR 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 1BOR 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 1BOR options. In determining which costs incurred by Bank and/or reductions in amounts received by Bank are attributable to any IBOR options made available to Borrower hereunder, any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower.

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

Exhibit A
4

results in more interest than if a 365-day year were used) equal to two percent (2%) above the rate of interest from time to time applicable to this Note.

C. BORROWING AND REPAYMENT:

1.Borrowing 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; 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, Doug Hansen, 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 Bank’s IBOR, with such payments applied to the oldest IBOR 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)IBOR. Each prepayment of an IBOR 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 of an amount on a date earlier than the scheduled payment date for such amount as required by this Agreement. The prepayment fee shall be equal to the amount (if any) by which:

Exhibit A
5

(i)the additional interest which would have been payable during the interest period 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 interest period for such Portion (or the scheduled payment date for the amount prepaid, if earlier).

Bank will have no obligation to accept an election of an IBOR Rate Portion 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 IBOR Rate Term, of an IBOR Rate Portion are not available in the offshore dollar inter-bank market; or

(ii)the IBOR Rate does not accurately reflect the cost of an IBOR Rate Portion.

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%) 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 that certain Credit Agreement between Borrower and Bank dated as of July 30, 1999, as amended from time to time, including, without limitation, those terms relating to arbitration of Disputes (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

Exhibit A
6

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 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.

4.Defined Terms. All capitalized terms not herein defined shall have the meanings given to them in the Credit Agreement.

“Borrower”

SOUTHWEST WATER COMPANY,
a Delaware corporation

By: 

Title: 

By: 

Title: 

Exhibit A
7

FIFTH AMENDED AND RESTATED REVOLVING NOTE

$10,000,000 Costa Mesa, California
March 14, 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 Blvd., Costa Mesa, California, 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 Ten Million Dollars ($10,000,000), 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 IBOR Rate plus the Applicable Margin or Prime Rate plus the Applicable Margin. 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 IBOR option selected hereunder, Bank is hereby authorized to note the date, principal amount, interest rate and applicable IBOR 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. This Note amends, restates in its entirety, and replaces that certain Fourth Amended and Restated Revolving Note dated as of September 30, 2001 in the original amount of Six Million Dollars ($6,000,000), made by Borrower payable to the order of Bank, pursuant to that certain Credit Agreement (as defined in Section D below).

A. DEFINITIONS:

As used herein, the following terms shall have the meanings set forth after each:

1.  “Applicable Margin” means the following amounts per annum, based upon the Leverage Ratio as set forth in the certificate received pursuant to Section 6.01 (a) (iv) of the Credit Agreement (“Compliance Certificate”):

		(in basis points per annum)	(in basis points per annum)
Pricing Level	Leverage Ratio	Applicable Margin for IBOR Rate loans	Applicable Margin for Prime Rate loans
1	<1.50x	125.0 bps	(25) bps
2	>=1.50x but <1.75x	150.0 bps	00 bps
3	>=1.75x	200.0 bps	25 bps

During the period from the date of this Note to the date on which the Bank receives the first Compliance Certificate after the date of this Note, the Applicable Margin shall be based on a pricing level 1 set forth in the above table. Thereafter, the Applicable Margin shall be in effect from the date the most recent Compliance Certificate is received by the Bank, provided however, that if the Borrower fails to timely deliver the next certificate, the Applicable Margin from the

1

date such Compliance Certificate was due shall be that indicated for the pricing level 3 set forth in the above table, and thereafter, the pricing level indicated by such Compliance Certificate when received.

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 at an offshore rate, a 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 Bank is open for business in California and dealing in offshore dollars,

3. “IBOR Rate Portion” means a portion of the principal amount outstanding under this Note which is bearing interest at a rate related to IBOR. No IBOR Rate Portion shall be less than Two Hundred Fifty Thousand Dollars ($250,000).

4. “IBOR Rate Term” means a period commencing on a Business Day and continuing for no shorter than one (1) month and no longer than six (6) 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 IBOR; provided however, that no IBOR Rate Term shall extend beyond the scheduled maturity date hereof. The last day of the interest period will be determined by Bank using the offshore dollar inter-bank market If any IBOR Rate Term would end on a day which is not a Business Day, then such IBOR Rate Term shall be extended to the next succeeding Business Day.

5. “IBOR 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.)

IBOR Rate =	IBOR Base Rate
	(1.00 - Reserve Percentage)

(a)“IBOR Base Rate” means the interest rate at which Bank’s Grand Cayman Branch, Grand Cayman, British West Indies, would offer U.S. dollar deposits for the applicable interest period to other major banks in the offshore dollar inter-bank market.

(b)“Reserve Percentage” means the total of the maximum reserve percentages for determining the reserves to be maintained by member banks of the Federal Reserve System for Eurocurrency Liabilities, as defined in Federal Reserve Board Regulation D, rounded upward to the nearest 1/100 of one percent. The percentage will be expressed as a decimal, and will include, but not be limited to, marginal, emergency, supplemental, special, and other reserve percentages.

6. “Prime Rate” means the rate of interest publicly announced from time to time by Bank in San Francisco, California, as its Prime Rate. The Prime Rate is set by

2

Bank based on various factors, including Bank’s costs and desired return, general economic conditions and other factors, and is used as a reference point for pricing some loans. Bank may price loans to its customers at, above or below the Prime Rate.

B. INTEREST:

1. Payment of Interest. Interest accrued on this Note shall be payable on the first day of each month, commencing April 1, 2003,

2. Selection of Interest Rate Options. At any time any portion of this Note bears interest determined in relation to Bank’s IBOR, it may be continued by Borrower at the end of the IBOR Rate Term applicable thereto so that all or a portion thereof bears interest determined in relation to the Prime Rate or in relation to Bank’s IBOR for a new IBOR 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 Bank’s IBOR for an IBOR Rate Term designated by Borrower. At the time each advance is requested hereunder or Borrower wishes to select the IBOR option for all or a portion of the outstanding principal balance hereof, and at the end of each IBOR 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 IBOR option is selected, the length of the applicable IBOR Rate Term. Any such notice may be given by telephone so long as, with respect to each IBOR selection, such notice is given to Bank prior to 10:00 a.m., California time, on the first day of the IBOR Rate Term. For each IBOR option requested hereunder, Bank will quote the applicable IBOR Rate to Borrower at approximately 10:00 a.m., California time, on the first day of the IBOR 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 IBOR 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 IBOR 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 IBOR Rate Term, Borrower shall be deemed to have made a Prime Rate interest selection for such advance or the principal amount to which such IBOR Rate Term applied.

3. Additional IBOR Provisions.

(a)If Bank at any time shall determine that for any reason adequate and reasonable means do not exist for ascertaining Bank’s IBOR, then Bank shall promptly give notice thereof to Borrower. If such notice is given and until such notice has been withdrawn by Bank, than (i) no new IBOR option may be selected by Borrower, and (ii) any portion of the outstanding principal balance hereof which bears interest determined in relation to Bank’s IBOR, subsequent to the end of the IBOR 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)

3

to make IBOR options available hereunder, or (ii) to maintain interest rates based on Bank’s IBOR, then in the former event, any obligation of Bank to make available such unlawful IBOR options shall immediately be cancelled, and in the latter event, any such unlawful IBOR-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 IBOR-based interest rates to remain in effect until the expiration of the IBOR Rate Term applicable thereto, then such permitted IBOR-based interest rates shall continue in effect until the expiration of such IBOR 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 IBOR 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 IBOR 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 IBOR options hereunder and/or to reduce any amount receivable by Bank in connection therewith, then in anysuch 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 IBOR options. In determining which costs incurred by Bank and/or reductions in amounts received by Bank are attributable to any IBOR options made available to Borrower hereunder, any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower.

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%) above the rate of interest from time to time applicable to this Note.

4

C. BORROWING AND REPAYMENT:

1.Borrowing 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; 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, Doug Hansen, 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 Bank’s IBOR, with such payments applied to the oldest IBOR 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)IBOR. Each prepayment of an IBOR 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 of an amount on a date earlier than the scheduled payment date for such amount as required by this Agreement. The prepayment fee shall be equal to the amount (if any) by which:

(i)the additional interest which would have been payable during the interest period on the amount prepaid had it not been prepaid, exceeds

5

(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 interest period for such Portion (or the scheduled payment date for the amount prepaid, if earlier).

Bank will have no obligation to accept an election of an IBOR Rate Portion 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 IBOR Rate Term, of an IBOR Rate Portion are not available in the offshore dollar inter-bank market; or

(ii)the IBOR Rate does not accurately reflect the cost of an IBOR Rate Portion.

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%) 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 that certain Credit Agreement between Borrower and Bank dated as of July 30, 1999, as amended from time to time, including, without limitation, those terms relating to arbitration of Disputes (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

6

this 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.

4.Defined Terms. All capitalized terms not herein defined shall have the meanings given to them in the Credit Agreement.

“Borrower”

SOUTHWEST WATER COMPANY,
a Delaware corporation

By: 

Title: 

By: 

Title: 

7

EX-10.2

Exhibit 10.2

CREDIT AGREEMENT

between

SOUTHWEST WATER COMPANY

and

UNION BANK OF CALIFORNIA, N.A.
June 6, 2003

TABLE OF CONTENTS

ARTICLE I DEFINITIONS		1
SECTION 1.01. Defined Terms		1
SECTION 1.02. Other Definitional Provisions		7
ARTICLE II THE CREDIT		7
SECTION 2.01. The Revolving Loans		7
(a)	The Revolving Commitment	7
(b)	Making the Revolving Loans	7
(c)	Reduction of the Revolving Commitment	8
(d)	Revolving Note	8
(e)	Standby Letters of Credit	8
SECTION 2.02. Mandatory Repayment		9
SECTION 2.03. Interest Computation and Payment; Fee Computation		9
SECTION 2.04. Unused commitment fee		9
SECTION 2.05. Annual Credit Facility Fee		10
ARTICLE III GENERAL PROVISIONS CONCERNING THE LOANS		10
SECTION 3.01. Use of Proceeds		10
SECTION 3.02. Payment on Non-Business Days		10
SECTION 3.03. Reduced Return		10
SECTION 3.04. Indemnities		10
SECTION 3.05. Funding Sources		11
ARTICLE IV CONDITIONS OF LENDING		11
SECTION 4.01. Conditions Precedent to Initial Revolving Loan		11
SECTION 4.02. Conditions Precedent to Each Revolving Loan		12
ARTICLE V REPRESENTATIONS AND WARRANTIES		13
SECTION 5.01. Representations and Warranties		13
(a)	Organization	13
(b)	Authorization; No Conflict	14
(c)	Governmental Consents	14
(d)	Validity	14
(e)	Financial Condition	14
(f)	Litigation	14
(g)	Employee Benefit Plans	14
(h)	Disclosure	15
(i)	Environmental Matters	15
(j)	Employee Matters	15
(k)	Solvency	16
(l)	Title to Properties	16
(m)	Tax Returns	16
(n)	Compliance with Other Agreements and Applicable Laws	16
(o)	No Default	16
(p)	Regulation U; Investment Company Act	16
(q)	Intangible Assets	16
ARTICLE VI COVENANTS		17
SECTION 6.01. Affirmative Covenants		17
(a)	Financial Information	17

i

(b)	Notices and Information	18
(c)	Corporate Existence, Etc	19
(d)	Payment of Taxes and Claims	19
(e)	Maintenance of Properties; Insurance	19
(f)	Inspection	20
(g)	Compliance with Laws Etc	20
(h)	Hazardous Waste Studies	20
SECTION 6.02. Negative Covenants		20
(a)	Consolidated Tangible Net Worth	20
(b)	Consolidated Net Profit	21
(c)	EBITDA Coverage Ratio	21
(d)	Liens Etc	21
(e)	Debt	21
(f)	Consolidation, Merger or Dissolution	22
(g)	Loans, Investments, Acquisitions, Secondary Liabilities	22
(h)	Asset Sales	23
(i)	Hostile Tender Offers	23
(j)	Distributions	24
(k)	Transactions with Affiliates	24
(l)	Books and Records	24
(m)	Restructure	24
ARTICLE VII EVENTS OF DEFAULT		24
SECTION 7.01. Events of Default		24
ARTICLE VIII MISCELLANEOUS		27
SECTION 8.01. Amendments, Etc		27
SECTION 8.02. Notices, Etc		27
SECTION 8.03. Right of Setoff: Security Interest in Deposit Accounts		27
SECTION 8.04. No Waiver; Remedies		28
SECTION 8.05. Costs and Expenses		28
SECTION 8.06. Participations		28
SECTION 8.07. Effectiveness: Binding Effect		28
SECTION 8.08. Governing Law		28
SECTION 8.09. Dispute Resolution		29
SECTION 8.10. Waiver of Notices		29
SECTION 8.11. Entire Agreement		29
SECTION 8.12. Severability of Provisions		29
SECTION 8.13. Execution in Counterparts		29
SECTION 8.14. Further Assurances		29

ii

Schedules

5.01(a) - Subsidiaries

5.01(f) - Litigation

5.01(i) - Environmental Matters

6.02(d) - Liens

6.02(e) - Other secured debt

Exhibits

A - Form of Note

B - Form of Legal Opinion

iii

CREDIT AGREEMENT

This Credit Agreement dated as of June 6, 2003 is entered into between SOUTHWEST WATER COMPANY, a Delaware corporation (the “Borrower”) and UNION BANK OF CALIFORNIA, N.A. (the “Bank”).

RECITALS

WHEREAS, the Borrower has requested that the Bank extend certain credit facilities to the Borrower in the place of Mellon 1^st Business Bank; and

WHEREAS, the Bank is willing to extend such credit facilities to the Borrower on the terms and conditions set forth below.

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.

“Agreement”: This Credit 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.

“BofA Loan Documents”: That Credit Agreement dated as of July 30, 1999 between Bank of America, N.A. and Borrower, and each agreement, document, instrument and guarantee required by Bank of America, N.A. in connection with such Credit Agreement and/or the credit extended thereunder, in each case as amended.

“Borrower”: As set forth in the introductory paragraph of this Agreement.

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“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.

“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.

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“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.

“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.

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“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.

“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

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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, 2004.

“Mellon”: Mellon 1st Business Bank.

“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, and (c) the Acquisition shall have been consummated in compliance with all applicable laws.

“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).

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“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.

“Suburban”: Suburban Water Systems, a California corporation.

“Suburban Loan Documents”: That Credit Agreement dated as of July 30, 1999 between Bank of America, N.A. and Suburban, and each agreement, document, instrument and guarantee required by Bank of America, N.A. 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

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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.

“Windermere”: Windermere Utility Co., Inc., a Texas corporation.

“WRI”: Wastewater Rehabilitation, Inc., a Texas corporation.

SECTION 1.02. Other Definitional Provisions.

(a)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.

(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.

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(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.

(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 (otherthan 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.

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(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 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.

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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 $. Each such fee shall be fully earned when paid and shall be non-refundable.

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.

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

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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.

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;

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(vi)Executed copies of all other Loan Documents;

(vii)Opinion from Borrower’s counsel substantially in the form of Exhibit B hereto;

(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;

(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; and

(k)Bank shall have received documentation satisfactory to Bank evidencing the cancellation of all credit facilities provided to Borrower and Suburban by Mellon.

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

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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.

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).

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(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 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

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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 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

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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 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.

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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 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

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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 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

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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 BofA 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 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

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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, 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).

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(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, 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 BofA 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.

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(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);

(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, providedfurther 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;

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(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.

(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.

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(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

(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 BofA Loan Document, and such default shall continue after the applicable grace period, if any, specified in the applicable BofA Loan Document; or

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(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, 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

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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, 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

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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.

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

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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 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).

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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 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.

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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.

UNION BANK OF CALIFORNIA, N.A.		SOUTHWEST WATER COMPANY
By:	By :
Name:	Name:
Title:	Title:
Address: Metro Los Angeles Commercial Banking 445 South Figueroa Street, 10th Floor Los Angeles, California  90071-1602 Attention: Richard Madsen Title: Regional Vice President Facsimile: (213) 236-4013	Address: 225 North Barranca Avenue, Suite 200 West Covina, California 91791-1605 Attention: Thomas C. Tekulve Vice President - Finance Facsimile: (626) 915-1558

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SCHEDULE 5.01(f) - LITIGATION

None other than as reported on Form 10-Q of Borrower for the quarter ended March 31, 2003, and Form 10-K of Borrower for the year ended December 31, 2002.

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SCHEDULE 5.01(i) - ENVIRONMENTAL MATTERS

See Form 10-Q of Borrower for the quarter ended March 31, 2003, and Form 10-K of Borrower for the year ended December 31, 2002.

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SCHEDULE 6.02(d) - LIENS

None except as disclosed in the audited consolidated financial statements of Borrower for the fiscal year ended 2002.

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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.

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EXHIBIT A

REVOLVING NOTE

$15,000,000 June 6, 2003

FOR VALUE RECEIVED, the undersigned SOUTHWEST WATER COMPANY, a Delaware corporation (“Borrower”) promises to pay to the order of UNION BANK OF CALIFORNIA, N.A. (“Bank”) at its office at 445 South Figueroa Street, 10^th Floor, Los Angeles, California 90071-1602, 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 Reference Rate minus one-quarter of one percent (0.25%). When interest is determined in relation to the Reference 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 Reference 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.“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.

2.“Credit Agreement” means that certain Credit Agreement between Borrower and Bank dated as of June 6, 2003, as amended from time to time, including, without limitation, those terms relating to arbitration of disputes.

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.

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5.“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).

6.“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.

7.“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.)

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 Los Angeles office 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.

8.“Reference Rate” means the variable per annum rate of interest most recently announced by Bank at its corporate headquarters as the “Union Bank of California, N.A. Reference Rate,” with the understanding that the “Union Bank of California, N.A. Reference Rate” is one of Bank’s index rates and merely serves as a basis upon which effective rates of interest are calculated for loans making reference thereto and may not be the lowest or best rate at which Bank calculates interest or extends credit. Any change in the Reference Rate

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announced by Bank shall take effect at the opening of business on the day specified in the announcement of such change.

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 July 15^th, 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 Reference 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 Reference 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 Reference 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 Reference 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, than (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 Reference 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

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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 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 Reference 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

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(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.

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 Reference 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.

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(a)Reference Rate. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to the Reference 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 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 Reference 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

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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 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: 

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EX-31

EXHIBIT 31

Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Anton C. Garnier, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Southwest Water Company;
   

2. Based on my knowledge, this 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 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 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:   August 13, 2003	/s/ ANTON C. GARNIER
	Anton C. Garnier Chief Executive Officer

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EXHIBIT 31

Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Richard J. Shields, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Southwest Water Company;
   

2. Based on my knowledge, this 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 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 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:   August 13, 2003	/s/ RICHARD J. SHIELDS
	Richard J. Shields Chief Financial Officer

2

EX-32

EXHIBIT 32

Certification
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)

Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of Southwest Water Company, a Delaware corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 (the “Form 10-Q”) of the Company fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated:   August 13, 2003	/s/ ANTON C. GARNIER
	Anton C. Garnier Chief Executive Officer

Dated:   August 13, 2003	/s/ RICHARD J. SHIELDS
	Richard J. Shields Chief Financial Officer

The foregoing certification is being furnished solely pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code).

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