Regulatory Matters:

In accordance with accounting principles for rate-regulated enterprises, Registrant records regulatory assets, which represent probable future recovery of costs from customers through the ratemaking process, and regulatory liabilities, which represent probable future refunds that are to be credited to customers through the ratemaking process. At September 30, 2016, Registrant had approximately $56.2 million of regulatory assets, net of regulatory liabilities, not accruing carrying costs. Of this amount, $23.3 million relates to the underfunded position in Registrant's pension and other post-retirement obligations, $5.6 million relates to a memorandum account authorized by the CPUC to track unrealized gains and losses on BVES's purchase power contracts over the term of the contracts, and $17.6 million relates to deferred income taxes representing accelerated tax benefits flowed through to customers, which will be included in rates concurrently with recognition of the associated future tax expense. The remainder relates to other items that do not provide for or incur carrying costs.

Regulatory assets represent costs incurred by GSWC for which it has received or expects to receive rate recovery in the future. In determining the probability of costs being recognized in other periods, GSWC considers regulatory rules and decisions, past practices, and other facts or circumstances that would indicate if recovery is probable. If the CPUC determines that a portion of GSWC’s assets are not recoverable in customer rates, GSWC must determine if it has suffered an asset impairment requiring it to write down the asset's value. Regulatory assets are offset against regulatory liabilities within each ratemaking area. Amounts expected to be collected or refunded in the next 12 months have been classified as current assets and current liabilities by ratemaking area. Regulatory assets, less regulatory liabilities, included in the consolidated balance sheets are as follows:



(dollars in thousands)	September 30, 2016			December 31, 2015
GSWC
Water Revenue Adjustment Mechanism, net of Modified Cost Balancing Account	$	65,444		$	45,171
Costs deferred for future recovery on Aerojet case	12,037			12,699
Pensions and other post-retirement obligations (Note 7)	24,835			21,996
Derivative unrealized loss (Note 4)	5,581			7,053
Flow-through taxes, net (Note 6)	17,634			16,176
Low income rate assistance balancing accounts	8,378			8,699
Other regulatory assets	26,309			25,668
Various refunds to customers	(6,126		)	(4,766		)
Total	$	154,092		$	132,696

Regulatory matters are discussed in detail in the consolidated financial statements and the notes thereto included in the Form 10-K for the year ended December 31, 2015 filed with the SEC. The discussion below focuses on significant matters and developments since December 31, 2015.

Alternative-Revenue Programs:

GSWC records the difference between what it bills its water customers and that which is authorized by the CPUC using the Water Revenue Adjustment Mechanism (“WRAM”) and Modified Cost Balancing Account (“MCBA”) accounts approved by the CPUC. The over- or under-collection of the WRAM is netted against the MCBA over- or under-collection for the corresponding ratemaking area and bears interest at the current 90-day commercial paper rate.

GSWC has implemented surcharges to recover its WRAM/MCBA balances as of December 31, 2015. For the nine months ended September 30, 2016 and 2015, surcharges (net of surcredits) of approximately $12.9 million and $1.7 million, respectively, were billed to customers to recover previously incurred under-collections in the WRAM/MCBA accounts. During the nine months ended September 30, 2016, GSWC recorded additional net under-collections in the WRAM/MCBA accounts of $33.2 million partially due to using 2015 adopted revenues since the CPUC has not approved GSWC's pending water rate case, which will set new rates for the years 2016 - 2018 as discussed below. As of September 30, 2016, GSWC had a net aggregated regulatory asset of $65.4 million which is comprised of a $69.8 million under-collection in the WRAM accounts and $4.4 million over-collection in the MCBA accounts.

As required by the accounting guidance for alternative revenue programs, GSWC is required to collect its WRAM balances, net of its MCBA, within 24 months following the year in which an under-collection is recorded. The recovery periods for the majority of GSWC's WRAM/MCBA balances are primarily within 24 months; however, as of December 31, 2015 there were some ratemaking areas that had recovery periods related to the 2015 WRAM balances that were greater than 24 months. As a result, during the fourth quarter of 2015, GSWC did not record $1.4 million of the 2015 WRAM under-collection balance as revenue. This amount is recognized as revenue in the periods in which it is determined that the amounts will be collected within 24 months. During the three and nine months ended September 30, 2016, GSWC recognized $110,000 and $800,000, respectively, of this amount as revenue as it was determined that these amounts would be recovered within 24 months. In 2016, GSWC implemented CPUC-approved surcharges for recovery of the 2015 WRAM balances, including the $1.4 million discussed above.

Other Regulatory Matters:

Pending Water General Rate Case:

In 2014, GSWC filed a general rate case (“GRC”) for all of its water regions and the general office to determine new rates for the years 2016-2018. A proposed decision is expected in the fourth quarter of 2016. Once a final decision is issued, the rates will be retroactive to January 1, 2016. GSWC has settled with the CPUC's Office of Ratepayer Advocates ("ORA") the majority of GSWC’s operating expenses, as well as the consumption levels to be used to calculate rates for 2016-2018, which reflect state-mandated conservation targets that were previously in place. The primary unresolved issues relate to GSWC’s capital budget requests and compensation for managerial level employees. At this time, GSWC cannot predict the final outcome of this GRC. The final decision, once issued, will be retroactive to January 1, 2016 and could result in a material change to GSWC's net income recorded during the first nine months of 2016 that may need to be adjusted in the quarter that a proposed decision is issued.

Year-to-date 2016 billed revenues have been based on 2015 adopted rates established in the prior GRC. The adopted revenues for 2016, once the CPUC issues a final decision in the current GRC, are expected to be lower than the 2015 adopted levels due primarily to decreases in: (i) supply costs caused by lower consumption, (ii) depreciation expense resulting from an updated depreciation study, and (iii) other operating expenses. As a result of the anticipated reduction in the 2016 adopted revenues, GSWC has adjusted its water revenues downward for the three and nine months ended September 30, 2016 with corresponding decreases to supply costs, depreciation expense and certain other expenses, to reflect the settled positions with ORA. The adjustment to 2016 recorded water revenues also reflects GSWC’s positions on unresolved capital budget and compensation-related issues in the pending GRC. These adjustments did not have a significant impact on pretax operating income for the three and nine months ended September 30, 2016 as the overall reduction in water revenues is mostly offset by lower supply costs, depreciation and other operating expenses.

Procurement Audits:

In December 2011, the CPUC issued a final decision adopting a settlement between GSWC and the CPUC on its investigation of certain work orders and charges paid to a specific contractor used previously for numerous construction projects primarily in one of GSWC's three main geographic water regions. As part of the settlement reached with the CPUC on this matter, GSWC agreed to be subject to three separate independent audits over a period of ten years from the date the settlement was approved by the CPUC. The audits cover GSWC's policies and procedures for the procurement of outside contracts for engineering or construction for capital projects related to other contractors after 1993. The first audit started in 2014 and covered an almost 20-year period from January 1, 1994 through September 30, 2013.

In March 2015, the accounting firm engaged by the CPUC to conduct the first independent audit issued its final report to the CPUC’s Division of Water and Audits (“DWA”). The final report, which was issued on a confidential basis, included GSWC's responses to the accounting firm’s findings, as well as the firm’s responses to GSWC's comments. DWA informed GSWC that it does not intend to pursue further investigation, refunds, or penalties in respect of past procurement activities as a result of the final report. Furthermore, in June 2015 ORA notified the administrative law judge in the ongoing general rate case that, having reviewed the final audit report, its potential concerns with the audit report were satisfied and, as such, ORA withdrew its request to have further review of this matter in the pending general rate case. The CPUC is expected to address the final audit report as part of the pending water GRC. At this time, GSWC does not believe that a loss associated with any disallowances and/or penalties from this first audit is likely.

Formal Complaint Filed at the CPUC:

In June 2016, a third party filed a formal complaint with the CPUC against GSWC in connection with a water main break that occurred in 2014. The water main break caused damage to a commercial building. Repairs to the building have been delayed for a variety of reasons, including a dispute and litigation between two of GSWC's insurance carriers regarding their respective coverage obligations, as well as questions as to the nature and extent of the building’s damage and the costs associated therewith. The complaint filed with the CPUC requests, among other things, that the CPUC investigate the main break, the damage to the commercial building, and the delay of its repairs, and the complaint asks the CPUC to order GSWC to immediately complete repairs. GSWC believes it has reasonable defenses to the complaint filed with the CPUC. In July 2016, GSWC filed an answer to the formal complaint with the CPUC as well as a motion to dismiss the complaint. Previously, the owners of the commercial building filed suit in Ventura County Superior Court against GSWC for damages to the building. The trial of this lawsuit is set for December 2016. At this time, GSWC believes it has sufficient insurance coverage to cover any judgment entered in the civil suit pending in Superior Court. However, GSWC cannot predict the outcome of the Superior Court litigation, the dispute and litigation between its insurers, or the CPUC proceeding.