EXHIBIT 13





American Water Works
Company, Inc. and Subsidiary Companies





---

Consolidated Summary of Selected Financial Data





(Dollars in thousands, except per share amounts)





For the years ended December 31,

2001

2000

1999

1998

1997RevenuesWater serviceResidential

$
806,220

$
759,697

$
733,956

$
691,279

$
658,955Commercial


289,027


278,463


262,940


249,564


235,561Industrial


79,488


82,406


77,953


78,092


73,596Public and other


159,224


153,302


149,531


146,299


137,289Other water revenues


16,225


11,859


11,997


13,983


11,0641,350,184


1,285,727


1,236,377


1,179,217


1,116,465Wastewater service


26,453


24,389


24,480


20,820


14,909Unregulated services


62,250


40,474








$
1,438,887

$
1,350,590

$
1,260,857

$
1,200,037

$
1,131,374Water sales (million gallons)Residential


176,659


171,548


175,487


168,617


169,307Commercial


82,715


82,455


81,857


79,115


78,542Industrial


44,193


46,348


45,862


46,361


46,088Public and other


40,791


40,784


41,477


40,110


39,831344,358


341,135


344,683


334,203


333,768Net income

$
161,483

$
161,061

$
138,949

$
150,439

$
137,691Earnings per diluted common share on average shares outstanding

$
1.61

$
1.61

$
1.40

$
1.54

$
1.42Common dividends paid per share

$
.94

$
.90

$
.86

$
.82

$
.76At year-endWater customers (thousands)


2,578


2,541


2,476


2,446


2,400Wastewater customers (thousands)


44


40


40


39


25Associates employed


6,400


5,050


4,970


5,128


5,110Total assets

$
6,607,099

$
6,134,798

$
5,952,206

$
5,458,658

$
4,992,023Preferred stocks with mandatory redemption requirementsAmerican Water Works Company, Inc.

$


$


$
40,000

$
40,000

$
40,000Subsidiaries


30,474


32,902


34,020


37,298


39,734Long-term debtAmerican Water Works Company, Inc.

$
297,000

$
159,000

$
211,000

$
216,500

$
131,000Subsidiaries


2,253,019


2,112,165


2,182,097


2,115,687


1,965,924Market price of common stock at year-end

$
41.75

$
29.38

$
21.25

$
33.75

$
27.31








5




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---

Managements Discussion and Analysis





Description of the Business





American Water Works Company and The
American Water System


The Companys goal is to consistently enhance long-term shareholder value. Our strategies to produce value are: investing in the business of water services,
providing management services to water and wastewater utilities, and delivering value added services and products.


The core business of American Water Works Company is
the ownership of common stock of companies that enable American Water Works to be a full water resource provider. The combination of American Water Works with its subsidiaries constitutes the American Water System  a system that has functioned
well for over 50 years. Each subsidiary functions independently, yet shares in the benefits of size and identity afforded by the American Water System.


Historically,
the Company primarily invested in acquisitions of water and wastewater utilities that complemented our existing service territories or that enhanced the Companys geographic diversification. In addition, the Company has invested in the common
equity of its utility subsidiaries so that they could reinforce, rehabilitate and replace existing service infrastructure and provide for growth within existing service territories.


The water utility industry is changing rapidly. Changes in regulation, the need for significant capital investment, low growth in consumption within existing service territories and continuing pressures for increased
efficiencies and productivity as well as new security requirements are changing the nature of the industry. To maintain its leadership position in this evolving industry, the Company will continue to grow through acquisitions of water and wastewater
utilities, through the expansion of its unregulated businesses and by emphasizing shared services among its utility subsidiaries.





Regulated Utility
Service


The regulated utility subsidiaries provide water and/or waste water service to approximately 10 million people in 23 states. As public utilities, each company is subject to the
rules of both federal and state environmental protection agencies, particularly with respect to the quality of the water they distribute. In addition, with the exception of Michigan-American Water Company, the utility companies function under
economic regulations prescribed by state regulatory commissions.


The mission of the utility subsidiaries of the Company is to provide high quality, reliable water and
wastewater service at an affordable price. There are several keys to continued success in this endeavor: efficient planning and deployment of capital investment, cultivating experienced managers and knowledgeable staff, supporting state-of-the-art
water quality programs, and maintaining responsive customer service.





Unregulated Services


| |  | Water and Wastewater Management Services
|- |  | ----------------------------------------

American Water Services continues to focus on the
growing water resource management segment of the water and waste water market, including municipal, industrial, and military clients. On November 7, 2001 American Water Services completed the acquisition of Azurix North America and Azurix
Industrials Corp. from Azurix Corp. The additional talent and diversity of services acquired through the Azurix transaction created a combined organization that will be able to provide a full range of water and wastewater management services
throughout the U.S. and Canada.


With the acquisition of Azurix North America and Azurix Industrials Corp., American Water Services has expanded its service offerings
from operations and maintenance contracts to now provide residuals management, underground infrastructure development and engineering services. It currently manages and operates 1,000 water and wastewater facilities, providing services to
approximately 5 million people in 18 states and three Canadian provinces. (including 11 which also have communities served by our utility subsidiaries)





| |  | Water and Wastewater Related Products and Services
|- |  | --------------------------------------------------

American Water Resources is a subsidiary
formed to offer water and wastewater related products and services to residential, governmental or business consumers. This company which was formed in 2000, has developed two business lines:





Consumer Protection Programs These service programs include water line protection (for a small monthly fee the customers external water line is
repaired or replaced when required) and the development of a similar service for waste water line protection.





American
Carbon Services This is a service provided to water utilities that use granular activated carbon for filtration. Rather than replace the carbon as it becomes spent, American Carbon Services regenerates it for the
utilitys reuse. It is more cost effective and has less impact on the environment.





Shared Services


American Water Works Service Company, a subsidiary, provides professional services to affiliated companies. These services include accounting, administration, communication, corporate secretarial, engineering,
financial, human resources, information systems, operations, rates and revenue, risk management and water quality. This arrangement, which provides these services at cost, affords affiliated companies professional and technical talent otherwise
unavailable economically or on a timely basis. In 2001 this subsidiary opened a national customer service center and another facility to consolidate treasury and accounting functions.


American Water Capital Corp. is a subsidiary that provides a single source of debt capital for the Company and its utility subsidiaries. By consolidating its financing requirements the Company created cash management
efficiencies and has access to a broader investor base.





Merger Agreement with RWE





On September 16, 2001 the Company entered into a merger agreement with RWE Aktiengesellschaft and Thames Water Aqua Holdings GmbH, which is RWEs holding company for








6




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American Water Works Company, Inc. and Subsidiary Companies





---

Managements Discussion and Analysis





its global water business, to merge with a subsidiary of RWE and become a wholly owned indirect subsidiary of RWE. Under the terms of the merger agreement RWE will purchase all the outstanding shares of American Water Works Company common
stock at a price of $46.00 per share in cash.


RWE is a global multi-utility company that does business through its subsidiaries and affiliates in over 120 countries.
Its core businesses are electricity, gas, water, and waste recycling. Upon completion of the transaction, American Water will be combined with the U.S. operations of Thames Water Plc, RWEs London-based international water services business.
American Water will manage the joint operations in North, Central and South America.


The transaction was approved at a special meeting of the stockholders of American
Water Works Company on January 17, 2002. Before the transaction can be completed, state and federal regulatory approvals are required. As of the end of January 2002, all of the applications for approval were filed where required by state regulatory
authorities. The states where applications for approval have been filed are Arizona, California, Hawaii, Illinois, Kentucky, Maryland, New Jersey, New Mexico, New York, Pennsylvania, Tennessee, Virginia and West Virginia. Approval of the state
public utility agencies in Georgia, Indiana, Iowa, Michigan, Missouri, Ohio and Texas is not required. Regulatory approval has not been requested in Connecticut, Massachusetts and New Hampshire since the sale of these operations to Kelda is pending.
On February 4, 2002, the Tennessee Regulatory Authority approved the transaction. As a result of the time required to complete the approval process by the various regulatory agencies, the Company does not anticipate completion of the merger until
the first half of 2003.





Growth and Development





Acquisitions and Divestitures of Utility Systems


Consistent with the Companys growth strategy, management continues to search for opportunities to acquire water and
wastewater systems that represent the prospect for enhanced shareholder value.


The year 2001 began with 22 acquisitions that were then awaiting regulatory approval.
During the year, contract negotiations for 19 more acquisitions were completed. Of that total of 41 transactions, 10 received regulatory approval and were finalized during 2001, adding approximately 40,000 new customers. At year-end there were 31
pending acquisitions.


The acquisitions finalized in 2001 included the purchase of the City of Coatesville Authoritys water and wastewater utility systems for
$48.2 million. The Coatesville, Pennsylvania system serves 8,600 water customers and 6,500 wastewater customers making this purchase of municipally-owned assets the largest privatization project of its kind in the nation.


On January 15, 2002 the Company and its subsidiaries completed the acquisition of all of the water and wastewater assets of Citizens Communications Company. The purchase price of $859
million in cash and $120 million of assumed liabilities is subject to adjustment upon the completion of an audited closing statement of net assets. In Arizona and California, the transaction adds approximately 145,000 customers to the 111,000
customers American Water Works already serves in these states. This strengthens the Companys foundation for continued growth in those key areas. In Illinois, Indiana and Ohio, 60,000 customers have been added, further expanding the
Companys already significant presence in the Midwest. In Pennsylvania, the number of customers served increases by 43,000. American Water Works has a significant presence in Pennsylvania with a total of 606,000 customers. The transaction will
also expand American Water Works presence in the wastewater sector by more than 94,000 customers.


The Citizens acquisition provides $140 million in additional
annual revenue and adds the expertise of 300 new associates to the Companys workforce. While this acquisition is anticipated to dilute per share earnings by an estimated six cents per share in 2002, it is expected to be accretive to earnings
within 18 to 24 months.


Excluding the Citizens acquisitions in six states, the Company had 25 water and wastewater acquisitions pending at December 31, 2001. Once
approved, those acquisitions are expected to add 25,000 customers and provide more than $7 million in additional annual revenue.


The Company completed 12 acquisitions
in 2000 that added approximately 38,000 new customers. In 1999, 21 acquisitions added approximately 518,000 new customers. The most significant of these transactions was the acquisition of National Enterprises Inc. (NEI), a privately owned holding
company with operations primarily in the water utility business. NEIs subsidiaries provided water utility service to more than 500,000 customers in Illinois, Indiana, Missouri and New York. Since most of NEIs customers were in the
Midwest this acquisition significantly furthered the Companys strategy of geographic diversification. As a part of the NEI acquisition, the Company also acquired passive investments in the telecommunications industry.


On August 30, 2001 the Company and Kelda Group plc jointly announced that they had reached an agreement whereby Keldas Aquarion Company subsidiary would acquire the Companys
New England operations. The transaction price is approximately $118 million in cash plus the assumption of $115 million in debt. The subsidiaries being sold serve a total of 65,000 customers and had revenues of $51 million in 2001. The sale, which
is subject to regulatory approval is expected to be consummated during the second quarter of 2002.


On September 28, 2001 the Company completed the sale under threat of
condemnation of its Salisbury Water Supply Company subsidiarys operating system to the Town of Salisbury, Massachusetts for $11.5 million in cash plus outstanding accounts receivable. The Salisbury system serves 3,000 customers and had annual
revenues of $1.9 million.




7




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Managements Discussion and Analysis





Condemnations of Utility Systems


In Illinois, the cities of Pekin and Peoria have been considering acquiring, by
eminent domain or otherwise, the utility assets of Illinois-American Water Company that are used to provide water service to their respective communities. Illinois-American is vigorously contesting these proposed takeovers.


In Pekin, in a November 2000 non-binding referendum, the residents voted to retain Illinois-Americans ownership of the water system. Another non-binding referendum on the same
question is scheduled for March 19, 2002. Illinois-American and the City of Peoria are involved in a court proceeding over the applicability of an 1889 franchise agreement that the city believes grants it a unilateral right to purchase the
Companys assets there.





Acquisitions of Unregulated Businesses


On November 7, 2001
the Companys American Water Services subsidiary completed the acquisition of Azurix North America and Azurix Industrials Corp. at a purchase price of $153.3 million in cash plus the assumption of $6.5 million in debt. This acquisition
strengthens American Waters position as a premier provider of water resource management services in the U.S. and Canada. The acquisition is expected to be accretive to American Waters earnings per share and cash flow in its first full
year.


Azurix North America was a wholly-owned subsidiary of Azurix Corp. and provides a broad range of water and waste water services, including operations and
maintenance, engineering, underground infrastructure development and residuals management. The company has completed projects in 41 U.S. states and Canadian provinces, employs 1,050 people and reported revenues in 2001 of $131.5 million.


Azurix Industrials Corp., also a former subsidiary of Azurix Corp., provides water and wastewater related technical, operation and maintenance services to industrial
markets. The company reported revenues of $2.2 million for 2001.


On September 20, 2001 American Water Services purchased all of Environmental Management
Corporations interest in their EA2 Systems joint venture for $4.2 million. EA2 has one water and three wastewater operations contracts in Indiana, employs 37 people and reported revenue of $8.4 million in 2001.


The EA2 purchase allows American Water Services to expand their Midwest presence and provides a platform for them to offer their full line of services in Indiana and surrounding states.


More information regarding acquisitions and divestitures is included in Note 4 to the financial statements.





Capital Spending Program


Investment in new facilities in 2001 totaled $381 million, which is 1% above the 2000 construction expenditures of
$377 million. Construction activities planned for 2002 total approximately $500 million.


With the benefit of comprehensive engineering, operational and financial
planning, each utility subsidiary prepares a capital expenditure plan representing a balance of water quality and source of supply initiatives, operational improvements, system growth opportunities, regulatory compliance requirements, and
infrastructure replacement needs. The actual expenditures recorded in any given year are influenced by many factors including the timing of required governmental approvals of projects, weather conditions, availability of labor resources, and
equipment and material deliveries. It is anticipated that approximately $2.5 billion will be invested in new utility facilities in the five years ending 2006. The full investment in this prudent construction program is expected to be recognized in
regulatory decisions.


Source of supply improvements accounted for approximately 9% of construction expenditures in 2001. Projects included the construction of new
groundwater sources in Hingham, Massachusetts; Mt. Olive Township, New Jersey; Clovis, New Mexico; Long Island, New York; and Moshannon, Pennsylvania. The source of supply in Seymour, Indiana was converted from a surface water to a groundwater
source. Significant progress was made in the construction of a replacement intake tunnel for the Gary, Indiana production facility, which accounts for the increased expenditures for this category of plant.


Investment in water treatment and pumping facilities comprised about 16% of the 2001 construction expenditures. A new treatment facility was completed in Atlantic County, New Jersey.
Significant treatment plant upgrades were completed in Huntington, West Virginia; Norristown, Pennsylvania; Hopewell, Virginia; and Champaign, Illinois. Additional finished water storage was provided at the Davenport, Iowa and White Deer,
Pennsylvania plants. Expenditures for this category of plant declined in 2001 reflecting the completion of several major treatment facilities.





Capital Expenditures by Category(000)

2001

2000

1999

1998

1997Water plantSources of supply

$
35,935

$
16,345

$
20,198

$
19,744

$
17,841Treatment and pumping


60,736


97,301


125,072


113,725


102,011Transmission and distribution


154,606


149,392


193,571


180,545


157,635Services, meters and fire hydrants


67,796


68,331


70,998


69,606


64,050General structures and equipment


41,032


31,549


49,122


48,676


39,688Wastewater plant


5,171


8,927


5,766


3,250


4,646Total utility plant


365,276


371,845


464,727


435,546


385,871Nonutility property


15,883


5,372


2,624


3,671


8,558$
381,159

$
377,217

$
467,351

$
439,217

$
394,429




8




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American Water Works Company, Inc. and Subsidiary Companies


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Transmission and distribution facilities accounted for approximately 41% of the 2001 construction expenditures.
Significant capital expenditures occurred across a large number of service areas for distribution system improvements. These projects improve existing service conditions, provide service to new areas, and allow full utilization of existing sources
of supply and treatment facilities between neighboring systems. Prominent projects include continuing regionalization efforts in Jefferson County, Pennsylvania; and Kanawha, Cabell, Fayette and Boone Counties in West Virginia. Other major
distribution/transmission projects were completed in St. Louis County, Missouri; Scranton, Pennsylvania; and Mt. Olive Township, New Jersey to improve system hydraulics or enhance system growth. Distribution storage tanks were constructed in Kanawha
and Fayette County, West Virginia; Mt. Olive Township, New Jersey; Davenport, Iowa; Hobart, Indiana, and Gregg and Cross Creek Townships in Pennsylvania.


Capital
expenditures for nonutility property are primarily for equipment and office space utilized by American Water Works Service Company. The increased spending in this category in 2001 reflects the purchase of equipment for the Companys new
facilities that were established to consolidate customer and financial services.


The Companys formal planning process involves a comprehensive evaluation by each
utility subsidiary of all aspects of public water supply. This process includes evaluation of source water supply reliability, adequacy of water treatment facilities and distribution systems, and the potential for regional water supply solutions and
acquisitions. In 2001, Comprehensive Planning Studies were issued for the Baldwin Hills service area in California; the Streator, Lincoln and Sterling service areas in Illinois; the Warren County, Hunterdon County, Morris County and Logan service
areas in New Jersey; the Pike County, Monroe County, and New Castle service areas in Pennsylvania; and the Gassaway/Sutton, Weston, Mercer/Summers County, and Webster Springs service areas in West Virginia. Studies are underway for subsidiaries in
Illinois, Indiana, Kentucky, Massachusetts, New Jersey, New York, Pennsylvania, Virginia and West Virginia. These continuing studies encompass 30 service areas.





Environmental Compliance





The American Water Systems policy is to be in total compliance with all environmental regulations,
including drinking water rules. The Companys compliance record is outstanding and our commitment goes beyond just compliance. For example, compliance with drinking water health standards in 2001 was 100% for the regulated utility subsidiaries
and 99.99% for the systems managed by American Water Services. Also, the American Water System continues to be a leader in achieving the more stringent standards contained in the voluntary U.S. Environmental Protection Agency (EPA) Partnership for
Safe Water with 55 Awards.


Numerous federal drinking water regulations have been in place in the U.S. since 1974 when the Safe Drinking Water Act required national
health standards. That Act was most recently amended in 1996, requiring additional standards to be set by EPA, which is continuing to implement that Congressional mandate. In 2001, EPA adopted a limit for arsenic effective in 2006 at 10 parts per
billion, one-fifth the present limit. A limited number of utility subsidiaries will need to install treatment to meet this limit, so studies, and design will begin in 2002 to phase the investment in over time. Disinfection byproduct limits were
lowered in 1998, and take effect in 2002. Also, more stringent surface water treatment performance standards become effective in 2002. The utility subsidiaries operating systems are already in compliance with these more stringent standards.


In 2002, EPA is expected to finalize regulations to limit radon, to control the recycling of filter backwash water, and to disinfect certain vulnerable ground waters.
The agency also plans to propose a new regulation to assure high quality water during pipeline distribution by controlling cross connections, to require greater disinfection of surface waters and to further lower disinfection byproduct limits by
2008. Removal of radon will be necessary at a few utility subsidiary sites by the deadline of 2007, since most states are expected to adopt the alternate plan to reduce indoor air radon levels, and only require ground waters with extremely high
radon to be treated. The filter backwash recycling rule is only expected to impact one utility subsidiary site, which has until 2006 to comply. The ground water disinfection rule will have virtually no impact since the American Water System
disinfects voluntarily at all but one site now. The distribution system protection rule will likely not impact capital needs, but will increase operation costs at some sites to conduct the required protection program. Greater disinfection of surface
waters will likely result in installation of UV for some systems, and lowering of byproducts will require some improvements to treatment facilities and increase operating costs, but these will not be needed for the next several years.


The record for other environmental compliance further demonstrates Americans commitment to compliance and environmental protection. Waste residuals generated at drinking water
and wastewater treatment plants are properly disposed, in compliance with permits. Discharges to streams comply with permit limits, and full disclosure is made if a violation occurs. For many drinking water treatment plants, the residuals are being
approved for beneficial use on farms, roadways, and in composting operations, thereby reducing the disposal costs and preserving valuable landfill capacity. This practice will continue into the future. All chemicals are handled in the appropriate
manner to prevent exposure to employees, and to prevent accidental releases to the environment. If such release occurs, the proper government agencies are immediately notified, per regulation, and the material cleaned up.


The American Water System has been involved in all rulemaking, and has provided its operating knowledge and cost estimates to the health authorities so as to assist them in making the
proper decision to protect public health and the environment at the lowest cost impact. The Company continues to be an active participant in the EPA regulatory develop-




9




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Managements Discussion and Analysis





ment process, and has even hosted expert workshops at its Corporate headquarters to share our knowledge with the EPA.


The future holds more stringent regulation. The American Water System will continue to be actively following and assisting EPA in the development of those regulations, consistent with its policy to protect its
drinking water consumers, and the environment. Any increased costs to the regulated utility subsidiaries to comply with these new mandates are expected to be recovered in rates, because the cost reflects better customer service and better
environmental protection.





Utility Regulation





Twenty-one state commissions regulate the Companys utility subsidiaries. They have broad authority to establish rates for service, prescribe service standards, review and approve rules and regulations and, in most instances, they must
approve long-term financing programs, transactions between the utility and affiliated interests, reorganizations, mergers and acquisitions prior to their completion. The jurisdiction exercised by each commission is prescribed by state legislation
and therefore varies from state to state.


Economic regulation deals with many competing, and often conflicting, public interests and policy goals. Rate adjustment
proceedings normally are initiated by the utility. After appropriate investigation by commission staff and intervenors, public hearings are held. These hearings, which are economic and service quality fact-finding proceedings, are typically
conducted in a trial-like setting where evidence is submitted, subject to cross examination, which then forms the basis for a commission decision. The purpose of this regulatory process is to set rates that will cover the reasonable operating costs
of providing quality service to customers and which will also allow the utility the opportunity to earn a fair return on the investment necessary to provide that service. A rate proceeding generally focuses on four areas:





| |  | The amount of investment in facilities which provide public service
|- |  | -------------------------------------------------------------------




| |  | The operating costs and taxes associated with providing the service
|- |  | -------------------------------------------------------------------




| |  | The capital costs for the funds used to provide the facilities
|- |  | --------------------------------------------------------------




| |  | The tariff design which allocates revenue requirements equitably across the customer base
|- |  | -----------------------------------------------------------------------------------------




The regulatory rate setting process is time-consuming. After considering the time required to complete the regulatory process, the utility subsidiaries file for rate adjustments that
will reflect as closely as possible the cost of providing service during the time new rates are intended to be effective. Management pursues methods of offsetting any adverse financial impact of regulatory lag and a number of approaches have proven
successful in achieving this result. For example, at least 12 states employ some form of forward looking test year, such as a future test year or recognition of known and measurable changes for some period beyond a historic test year. Such
mechanisms result in rates that are more reflective of costs that are likely to be incurred during the period the rates will be in effect. In addition, six subsidiaries have received rate orders allowing recovery of interest and depreciation expense
related to the interim period from the time a major construction project is placed in service until new rates reflecting the cost of the project are placed into effect. Six subsidiaries also now recover in rates a return on utility plant before it
is in service instead of capitalizing an allowance for funds used during construction. Ten subsidiaries have implemented staged rate increases over several years, reflecting additional annual investments and expenses approximately when they are
incurred and reducing the frequency of general rate increase requests.


Through legislation or administrative rulemaking, four states allow utilities to recover certain
costs of distribution system infrastructure replacement without the necessity of filing a full rate proceeding. Since distribution system infrastructure replacement is a significant element of capital expenditures made by subsidiaries, such programs
can reduce regulatory lag and increase the time between full rate cases.


Additionally, eight regulatory jurisdictions permit forms of rate design known as single
tariff pricing. This is a concept which sets similar rates for service to customers of subsidiaries with multiple service districts. It allows simplification of administration, and reduces the complexity of rate proceedings. This concept also
spreads fixed costs over a larger customer base and helps to mitigate adverse rate impacts to customers resulting from necessary capital improvements, while permitting flexibility in the timing of utility subsidiary financing.





Rate Case Activity


During the past year, and through January of 2002, regulatory commissions
authorized 11 subsidiaries to increase rates for service by an annual amount of $46.3 million. The primary driving force for price increases was to obtain a return on the additional capital investment in essential water service facilities. This has
been the case for a number of years and will continue to be the situation for the foreseeable future, as a result of the ongoing need for additional capital investments to reinforce and replace water utility infrastructure and to comply with
increasing water quality requirements.


On January 1, 2001, California-American Water Company placed into effect an increase of $1.1 million in
additional annual revenue for the Coronado Division to offset the increase in cost of purchased water. On March 15, 2001, the California Public Utility Commission (CPUC) approved a settlement for the Los Angeles Division granting an annual increase
of $.9 million in 2001.


In November 2001, the CPUC initiated a rulemaking proceeding and instituted interim procedures which alter existing methods for treating
balancing accounts and offsettable expenses. Previously, regulated companies were allowed to adjust rates outside of the context of a general rate case for certain costs, such as purchased water and purchased power, through the use of balancing
accounts and offsets to rates. The interim procedures and new rulemaking would make such recovery mechanisms unavailable unless the utility demon-




10




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American Water Works Company, Inc. and Subsidiary Companies





---




strates it is in compliance with its rate case filing cycle and not earning in excess of a
Commission approved pro forma return on equity. Because California-American has in the past complied with these provisions when seeking balancing account or offset recovery, it is unlikely that establishing such requirements through a formal
rulemaking will have a significant adverse impact on the Company.


On February 15, 2001, the Illinois-American Water Company received an order from the Illinois
Commerce Commission approving additional revenues in the amount of $7.2 million on an annual basis.


The Iowa Regulatory Utilities Board entered an order on July 16,
2001 granting Iowa-American Water Company an interim increase in the amount of $1.9 million. Iowa-American then negotiated a settlement agreement effective on August 20, 2001 providing for a total increase of $2.0 million. The settlement allowed
implementation of new permanent rates six months prior to the statutory date of February 2002 and did not require a refund of any portion of the interim increase.


Kentucky-American Water Company was awarded an increase in annual revenues of $2.2 million, effective December 12, 2000. The Kentucky Public Service Commission subsequently granted a petition for rehearing the Company had filed regarding a
number of issues. On May 9, 2001, the Commission issued a Rehearing Order awarding the Company additional revenues of $397,000. The May Rehearing Order also reversed the Commissions earlier denial of an acquisition adjustment related to the
companys purchase of the Boonesboro Water Association, allowing partial recovery of the acquisition adjustment in view of the Commissions desire to support regionalization.


Missouri-American Water Company filed an application for additional revenues on June 23, 2000, which included a proposal to fund a long-term infrastructure replacement project. The Missouri Public Service Commission
staff recommended a decrease from existing revenues of $9.5 million. Staff proposed departure from normal ratemaking practice related to calculating depreciation expense, and also opposed the companys proposed infrastructure replacement
program. On May 3, 2001, the Commission issued an order granting a rate increase of $5.2 million or 5.4%. The order rejected staffs proposed approach to calculating depreciation accruals but denied the Companys request for funding an
infrastructure replacement program as well as certain deferrals related to infrastructure replacement. It also denied recovery of certain costs related to the acquisition of the NEI properties. A number of these issues are currently on appeal to the
Missouri courts.


In a separate order effective February 20, 2001, Missouri-American was allowed to implement a surcharge to recover annually $700,000 of property taxes
associated with its St. Joseph treatment plant.


On March 5, 2001 West Virginia-American Water Company filed a rate case seeking recognition of $53.7 million in
increased investment in utility plant. On December 21, 2001, the West Virginia Public Service Commission approved an increase in revenues of $4.6 million on an annual basis effective for service rendered on and after December 31, 2001.





Additional Annual Revenues Authorized by Rate Decisions(000)

2001

2000

1999Arizona

$


$


$
811California


1,979


2,481


780Connecticut





2,628


Illinois


7,183





Indiana








14,219Iowa


2,038





Kentucky


397


2,171


Maryland








360Massachusetts


1,173





Michigan


70





Missouri


5,866


10,233


New Hampshire


202


545


New Jersey








13,083New York





539


100Ohio





1,310


Pennsylvania





780


24,600Virginia





936


776West Virginia


4,552


5,561


4,522$
23,460

$
27,184

$
59,251





Pennsylvania-American Water Company filed a request on April 27, 2001 to increase
rates, that was primarily driven by an increased plant investment of $250 million since the previous rate case. The final order of the Pennsylvania Public Utility Commission granted an increase of $24 million effective January 25, 2002.


In addition to the order received in Pennsylvania, three other orders granting a total of $2.0 million in additional annual revenues were received during the first two
months of 2002. At March 1, 2002 two applications requesting additional annual revenues of $13.2 million were awaiting regulatory decisions. One of these cases, a $12.7 million request by Indiana-American, is anticipated to be concluded by the
middle of 2002. The Company plans additional filings in 2002, including two related to the recent Citizens acquisition. Approximately $132 million in capital expenditures necessary to ensure the delivery of high quality water is not reflected in
current rates for the former Citizens customers. In some instances, rates have not been adjusted for six years. Plans are in place to move forward in a timely manner to request rate increases needed to recover those capital costs.





Citizens Acquisition


On October 15, 1999, the company entered into an agreement to acquire all of the
water and wastewater assets of Citizens Communications Company. The transaction called for the Companys utility subsidiaries to acquire the water and wastewater assets of Citizens and its subsidiaries in Arizona, California, Illinois, Indiana,
Ohio and Pennsylvania. Regulatory agencies in all six states approved the acquisition of Citizens water and wastewater assets. The transaction closed on January 15, 2002.


In no states will the rates be increased to support this transaction. This acquisition will allow the company to obtain savings that would otherwise not be possible. The benefit of these savings will be shared with the ratepayer through a
reduction in future rate increases.




11




---




---

Managements Discussion and Analysis





Security


After the tragic events of September 11, 2001, the regulated utility subsidiaries reviewed existing
security measures and took appropriate additional action to protect these essential supply, treatment, and distribution facilities and service to customers. The Company incurred $7.4 million of incremental operating expenses after September 11 to
increase security, of which $7.1 million was deferred as a regulatory asset pending future recovery in rates. In addition, $16.3 million of additional security related capital expenditures were made that will increase rate base in future rate
proceedings. The utility subsidiaries have developed and are implementing strategies to obtain timely recovery of the increased costs associated with enhanced security measures. These strategies differ based on the particular circumstances in each
state. Generally, however, cost recovery mechanisms include seeking recovery in pending rate proceedings, the use of surcharge mechanisms, or deferral of security related costs for recovery in subsequent rate proceedings. In all states, companies
are taking appropriate proactive measures to protect the confidentiality of security related information in the regulatory process. Two states, Pennsylvania and New Jersey have established taskforces for the purpose of addressing public utility
security issues, including protection of sensitive security related information and appropriate cost recovery. Pennsylvania-American and New Jersey-American are both participants in these processes in their respective states.





Business Services Projects


During 2001 the Company continued the consolidation of its various customer
service centers and financial services operations.


The new national customer service center in Alton, Illinois that began operation in the second quarter of 2001 will
increase the Companys current focus on high quality customer service. This center can be more cost-effectively staffed and equipped to provide a higher level of service than can currently be provided with the numerous existing centers. The
process of transitioning the customer service operations of the utility subsidiaries to the new center will be completed in 2003.


In the third quarter of 2001 a new
shared services center in Mt. Laurel, New Jersey began to assume responsibility for various accounting, treasury and human resources activities. The process of transitioning the utility subsidiaries to the new center was completed in January 2002.
The shared services center will improve the Companys financial processes, reduce costs, and allow the operating subsidiaries to focus on providing utility service.


The utility subsidiaries are implementing strategies to secure recovery of the $36.3 million of one-time business process reengineering costs associated with the consolidation initiative that were deferred as a regulatory asset at December
31, 2001. Such costs were included and allowed in recent rate cases for Pennsylvania-American and West Virginia-American. Indiana-American included the one-time costs in its pending rate proceeding which has not yet concluded. Special filings
seeking authority to defer these costs for later recovery have been made by utility subsidiaries in Kentucky, New York and Hawaii and these proceedings are pending. The New Mexico Commission has approved deferral. For the other regulated utility
subsidiaries no special authority is required to defer the one-time costs and the companies are doing so for anticipated recovery in a later rate proceeding.


In
addition to the one-time costs associated with reengineering business processes, $10.8 million has been invested to equip these two new centers. The cost of consolidating and enhancing these services is expected to be fully offset by reduced
operating expenses, resulting in no impact on customers rates.





Critical Accounting Policies


Statement of Financial Accounting Standards No. 71 Accounting for the Effects of Certain Types of Regulation (SFAS 71) sets forth the application of generally accepted accounting principles for those companies whose rates are
established by or are subject to approval by an independent third-party regulator. Under SFAS 71, the regulated utility subsidiaries defer costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that those
costs and credits will be recognized in the rate-making process in a period different from the period in which they would have been reflected in income by an unregulated company. These deferred regulatory assets and liabilities are then reflected in
the income statement in the period in which the same amounts are reflected in the rates charged for service.


The utility subsidiaries have incurred various costs and
received various credits which have been reflected as regulatory assets and liabilities on their balance sheets. Accounting for such costs as regulatory assets in accordance with SFAS 71 is based on managements judgments that it is probable
that future revenue in an amount at least equal to the capitalized cost will result from inclusion of that cost in allowable costs for rate-making purposes. Similar judgment is required to assess when credits should be recorded as an obligation to
the utility companys customers.


The disallowance of recovery of a previously deferred cost in a rate proceeding would result in a charge to income in that
period, as would the imposition of a previously unrecorded liability to the companys customers. In addition, a previously deferred cost must be immediately expensed if in managements judgment it no longer meets the probable future
recovery standard.


More information about the regulatory assets and liabilities recorded by the utility subsidiaries can be found in Note 2 to the financial
statements.


Revenue from many of American Water Services contracts are recognized over the contract term based on the percentage of costs incurred during the
period compared to the total estimated costs to be incurred over the entire contract. These cost estimates reflect the judgment of management. Losses on contracts are recognized during the period in which the loss first becomes known. Revenue
recognized in excess of billings on service contracts are recorded as unbilled revenue. Billings in excess of revenues recognized on service contracts are recorded as a liability on the Companys balance sheet until the




12




---




American Water Works Company, Inc. and Subsidiary Companies





---




above revenue recognition criteria are met. Changes in contract performance and related
estimated contract profitability may result in revisions to costs and revenues and are recognized in the period in which revisions to previous estimates of management are determined.





Results of Operations





The Companys experience in assessing the impact of inflation on its business
indicates that with timely rate increases authorized by regulators, revenue will likely keep pace with inflation. Inflation did not significantly impact the Companys financial position or results of operations in 1999 through 2001, and it is
not expected to materially affect 2002 results.





Consolidated Results


The results of
operations for the years ended December 31, 2001 and 2000 reflect the operations of American Water Services which was formed when the Company acquired its joint venture partners 50 percent interest in AmericanAnglian Environmental Technologies
on December 31, 1999. Prior to January 1, 2000 the results of operations of the Companys former contract management business joint venture were accounted for under the equity method. The operating results of Azurix North America and Azurix
Industrials Corp. have been included in the consolidated statement of income since the completion of the acquisition on November 7, 2001.





(000)

2001


2000


1999Revenues

$
1,438,887


$
1,350,590


$
1,260,857Operating expenses


979,293



894,412



841,263Operating income


459,594



456,178



419,594RWE and NEI merger expenses


(9,992
)






(20,535
)Gain from sale of Salisbury system


4,820







Other income (deductions), net


(182,615
)


(189,811
)


(168,710
)Income before income taxes


271,807



266,367



230,349Income taxes


110,324



105,306



91,400Net income


161,483



161,061



138,949Dividends on preferred stocks


584



3,700



3,984Net income to common stock


160,899



157,361



134,965Other comprehensive income (loss), net


(19,345
)


(67,158
)


59,323Comprehensive income

$
141,554


$
90,203


$
194,288Net income to common stock

$
160,899


$
157,361


$
134,965Diluted earnings per share

$
1.61


$
1.61


$
1.40





Revenues


Revenues of $1.439 billion in
2001 were 7% above those for 2000. While overall total sales volume increased slightly, industrial sales decreased by 2.2 billion gallons due to a downturn in the economy. Timely rate increases, the addition of 40,000 customers and the Azurix
acquisition all contributed to revenue growth.


Revenues for 2000 increased 7% from the amount recorded in 1999. Contract management revenues from American Water
Services accounted for almost half of this revenue increase. The remainder of the increase resulted from rate increases and the addition of 65,000 customers through acquisitions and growth in existing service territories. These growth factors served
to offset a sales volume decrease caused by abnormal summer weather conditions.





Operating Expenses


Operation and maintenance expenses grew by 10% in 2001 to $664.5 million. The Azurix acquisition accounted for more than a third of this increase. Increased transition costs that the Company incurred as it completes
various consolidation efforts also contributed to this increase.


The 6% increase in operation and maintenance expense in 2000 was solely due to the inclusion of
American Water Services expenses in consolidated operations for the first time.


Operating expenses include depreciation and general taxes, which totaled $185.2
million and $129.5 million in 2001, respectively. Construction projects, completed by the companys utility subsidiaries, were the principal reason for increases in depreciation expense and the property tax portion of general taxes in both 2001
and 2000.





Other Income (Deductions)


Interest expense, the primary component of other
income (deductions) rose slightly to $192.5 million in 2001 compared to 2000. Interest expense in 2001 associated with an increase in long and short-term debt, was for the most part offset by lower interest rates. This expense had increased by 8% in
2000. due to increased borrowings.


The total allowance for funds used during construction (AFUDC) recorded by the utility subsidiaries in 2001 was $8.9 million
compared to $13.7 million in 2000 and $22.4 million in 1999.


Merger expenses incurred in connection with the RWE acquisition in 2001, primarily investment banking and
legal fees, totaled $10.0 million in 2001. The $20.5 million of merger costs in 1999 that were incurred in connection with the NEI merger included severance costs as well as vesting of certain benefits, professional fees, and other costs.


The sale of water assets serving the City of Salisbury, Massachusetts resulted in a 2001 pre-tax gain of $4.8 million.


Other income in 2001 reflects a $5.2 million pre-tax gain from the sale of a portion of the Companys investment in Deutsche Telekom.


Other income deductions in 2000 reflect $4.5 million of one-time charges related to two adverse rate orders. Other income deductions in 1999 include the Companys share of losses at
its former AmericanAnglian Environmental Technologies contract management joint venture.





Income Taxes


Income taxes increased by 5% to $110.3 million in 2001, following a 15% increase in 2000. The Companys effective income tax rate increased to 40.6% in 2001 from 39.5% in 2000, reflecting the fact that it is not
probable that the $10.0 million of RWE merger expenses related to investment banking and legal fees incurred in 2001 will be deductible for tax purposes. Income tax expense in 1999 reflects the decrease in taxable income primarily related to tax
deductible severance and integration costs incurred in connection with the NEI merger.




13




---




---

Managements Discussion and Analysis





Net Income to Common Stock


Net income to common stock in 2001 was $160.9 million, compared to net income to
common stock of $157.4 million in 2000 and $135.0 million in 1999. Excluding the impact of the RWE and NEI merger costs and the gain on the sale of the Salisbury assets, net income to common stock was $168.0 million in 2001 compared to $157.4
million in 2000 and $147.9 million in 1999.





Other Comprehensive Income


Other
comprehensive income reflected a net loss of $19.3 million in 2001, compared to a net loss of $67.2 million in 2000 and a net gain of $59.3 million in 1999. The Companys other comprehensive income represents the after tax unrealized gain/ loss
on passive investments in publicly traded companies. The most significant holdings are in Deutsche Telekom and ITC/ \DeltaCom, Inc., two investment telecommunications firms acquired in the merger with NEI, and an investment in SJW Corp.





Comprehensive Income


Comprehensive income was $141.6 million in 2001 compared to $90.2
million in 2000 and $194.3 million in 1999.





Earnings per Share


Diluted earnings per
share in 2001 were $1.61, which equalled earnings per share in 2000. Earnings per share reported in 1999 were $1.40. Excluding the impact of the RWE and NEI merger costs and the gain on the sale of the Salisbury assets, diluted earnings per share in
2001 were $1.69, compared with to $1.61 in 2000 and $1.53 in 1999.





Segment Reporting





The Company has identified Regulated Utility Services and Unregulated Services as its two reportable segments. Prior to the November 2001 acquisition of Azurix North America and Azurix Industrials Corp. the
Companys unregulated operations had not been reflected as a reportable segment due to their limited scope and impact on the financial results of the Company. The results of operations reported by segment include costs allocated by American
Water Works Service Company. Corporate costs of American Water Works Company are not allocated to its subsidiaries, and are not reflected in the results of operations reported by segment.





Regulated Utility Services


The Regulated Utility Services segment includes 26 subsidiaries that provide water and wastewater services to 10
million people in 23 states. All of these companies are subject to both federal and state regulation regarding the quality of water distributed and the discharge of waste residuals. With the exception of one company that serves 4,000 customers, the
utility subsidiaries also function under economic regulations prescribed by state regulatory commissions. A subsidiary which owns a treatment plant in Massachusetts that is leased to an affiliated utility subsidiary is also included in this segment.





Revenues


Revenues for 2001 increased 5% or almost $67 million, to $1.377 billion from
the $1.310 billion recorded in 2000. The increase resulted from timely rate increases and the addition of 40,000 customers, offset by sales volume losses in industrial water sales. The total volume of water sold increased 1% to 344.4 billion gallons
in 2001 compared with 2000.


Rate authorizations adjusted the water service rates in effect for nine utility subsidiaries during 2001. These authorizations are expected
to increase annual revenues by $23.5 million. Operating revenues for 2001 included approximately $15.1 million that resulted from these rate orders.


Revenues of $1.310
billion in 2000 were 4% above those for 1999. Ten utility subsidiaries received rate orders in 2000, authorizing increases in annual revenues aggregating $27.2 million. Operating revenues for 2000 included approximately $8.9 million which resulted
from these rate orders. The 341.1 billion gallons of water sold in 2000 was 1% less than sales in 1999.


While it is still too early in 2002 to determine if there will
be any impact, drought warnings and advisories have already been issued in some states. These initial steps may lead to water use restrictions and reduced water sales during the remainder of the year if adequate rain or snowfall does not replenish
supplies.





Percentage of Regulated Utility Service Revenues by Customer Class2001

2000

1999Residential

58.6%

58.0%

58.2%Commercial

21.0%

21.2%

20.8%Industrial

5.8%

6.3%

6.2%Public and other

11.5%

11.7%

11.9%Other water revenues

1.2%

0.9%

1.0%Water service

98.1%

98.1%

98.1%Wastewater service

1.9%

1.9%

1.9%100.0%

100.0%

100.0%





Residential Revenue


Residential water
service revenues in 2001 amounted to $806.2 million, an increase of 6% over those for 2000. This 2001 revenue improvement followed an increase of 4% in 2000. The volume of water sold to residential customers increased by 3% in 2001 to 176.7 billion
gallons. The average unit price of residential water increased by 3% in 2001 and by 6% in 2000.





Commercial Revenue


Revenues from commercial customers in 2001 rose by 4% to $289.0 million, following an increase of 6% in 2000. Commercial customers purchased 82.7 billion gallons of water in 2001, slightly more than in 2000. The
average unit price of commercial water increased by 3% in 2001 and by 5% in 2000.





Industrial Revenue


Industrial water use of 44.2 billion gallons in 2001 was 5% less than in 2000 reflecting the downturn in the economy.




14




---




American Water Works Company, Inc. and Subsidiary Companies


---




Revenues from industrial sales of $79.5 million in 2001 were 4% below those recorded in 2000 and the average unit price of water
increased 1%. In 2000, revenues from industrial sales were 6% above those for 1999 and the average unit price of water increased by 5%.





Public and
Other Revenue


Public and other revenues in 2001 increased by 4% to $159.2 million following an increase of 3% in 2000. Revenues derived from municipal governments for fire protection
services and customers requiring special private fire service facilities totaled $63.9 million in 2001, exceeding 2000 revenue from these customers by 2%. The 40.8 billion gallons of water sold to governmental entities and resale customers in 2001
was equal to the quantities sold in 2000. Revenues generated by these sales in 2001 totaled $95.3 million and exceeded 2000 revenues by 5%.





Percentage of Water Sales (Gallons by Customer Class)2001

2000

1999Residential

51.3%

50.3%

50.9%Commercial

24.0%

24.1%

23.8%Industrial

12.8%

13.6%

13.3%Public and other

11.9%

12.0%

12.0%100.0%

100.0%

100.0%





Wastewater Service Revenue


Utility
subsidiaries provided wastewater service in Hawaii and to portions of the Companys service areas in New Jersey, Pennsylvania, Indiana, Missouri and Kentucky. Revenues from these services amounted to $26.5 in 2001, $24.4 million in 2000 and
$24.5 million in 1999. The growth in wastewater revenues in 2001 reflects the acquisition of the operations of Coatesville in Pennsylvania.





Regulated Utility Service Operating Expenses(000)

2001

2000

1999Operation and maintenance expenses

$
595,981

$
551,443

$
552,398Depreciation and amortization


178,120


162,182


150,945General taxes


125,608


122,282


120,485$
899,709

$
835,907

$
823,828





Operating Expenses


Operating expenses in
2001 increased by 8% to $899.7 million, following a 1% increase in 2000.


Operation and maintenance expenses totaled $596.0 million in 2001, 8% higher than in 2000.
Operation and maintenance expenses had decreased slightly in 2000.


Associate-related costs include wage and salary, group insurance, and pension expense. These costs,
representing 40% of operation and maintenance expenses, increased 5% in 2001 after a 5% decrease in 2000.


The primary components of associate-related costs are wages
and salaries, which were up 2% to $196.3 million in 2001 following a 3% decrease in 2000.


Group insurance expense, which includes the cost of providing current health
care and life insurance benefits as well as the expected cost of providing postretirement benefits, increased by 6% to $42.6 million in 2001 after a 3% decrease in 2000. The increased group insurance expense in 2001 reflects higher group insurance
premiums for active associates. The cost accrued for postretirement benefits in 2001 increased due to lower than expected returns on plan assets and a decrease in the discount rate actuarial assumption. Postretirement benefit plan costs had
decreased in 2000 due to an increase in the discount rate actuarial assumption.


Pension expense was $2.0 million in 2001 compared to pension
income of $3.8 million in 2000, reflecting lower than expected returns on plan assets and a settlement gain in 2000 in connection with the purchase of non-participating annuity contracts to cover vested benefits of certain retirees that had
previously been provided through an immediate participation guarantee contract. The purchase of non-participating annuity contracts allowed the Company to terminate a restrictive contract with an insurance company and is expected to increase the
long-term investment return on plan assets. As a result of the purchase of the annuity contracts, the Company remeasured its pension assets and pension benefit obligation, which resulted in the pension settlement gain. Pension expense also decreased
in 2000 due to an increase in the discount rate actuarial assumption. Pension expense in excess of the amount contributed to the pension plans is deferred by certain regulated subsidiaries pending future recovery in rates charged for water services
as contributions are made to the plans. These subsidiaries have recorded their portion of the settlement gain as a reduction of the regulatory asset.


At December 31,
2001 the Company lowered the discount rate assumption used for its pension and postretirement benefit plans to reflect current high-quality corporate bond yields. This change, and anticipated increases in the cost of medical claims, are expected to
result in increased benefit plan expense in 2002. More information regarding the Companys benefit plans is included in Note 8 to the financial statements.





Regulated Utility Service Operation and Maintenance Expenses(000)

2001

2000

1999Associate-related costs

$
240,919

$
229,561

$
242,674Fuel and power


52,941


48,932


48,559Purchased water


54,230


47,867


45,404Chemicals


25,029


22,040


22,749Waste disposal


18,633


17,284


16,137Maintenance materials and services


36,582


37,211


39,152Operating supplies and services


111,401


101,603


95,900Customer billing and accounting


32,098


27,513


26,168Other


24,148


19,432


15,655$
595,981

$
551,443

$
552,398




15




---




---

Managements Discussion and Analysis





Expenses associated with the collection, treatment, and pumping of water include the cost of fuel and power, water purchased from other suppliers,
chemicals for water treatment and purification, and waste disposal. These production costs increased by 11% in 2001 after a 2% rise in 2000. The cost increase in 2001 reflects higher purchased water and energy expense. The unit cost of water
produced was up 6% in 2001 after a 4% increase in 2000.


Operating supplies and services include the day-to-day expenses of office operation, legal and other
professional services, as well as information systems and other office equipment rental charges. These costs increased by 10% in 2001 after a 6% increase in 2000. The expenses in this category in 1999 included $5.6 million of costs connected with
the take-over attempts of the Companys operations in Chattanooga, Tennessee and Peoria, Illinois.


Customer billing and accounting expenses increased by 17% in
2001 and by 5% in 2000. The increase in 2001 reflects additional costs incurred in conjunction with the transition to a centralized customer service operation. These duplicative costs will subside as the transition to the new center is completed.


Other operation and maintenance expenses include casualty and liability insurance premiums and regulatory costs. These expenses increased by 24% in 2001 after
increasing by 24% in 2000. The large increases in 2001 and 2000 were due to an increase in insurance claims. Insurance expense is expected to increase in 2002.


Depreciation and amortization increased by 10% in 2001 and 7% in 2000. The higher depreciation expense in both years was primarily due to growth in utility plant in service including major new treatment plants in Alton, Illinois and St.
Joseph, Missouri.


General taxes, which include gross receipts, franchise, property, capital stock, payroll and other taxes, increased by 3% in 2001 after a 1% rise in
2000. Gross receipts and franchise taxes that are a function of revenues, increased by 4% in 2000. Property and capital stock taxes are assessed on the basis of tax values assigned to assets and capitalization and these taxes in 2001 were 15% above
those in 2000. These taxes had increased by 4% in 2000.





Other Income and Income Deductions


Interest expense rose 1% to $173.2 million compared to $172.2 million in 2000. This expense had increased by 7% in 2000. The increases can be attributed primarily to an increase in total debt, the effect of which was offset in 2001 by lower
interest rates.


The total allowance for funds used during construction (AFUDC) recorded in 2001 was $8.9 million, compared to $13.7 million in 2000 and $22.4 million
in 1999. The decreased amounts of AFUDC recorded reflect the completion of several major projects to construct new water service facilities. The utility subsidiaries record AFUDC to the extent permitted by the regulatory authorities.


The sale of water assets serving the City of Salisbury, Massachusetts resulted in a 2001 pre-tax gain of $4.8 million.


Other income deductions in 2000 reflect $4.5 million of one-time charges related to rate orders received in Missouri and Kentucky. The most significant of these charges was related to the Missouri Public Service
Commissions decision to deny recognition of certain investments in the former treatment plant the Company deemed essential to provide water service while a new treatment plant was being constructed. An appeal of the Kentucky order was
partially successful in 2001, and an appeal of the Missouri order is pending.





Unregulated Services


The Unregulated Services segment includes American Water Services and its subsidiaries and American Water Resources.


The mission of
American Water Services is to provide a broad range of water and wastewater services throughout the United States and Canada. With the acquisition of Azurix North America and Azurix Industrials Corp. in 2001 American Water Services has enhanced its
capability to provide operations and maintenance, residual, underground infrastructure and engineering services.


The Company intends to be a key player within the
full-service water and wastewater management market. The ability of American Water Services to be competitive and to actively participate in this markets growth is significantly enhanced by American Water Works Companys presence in the
United States regulated utility market. American Water Services is the fourth largest operations and maintenance contractor in the United States. It currently manages and operates 1,000 water and wastewater facilities in eighteen states and three
Canadian provinces.


Approximately one-half of American Water Services revenues are derived from contract management services. This business is highly
competitive, and contracts are usually awarded for a period of at least five years. Management judgment is required to forecast costs that the Companys bids will be based on.


The other half of American Water Services revenues are derived from residuals management, underground infrastructure development and engineering service contracts. These revenues are based primarily on contracts
with terms from three to nine months and are awarded on a bid basis.


American Water Resources currently offers a consumer protection program where for a monthly fee a
residential customers external water line is repaired or replaced when required. American Water Resources also provides a service to regenerate granular activated carbon that is used by water utilities in the filtration process. In addition,
this subsidiary leases equipment and office space to affiliated companies.





Operating Revenues


Revenues from unregulated services totaled $69.2 million in 2001 compared to $47.0 million in 2000. The majority of this increase is directly related to the acquisitions of Azurix and EA2. The increase in revenues also reflects recognition
of the partial year revenues of new contracts awarded in 2001, general Consumer Price Index increases to existing contracts throughout the year in accordance with contract terms, and revenues from the water line protection program.




16




---




American Water Works Company, Inc. and Subsidiary Companies


---

During 2001 American Water Services was awarded contracts in East Palo Alto, California; Houston, Texas; London, Ontario; Camp Creek, Georgia and Coral
Springs, Florida that are expected to result in total future revenues of $158 million. In addition American Water Services renewed contracts at Dedham, Massachusetts; Avalon, New Jersey; Poconos, Pennsylvania; Moore County, North Carolina and
Cohasset, Massachusetts with total future revenue of $23.4 million.





Operating Expenses


Operating expenses increased to $72.7 million in 2001 from $48.5 million in 2000. The majority of this increase was as a result of the Azurix North America and EA2 acquisitions.





Other Income and Income Deductions


Interest expense increased by $1.0 million, primarily due to the funding of the acquisitions of Azurix
America and EA2.





Liquidity and Capital Resources





Internal sources of cash flow are provided by retention of a portion of earnings, amortization of deferred charges, deferral of taxes and depreciation expense. Internal cash generation is influenced by weather
patterns, economic conditions and the timing of rate relief. When internal cash generation is not sufficient to meet corporate obligations on a timely basis, external sources of funds are utilized. The availability and cost of external cash reflect
the consistency and reliability of earnings. External sources of cash consist of short-term bank loans, the sale of securities  commercial paper, unsecured notes, bonds, preferred stock and common stock  as well as advances and
contributions from developers.


Until September 17, 2001, the Companys Dividend Reinvestment and Stock Purchase Plan allowed shareholders and customers of the
utility subsidiaries to purchase up to $5,000 of common stock each month directly from the Company at a 2% discount from the then prevailing market price. This plan was suspended in connection with the anticipated merger with RWE.


New shares of common stock also were previously issued in connection with the Companys Dividend Reinvestment and Stock Purchase Plan, the Employees Stock Ownership Plan, the
Savings Plan for Employees and the 2000 Stock Award and Incentive Plan. This strategy has been suspended in anticipation of the merger with RWE. The Companys shares necessary to meet the obligations under the employee benefit plans are now
purchased in the open market.


The Companys utility subsidiaries fund construction programs and supplement cash flow through the use of short-term borrowings. In
June 2000 the Company created American Water Capital to provide a single source of debt capital for the Company and its utility subsidiaries. As a result of consolidating subsidiary credit lines and cash management activities in American Water
Capital, the Company was able to reduce the consolidated credit requirements by approximately $228 million. American Water Capital derives its credit worthiness from a strong support agreement with American Water Works, which is considered the
equivalent of an unconditional guarantee of the obligations of American Water Capital. As a result, American Water Capital was rated A- (positive outlook) by Standard and Poors and Baa1 (review for possible upgrade) by Moodys Investor Service
at December 31, 2001.





Consolidated Capitalization Ratios(At December 31)

Common Equity

Preferred Stock

Debt2001

36%

1%

63%2000

37%

1%

62%1999

37%

2%

61%1998

37%

2%

61%1997

36%

3%

61%


Note: Debt includes amounts due within one year.





American Water Capital maintains a $500 million commercial paper program, the first of its kind in the water utility industry. American Water Capital also has a $500 million bank credit facility involving ten domestic
and international banks that supports the commercial paper program. Borrowing under the revolving credit line, at the Companys option, bears interest at a rate based upon either a defined base rate or the London Interbank Offered Rate (LIBOR).
The Company pays a commitment fee of 12.5 basis points on the entire amount of the commitment (whether borrowed or not borrowed) and a usage fee of 40 basis points (50 basis points if borrowings exceed $167,000). These fees may fluctuate based upon
the Companys current bond rating.


The issuance of commercial paper reduces the amount available under the bank credit facility. At December 31, 2001 $395.6
million of commercial paper and $18.5 million of bank borrowings were outstanding. Ample credit lines are available to provide funds needed for 2002 construction requirements and to maintain short-term borrowings not yet refinanced on a long-term
basis. Short-term borrowings are repaid with internally generated cash, and the proceeds obtained from selling debt securities either publicly or to institutional investors on a private placement basis.


On March 29, 2001, American Water Capital issued $140 million of unsecured notes on behalf of nine affiliated utilities bearing interest at 6.87%. Proceeds from the sale of the bonds
were used to repay short-term borrowings, fund construction programs, and to refinance existing debt. In addition on November 6, 2001, RWE entered into a Note Purchase Agreement with American Water Capital and American Water Works committing to
purchase $1.05 billion and $150 million, respectively, of the companies unsecured notes. The agreement specifies the notes will mature on November 6, 2006 and bear interest at 4.92% payable annually. The agreement also provides for multiple
issuances, the first of which occurred at the closing date and included $148.5 million by American Water Capital and $150 million by American Water Works. The American Water Capital proceeds were used to repay short-term debt for seven affiliated
utilities, while the $150 million borrowed by American Water Works was used to fund the Azurix acquisition. The second and final issue under the Note Purchase Agree-




17




---




---

Managements Discussion and Analysis





ment closed on January 14, 2002 totaling $900 million to American Water Capital and was primarily used to fund the purchase of the Citizens water and wastewater assets.


Upon giving effect to the above financings through January 14, 2002, and the call of American Water Works preferred stocks effective March 1, 2002, the
Companys total debt represents 70% of total capitalization. The Companys bank credit facility that expires on June 25, 2002 includes a limitation on total debt not to exceed 72.5% of total capitalization. Upon renewal of the credit
facility, the Company will seek to increase the debt limitation given the pending upgrades from the rating agencies in connection with the RWE merger. However, if the Company were not successful in increasing the debt limitation, the Company may
need to issue additional equity in order to continue its acquisition strategy. In addition if the RWE merger did not close, the Company would need to issue equity in order to maintain its credit ratings.


The Company and its subsidiaries plan to fund construction programs, continue acquisitions and repay short-term borrowings and maturing bonds in 2002 with the issuance of approximately
$470 million of long-term debt, and with additional common equity investments from American Water Works. Effective February 7, 2001 American Water Capital has the ability to issue up to $1.6 billion aggregate principal amount of debt securities
under a shelf registration filed with the Securities and Exchange Commission. However with the issuance of the unsecured notes to RWE, the Company does not anticipate using approximately $1 billion of the shelf securities available. The combined
amount of short-term borrowings and bonds maturing within one year is expected to decline to approximately $475 million in 2002. A discussion of the acquisition and capital spending programs begins on page 7.


The following table summarizes information about the Companys obligations to make future payments under contracts such as debt and lease agreements:





Contractual Obligations at December 31, 2001Payments Due By Period(000)

Less Than 1 Year

1-3 Year

4-5 Year

After 5 Year

TotalLong-term debt (includes capital lease obligations)

$
166,087

$
269,347

$
383,573

$
1,897,099

$
2,716,106Preferred stocks called for redemption


11,673











11,673Preferred stocks with mandatory redemption requirements


707


1,296


1,295


27,176


30,474Operating lease obligations


10,268


15,416


10,791


5,777


42,252$
188,735

$
286,059

$
395,659

$
1,930,052

$
2,800,505





In addition to the American Water Capital bank credit facility, American Water
Works has secured certain commitments of American Water Services in the form of standby letters of credit totaling $12 million and has guaranteed $9 million of debt related to wastewater treatment capacity owned by the City of Tolleson, AZ that is
used by Arizona-American.


The Company does not have any off-balance sheet financings (or relationships with special purpose entities for purposes of off- balance sheet
financing), derivative instruments or hedging activities.




18




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American Water Works Company, Inc. and Subsidiary Companies


---

Market Risk





The Company is exposed to market risk, including changes in
interest rates, certain commodity prices and equity prices. The exposure to changes in interest rates is a result of financing through the issuance of fixed-rate long-term debt and preferred stocks. The following table provides the principal amounts
by period of maturity and the weighted average effective interest rate for all such obligations outstanding in the period for the Companys obligations that are sensitive to interest rate changes. The exposure to equity price risk is generally
associated with the Companys investments in equity securities of several telecommunications companies.





Interest Rate Risk(000)

2002

2003

2004

2005

2006

Thereafter

Total

Fair Value at Dec. 31, 2001Fixed-rate long-term debt, including current portion

$
165,647

$
210,337

$
43,161

$
64,124

$
170,808

$
2,059,060

$
2,713,137

$
2,744,060Average interest rate


6.75%


6.71%


6.64%


6.62%


6.59%


6.70%Fixed-rate preferred stocks with mandatory redemption requirements

$
707

$
648

$
648

$
648

$
647

$
27,176

$
30,474

$
32,679Average interest rate


8.08%


8.10%


8.13%


8.15%


8.18%


8.21%(000)

2001

2002

2003

2004

2005

Thereafter

Total

Fair Value at Dec. 31, 2000Fixed-rate long-term debt, including current portion

$
160,944

$
146,088

$
207,998

$
49,470

$
63,134

$
1,802,010

$
2,429,644

$
2,478,382Average interest rate


7.07%


7.01%


7.00%


6.95%


6.92%


6.89%Fixed-rate preferred stocks with mandatory redemption requirements

$
1,028

$
2,208

$
648

$
648

$
648

$
27,722

$
32,902

$
34,395Average interest rate


8.11%


8.12%


8.11%


8.14%


8.16%


8.19%





New Accounting Standards





Accounting for Derivative Instruments and Hedging Activities


On January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133
Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended. This statement establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS 133 requires that an entity
recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. This new accounting standard did not have any effect on the Companys financial position or results of
operations. The Companys contracts that meet the definition of a derivative are for normal purchases and normal sales, are expected to result in a physical delivery, and are of quantities expected to be used or sold over a reasonable period in
the normal course of business. The Company has no hedging activities.





Business Combinations/ Goodwill and Other Intangible Assets


In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations (SFAS 141) and No. 142, Goodwill and Other
Intangible Assets (SFAS 142), collectively referred to as the Standards SFAS 141 supersedes Accounting Principles Board Opinion (APB) No. 16, Business Combinations. The provisions of SFAS 141 (1) require that the
purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) provide specific criteria for the initial recognition and measurement of intangible assets apart from goodwill, and (3) require that unamortized
negative goodwill be written off immediately as an extraordinary gain instead of being deferred and amortized. SFAS 141 also requires that upon adoption of SFAS 142 the Company reclassify the carrying amounts of certain intangible assets into or out
of goodwill, based on certain criteria. SFAS 142 supersedes APB 17, Intangible Assets, and is effective for fiscal years beginning after December 15, 2001. SFAS 142 primarily addresses the accounting for goodwill and intangible assets
subsequent to their initial recognition. The provisions of SFAS 142 (1) prohibit the amortization of goodwill and indefinite-lived intangible assets, (2) require that goodwill and indefinite-lived intangibles assets be tested annually for impairment
(and in interim periods if certain events occur indicating that the carrying value of goodwill and/or




19




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---

Managements Discussion and Analysis





indefinite-lived intangible assets may be impaired), (3) require that reporting units be identified for the purpose of assessing potential future impairments of goodwill, and
(4) remove the forty-year limitation on the amortization period of intangible assets that have finite lives.


The provisions of the Standards also apply to
equity-method investments made both before and after June 30, 2001. SFAS 141 requires that the unamortized deferred credit related to an excess over cost arising from an investment that was accounted for using the equity method (equity-method
negative goodwill), and that was acquired before July 1, 2001, must be written-off immediately and recognized as the cumulative effect of a change in accounting principle. Equity-method negative goodwill arising from equity investments made after
June 30, 2001 must be written-off immediately and recorded as an extraordinary gain, instead of being deferred and amortized. SFAS 142 prohibits amortization of the excess of cost over the underlying equity in the net assets of an equity-method
investee that is recognized as goodwill.


The Company will adopt the provisions of SFAS 142 in its first quarter ended March 31, 2002. The Company is in the process of
preparing for its adoption of SFAS 142 and is making the determinations as to what its reporting units are and what amounts of goodwill, intangible assets, other assets, and liabilities should be allocated to those reporting units. The Company
expects that it will no longer record $1.7 million of annual tax deductible amortization relating to its existing goodwill associated with the 1999 acquisition of its joint venture partners interest in AmericanAnglian Environmental
Technologies.


SFAS 142 requires that goodwill be tested annually for impairment using a two-step process. The first step is to identify a potential impairment and, in
transition, this step must be measured as of the beginning of the fiscal year. However, a company has six months from the date of adoption to complete the first step. The Company expects to complete that first step of the goodwill impairment test
during the second quarter of 2002. The second step of the goodwill impairment test measures the amount of the impairment loss (measured as of the beginning of the year of adoption), if any, and must be completed by the end of the Companys
fiscal year. Intangible assets deemed to have an indefinite life will be tested for impairment using a one-step process which compares the fair value to the carrying amount of the asset as of the beginning of the fiscal year, and pursuant to the
requirements of SFAS 142 will be completed during the first quarter of 2002. Any impairment loss resulting from the transitional impairment tests will be reflected as the cumulative effect of a change in accounting principle in the first quarter of
2002. The Company has not yet determined what effect these impairment tests will have on the Companys earnings and financial position.





Accounting for Asset Retirement Obligations


In June of 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143,
Accounting for Asset Retirement Obligations, (SFAS 143) on the accounting for obligations associated with the retirement of long-lived assets. SFAS 143 requires a liability to be recognized in the financial statements for retirement
obligations meeting specific criteria. Measurement of the initial obligation is to approximate fair value with an equivalent amount recorded as an increase in the value of the capitalized asset. The asset will be depreciable in accordance with
normal depreciation policy and the liability will be increased, with a charge to the income statement, until the obligation is settled. SFAS 143 is effective for fiscal years beginning after June 15, 2002. The Company is currently evaluating the
effects that adoption of the provisions of SFAS 143 will have on its results of operations and financial position but does not expect them to be material.





Accounting for the Impairment or Disposal of Long-Lived Assets


In August of 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (SFAS 144) that replaces Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of. SFAS 144 requires that one accounting model be used for long-lived assets to be disposed of by sale and broadens discontinued operations to include more disposal transactions. Under SFAS 144, operating losses of discontinued
operations are recognized in the period in which they occur, instead of accruing future operating losses before they occur. SFAS 144 is effective for fiscal years beginning after December 15, 2001. The Company is currently evaluating the effects
that adoption of the provisions of SFAS 144 will have on its results of operations and financial position but does not expect them to be material.





Forward Looking Information


Forward looking statements in this report, including, without limitation, statements relating to the Companys plans, strategies, objectives,
expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements. These factors
include, among others, the following: the success of pending applications for rate increases, inability to obtain, or to meet conditions imposed for, regulatory approval of pending acquisitions, weather conditions that tend to extremes of
temperature or duration; availability, terms and development of capital; business abilities and judgment of personnel; changes in, or the failure to comply with governmental regulations, particularly those affecting the environment and water
quality; competition; success of operating initiatives, advertising and promotional efforts; existence of adverse publicity or litigation; changes in business strategy or plans; quality of management; general economic and business conditions; and
other factors described in filings of the Company with the SEC. The Company undertakes no obligation to publicly update or revise any forward looking statement, whether as a result of new information, future events or otherwise.




20




---




American Water Works Company, Inc. and Subsidiary Companies





---

Managements Responsibility for Financial Reporting





The management of the Company is responsible for the preparation of the following financial statements and for their integrity and objectivity. These financial statements conform to accounting principles generally
accepted in the United States of America and, where required, include amounts which represent managements best judgments and estimates. The Companys management also prepared the other information in this Annual Report and is responsible
for its accuracy and consistency with the financial statements.


The Company maintains internal control systems to enable it to fulfill its obligations for responsible
financial reporting. These systems include an Internal Audit Department which monitors internal controls and reports directly to the Audit Committee of the Board of Directors. Management views the purpose of internal auditing as an independent
examination and assessment of Company activities related to compliance with policy, procedures and the law as well as the safeguarding of assets.


The Audit Committee
of the Board of Directors consists of five independent directors who meet with the Companys senior financial personnel, internal auditors and independent accountants. They report their findings to the Board of Directors and recommend a firm of
independent accountants.


The Companys independent accountants, PricewaterhouseCoopers LLP, are engaged to conduct an independent audit of the Companys
financial statements in accordance with auditing standards generally accepted in the United States of America. Their audit includes obtaining a sufficient understanding of the internal control structure to establish a basis for reliance thereon in
determining the nature, extent and timing of the tests applied in the audit of the financial statements. Their opinion on the fairness of the reported operating results, cash flows and financial condition appears below.





/s/    ELLEN C. WOLFEllen C. Wolf Vice President and Chief Financial Officer





February 4, 2002





---

Report of Independent Accountants





To the Stockholders and Board of
Directors of


American Water Works Company, Inc.





In our opinion, the accompanying
consolidated balance sheets and the related consolidated statements of income and comprehensive income and of retained earnings, of cash flows, of capitalization and of common stockholders equity present fairly, in all material respects, the
financial position of American Water Works Company, Inc. and Subsidiary Companies at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity
with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Companys management; our responsibility is to express an opinion on these financial statements based on our
audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.





LOGO


Philadelphia, Pennsylvania





February 4, 2002




21




---




---

Consolidated Balance Sheet





(Dollars in thousands)





At December 31,

2001


2000AssetsProperty, plant and equipmentUtility plantat original cost less accumulated depreciation

$
5,458,909


$
5,202,833Utility plant acquisition adjustments, net


68,916



75,294Nonutility property, net of accumulated depreciation


94,149



37,831Excess of cost of investments in subsidiaries over book equity at acquisition, net


20,715



24,103Total property, plant and equipment


5,642,689



5,340,061Current assetsCash and cash equivalents


19,691



28,571Customer accounts receivable


153,142



103,975Allowance for uncollectible accounts


(7,660
)


(2,575
)Unbilled revenues


86,065



83,878Miscellaneous receivables


16,483



15,117Materials and supplies


32,281



20,683Deferred vacation pay


11,422



10,923Restricted funds


224



224Other


18,940



16,900Total current assets


330,588



277,696Regulatory and other long-term assetsRegulatory assetincome taxes recoverable through rates


217,330



216,652Other investments


39,956



73,997Debt and preferred stock expense


45,882



47,630Deferred pension expense


30,712



23,479Deferred postretirement benefit expense


9,318



10,129Deferred security costs


7,058



Deferred business services project expenses


36,311



4,796Deferred tank painting costs


16,585



16,829Restricted funds


8,570



8,343Goodwill


115,773



31,487Intangible assets


23,400



Other


82,927



83,699Total regulatory and other long-term assets


633,822



517,041Total assets

$
6,607,099


$
6,134,798




22




---




American Water Works Company, Inc. and Subsidiary Companies





---







2001

2000Capitalization and LiabilitiesCapitalizationCommon stockholders equity

$
1,758,018

$
1,669,677Preferred stocks called for redemption


11,673


11,673Preferred stocks of subsidiaries with mandatory redemption requirements


30,474


32,902Preferred stocks of subsidiaries without mandatory redemption requirements


7,268


8,118Long-term debtAmerican Water Works Company, Inc.


297,000


159,000Subsidiaries


2,253,019


2,112,165Total capitalization


4,357,452


3,993,535Current liabilitiesShort-term debt


414,083


412,179Current portion of long-term debt


166,087


161,395Accounts payable


67,996


52,447Taxes accrued, including federal income


21,756


25,960Interest accrued


43,015


42,641Accrued vacation pay


11,577


11,564Other


100,220


67,865Total current liabilities


824,734


774,051Regulatory and other long-term liabilitiesAdvances for construction


230,801


216,125Deferred income taxes


624,449


605,343Deferred investment tax credits


38,633


40,098Accrued pension expense


62,355


50,414Accrued postretirement benefit expense


13,808


13,930Other


41,007


37,823Total regulatory and other long-term liabilities


1,011,053


963,733Contributions in aid of construction


413,860


403,479Commitments and contingencies





Total capitalization and liabilities

$
6,607,099

$
6,134,798





The accompanying notes are an integral part of these financial statements.




23




---




American Water Works Company, Inc. and Subsidiary Companies





---

Consolidated Statements of Income and Comprehensive Income and of Retained Earnings





(Dollars in thousands, except per share amounts)





For the years ended December 31,

2001


2000


1999Consolidated Income and Comprehensive IncomeOperating revenues

$
1,438,887


$
1,350,590


$
1,260,857Operating expensesOperation and maintenance


664,549



603,305



566,948Depreciation and amortization


185,211



165,888



151,641General taxes


129,533



125,219



122,674979,293



894,412



841,263Operating income


459,594



456,178



419,594Other income (deductions)Interest


(192,522
)


(191,783
)


(178,215
)Allowance for other funds used during construction


4,905



7,804



11,849Allowance for borrowed funds used during construction


4,043



5,891



10,577Amortization of debt expense


(2,763
)


(2,770
)


(2,754
)Preferred dividends of subsidiaries


(2,985
)


(3,165
)


(3,311
)RWE and NEI merger related costs


(9,992
)






(20,535
)Gain from sale of Salisbury system


4,820







Other, net


6,707



(5,788
)


(6,856
)(187,787
)


(189,811
)


(189,245
)Income before income taxes


271,807



266,367



230,349Provision for income taxes


110,324



105,306



91,400Net income


161,483



161,061



138,949Dividends on preferred stocks


584



3,700



3,984Net income to common stock


160,899



157,361



134,965Other comprehensive income (loss), net of taxUnrealized gain (loss) on securities


(16,187
)


(67,158
)


59,323Reclassification adjustment for gain included in net income


(3,158
)






Other comprehensive income (loss), net of tax


(19,345
)


(67,158
)


59,323Comprehensive income

$
141,554


$
90,203


$
194,288Average shares of basic common stock outstanding


99,465



97,988



96,544Earnings per average common share outstanding:Basic

$
1.62


$
1.61


$
1.40Diluted

$
1.61


$
1.61


$
1.40Consolidated Retained EarningsBalance at beginning of year

$
1,069,486


$
1,001,029


$
945,434Add: net income


161,483



161,061



138,949Gain (loss) on treasury stock


801



(801
)


1,231,770



1,161,289



1,084,383Deduct: dividends paidPreferred stock


128



3,244



3,528Preference stock


456



456



456Common stock$.94 per share in 2001, $.90 per share in 2000, $.86 per share in 1999


93,414



88,103



76,479National Enterprises Inc. common stock










2,89193,998



91,803



83,354Balance at end of year

$
1,137,772


$
1,069,486


$
1,001,029





The accompanying notes are an integral part of these financial statements.




24




---




American Water Works Company, Inc. and Subsidiary Companies





---

Consolidated Statement of Cash Flows





(Dollars in thousands)





For the years ended December 31,

2001


2000


1999Cash Flows from Operating ActivitiesNet income

$
161,483


$
161,061


$
138,949AdjustmentsDepreciation and amortization


185,211



165,888



151,641Provision for deferred income taxes


30,980



27,431



31,411Provision for losses on accounts receivable


10,582



8,608



7,731Allowance for other funds used during construction


(4,905
)


(7,804
)


(11,849
)Gain from sales of assets


(14,124
)


(3,713
)


(1,595
)Employee stock plan expenses


4,808



3,330



5,185Employee benefit expenses greater (less) than funding


(49
)


(1,698
)


4,217Deferred regulatory costs


(44,415
)


(9,882
)


(5,373
)Amortization of deferred charges


15,986



10,671



13,985Other, net


1,094



(2,492
)


243Changes in assets and liabilities, net of effects from acquisitionsAccounts receivable


(31,963
)


(24,169
)


(10,934
)Unbilled revenues


(2,187
)


(5,114
)


(2,262
)Other current assets


(1,125
)


(5,370
)


(1,978
)Accounts payable


4,907



(14,644
)


(3,150
)Taxes accrued, including federal income


(4,759
)


9,423



(8,751
)Interest accrued


374



(1,031
)


1,809Other current liabilities


15,714



(7,349
)


20,113Net cash from operating activities


327,612



303,146



329,392Cash Flows from Investing ActivitiesCapital expenditures


(380,656
)


(377,217
)


(467,351
)Allowance for other funds used during construction


4,905



7,804



11,849Acquisitions


(214,378
)


(51,821
)


(41,764
)Proceeds from the sale of assets


23,745



6,827



2,703Removal costs from property, plant and equipment retirements


(16,639
)


(14,309
)


(15,409
)Restricted funds


(227
)


12,548



1,737Net cash used in investing activities


(583,250
)


(416,168
)


(508,235
)Cash Flows from Financing ActivitiesProceeds from long-term debt


457,997



47,908



128,332Proceeds from common stock, net of issuance costs


36,082



33,304



36,617Net borrowings (repayments) under short-term debt agreements


1,904



172,315



150,024Advances and contributions for construction, net of refunds


32,348



31,565



43,121Debt issuance costs


(1,114
)


(2,262
)


(5,376
)Repayment of long-term debt


(182,251
)


(46,800
)


(82,830
)Redemption of preferred stocks


(3,278
)


(41,118
)


(3,278
)Dividends paid


(93,998
)


(91,803
)


(83,354
)Purchase of common stock for treasury


(932
)


(4,616
)


(1,190
)Net cash from financing activities


246,758



98,493



182,066Net increase (decrease) in cash and cash equivalents


(8,880
)


(14,529
)


3,223Cash and cash equivalents at beginning of year


28,571



43,100



39,877Cash and cash equivalents at end of year

$
19,691


$
28,571


$
43,100Cash paid during the year for:Interest, net of capitalized amount

$
194,462


$
196,841


$
180,475Income taxes

$
87,208


$
78,942


$
69,015





Common stock issued in lieu of cash in connection with the Employee Stock
Ownership Plan, the Savings Plan for Employees and the 2000 Stock Award and Incentive Plan totaled $1,488 in 2000 and $5,428 in 1999. Common stock placed into treasury in connection with the Employee Stock Ownership Plan, the Savings Plan for
Employees and the 2000 Stock Award and Incentive Plan totaled $1,759 in 2001, $4,872 in 2000 and $3,675 in 1999. Capital lease obligations of $503 were recorded in 2001.





The accompanying notes are an integral part of these financial statements.




25




---




---

Consolidated Statement of Capitalization





(Dollars in thousands, except per share amounts)





At December 31,

2001


2000Common Stockholders Equity:Common stock$1.25 par value, authorized 300,000,000 shares,issued 100,016,273 shares in 2001 and 98,819,845 shares in
2000

$
125,020


$
123,525Paid-in capital


489,868



454,568Retained earnings


1,137,772



1,069,486Accumulated other comprehensive income


5,958



25,303Unearned compensation


(539
)


(359
)Treasury stock at cost1,891 shares in 2001 and 129,216 shares in 2000


(61
)


(2,846
)1,758,018



1,669,677At December 31, 2001, common shares reserved for issuance in connection with the Companys
stock plans were 80,865,863 shares for the Stockholder Rights Plan, 1,641,852 shares for the Dividend Reinvestment and Stock Purchase Plan, 565,493 shares for the Employees Stock Ownership Plan and 532,381 shares for the Savings Plan for
Employees. Up to 4,234,367 shares of common stock may be issued under the 2000 Stock Award and Incentive Plan, of which approximately 3,300,000 shares were available to be granted at December 31, 2001.Preferred Stocks With Mandatory Redemption Requirements:Cumulative preferred stock$25 par value, authorized 1,770,000 shares8.5% series (non-voting), outstanding 1,600,000
shares, redeemed at par value on December 1, 2001.






Preferred Stocks Without Mandatory Redemption Requirements:(All shares redeemed March 1, 2002)Cumulative preferred stock$25 par value 5% series (one-tenth of a vote per share), outstanding 101,777 shares


2,544



2,544Cumulative preference stock$25 par value, authorized 750,000 shares 5% series (non-voting), outstanding 365,158
shares


9,129



9,129Cumulative preferential stock$35 par value, authorized 3,000,000 shares (one-tenth of a vote per share) no outstanding
shares






11,673



11,673Preferred Stocks of Subsidiaries:Dividend rate3.9% to less than 5%


4,444



4,6105% to less than 6%


4,637



4,6696% to less than 7%


1,365



1,4557% to less than 8%


3,094



3,9848% to less than 9%


21,250



23,0509% to less than 10%


2,952



3,11210% to less than 11%






14037,742



41,020Preferred stock agreements of certain subsidiaries require annual sinking fund payments in varying
amounts and permit redemption at various prices at the option of the subsidiaries on thirty days notice, or in the event of involuntary liquidation, at par value plus accrued dividends. Sinking fund payments for the next five years will amount to
$707 in 2002, $648 in 2003, $648 in 2004, $648 in 2005 and $647 in 2006.




26




---




American Water Works Company, Inc. and Subsidiary Companies





---




Current Maturities

2001

2000Long-Term Debt of American Water Works Company, Inc.:7.41% Series C debentures, due May 1, 2003

$


$
81,000

$
81,0006.28% Series D debentures, due July 2, 2002


10,000





10,0006.28% Series D debentures, due July 2, 2003





45,000


45,0006.32% Series D debentures, due July 2, 2004





15,000


15,0007.02% Senior Note, due August 1, 2005


2,000


6,000


8,0004.92% Senior Note, due November 6, 2006





150,000


12,000


297,000


159,000Long-Term Debt of Subsidiaries:Interest rate1% to less than 2%


849


25,363


16,9132% to less than 3%


54


63


3% to less than 4%


70


314


3534% to less than 5%


768


155,295


3,5525% to less than 6%


109


487,563


487,9226% to less than 7%


3,479


649,658


513,1827% to less than 8%


116,117


588,571


706,5808% to less than 9%


15,666


99,103


113,2009% to less than 10%


12,557


194,189


214,64610% to less than 11%


3,978


50,371


53,352153,647


2,250,490


2,109,700Capital leases


440


2,529


2,465$
154,087


2,253,019


2,112,165$
4,357,452

$
3,993,535





Maturities of long-term debt of subsidiaries, including sinking fund
requirements, during the next five years will amount to $154,087 in 2002, $82,808 in 2003, $41,539 in 2004, $62,244 in 2005 and $169,329 in 2006.





Long-term debt of subsidiaries is substantially secured by utility plant and by a pledge of certain securities of subsidiaries and affiliates.





The accompanying notes are an integral part of these financial statements.




27




---




---

Consolidated Statement of Common Stockholders Equity





(Dollars in thousands, except per share amounts)





Common Stock

Paid-in


Retained


Accumulated Other Comprehensive


Unearned


Treasury Stock


Common Stockholders EquityShares

Par Value

Capital


Earnings


Income


Compensation


Shares


At CostBalance at December 31, 1998

95,831,790

$
119,789

$
384,255


$
945,434


$
33,138


$
(980
)

800


$
(25
)

$
1,481,611Net income











138,949


















138,949Dividend reinvestment

291,808


365


7,896






















8,261Stock purchase

839,288


1,050


22,714






















23,764Employees stock ownership plan

109,932


137


3,040






















3,177Savings plan for employees

200,153


251


5,699






















5,950Incentive plan

30,788


38


830











(76
)









792Other comprehensive income















59,323














59,323Treasury stock






















108,875



(3,675
)


(3,675
)Dividends:Preferred stocks











(3,984
)

















(3,984
)Common stock











(79,370
)

















(79,370
)Balance at December 31, 1999

97,303,759


121,630


424,434



1,001,029



92,461



(1,056
)

109,675



(3,700
)


1,634,798Net income











161,061


















161,061Dividend reinvestment

389,151


486


8,337






















8,823Stock purchase

1,029,257


1,287


22,256






















23,543Employees stock ownership plan

32,134


40


631






















671Savings plan for employees

65,544


82


1,293






















1,375Incentive plan







(2,383
)










697










(1,686
)Other comprehensive income















(67,158
)













(67,158
)Treasury stock











(801
)









19,541



854



53Dividends:Preferred stocks











(3,700
)

















(3,700
)Common stock











(88,103
)

















(88,103
)Balance at December 31, 2000

98,819,845


123,525


454,568



1,069,486



25,303



(359
)

129,216



(2,846
)


1,669,677Net income











161,483


















161,483Dividend reinvestment

240,350


300


6,963






















7,263Stock purchase

913,894


1,142


26,437






















27,579Employees stock ownership plan






























Savings plan for employees






























Incentive plan

42,184


53


1,187











(180
)









1,060Other comprehensive income















(19,345
)













(19,345
)Treasury stock







713



801










(127,325
)


2,785



4,299Dividends:Preferred stocks











(584
)

















(584
)Common stock











(93,414
)

















(93,414
)Balance at December 31, 2001

100,016,273

$
125,020

$
489,868


$
1,137,772


$
5,958


$
(539
)

1,891


$
(61
)

$
1,758,018





The accompanying notes are an integral part of these financial statements.




28




---




American Water Works Company, Inc. and Subsidiary Companies





---

Notes to Financial Statements





(Dollars in thousands, except per share amounts)





Note 1: Organization and Operation


American Water Works Company, Inc. through its regulated and unregulated subsidiaries provides water and wastewater service in 28 states and three Canadian Provinces. As public utilities, the regulated subsidiaries
function under rules and regulations prescribed by state regulatory commissions. The Company provides water and wastewater management services through its unregulated subsidiary, American Water Services. This subsidiary had been operated as a joint
venture until December 31, 1999 when the Company acquired its partners interest (see AmericanAnglian Environmental Technologies in Note 4). In addition, American Water Resources is a wholly-owned subsidiary whose function is to primarily
invest in water and wastewater related products and services.


The Company has identified Regulated Utility Services and Unregulated Services as its two reportable
segments. Prior to the November 2001 acquisition of Azurix North America and Azurix Industrials Corp. (see Azurix North America and Azurix Industrials in Note 4) the Companys unregulated operations had not been reflected as a reportable
segment due to their limited scope and impact on the financial results of the Company.





Note 2: Significant Accounting Policies


Principles of Consolidation


The consolidated financial statements include the accounts of the parent company and all of its subsidiaries.
Intercompany accounts and transactions are eliminated in consolidation. Prior to January 1, 2000 the results of operations of the Companys former AmericanAnglian Environmental Technologies joint venture were accounted for under the equity
method of accounting. The operating results of Azurix North America and Azurix Industrials Corp. have been included in the consolidated statement of income since the completion of the acquisition on November 7, 2001.





Use of Estimates


The preparation of financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.





Regulation


The utility subsidiaries have incurred various costs and received various credits which have been reflected as regulatory assets and liabilities on the Companys consolidated balance sheet. Accounting
for such costs and credits as regulatory assets and liabilities is in accordance with Statement of Financial Accounting Standards No. 71 Accounting for the Effects of Certain Types of Regulation (SFAS 71). This statement sets forth the
application of generally accepted accounting principles for those companies whose rates are established by or are subject to approval by an independent third-party regulator. Under SFAS 71, utility companies defer costs and credits on the balance
sheet as regulatory assets and liabilities when it is probable that those costs and credits will be recognized in the rate making process in a period different from the period in which they would have been reflected in income by an unregulated
company. These deferred regulatory assets and liabilities are then reflected in the income statement in the period in which the same amounts are reflected in the rates charged for service.





Property, Plant and Equipment


Additions to utility plant and replacements of retirement units of property are capitalized. Costs include
material, direct labor and such indirect items as engineering and supervision, payroll taxes and benefits, transportation and an allowance for funds used during construction. The costs incurred to acquire and internally develop computer software for
internal use are capitalized as a unit of property. Repairs, maintenance and minor replacements of property are charged to current operations. The cost of property units retired in the ordinary course of business plus removal cost (less salvage) is
charged to accumulated depreciation. The cost of property, plant and equipment is generally depreciated using the straight-line method over the estimated service lives of the assets. The depreciation rates, based on the average balance of
depreciable property, were 2.64% in 2001, 2.54% in 2000 and 2.51% in 1999.


Nonutility property consists primarily of buildings and equipment utilized by American Water
Works Service Company which provides various services to affiliated companies and by American Water Services in its unregulated management services business. This property is stated at cost, net of accumulated depreciation calculated using the
straight-line method over the estimated useful lives of the assets.


Utility plant acquisition adjustments include the difference between the purchase price of utility
plant and its original cost (less accumulated depreciation) and are generally being amortized over a period of 40 years.


The excess of cost of investments in
subsidiaries is primarily attributable to various acquisitions of utility subsidiaries that occurred prior to October 31, 1970, that are not being amortized because, in the opinion of management, there has been no diminution in value.





Cash and Cash Equivalents


Substantially all of the Companys cash is invested in interest bearing
accounts. The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents consist primarily of investment grade commercial paper, bank certificates of deposit and
United States Government securities. Cash equivalents are stated at cost plus accrued interest which approximates market value.





Materials and
Supplies


Materials and supplies are stated at the lower of average purchased cost and net realizable value.





Regulatory Assets


The Company has recorded a regulatory asset for the additional revenues expected to be realized as the tax effects of




29




---




---

Notes to Financial Statements





(Dollars in thousands, except per share amounts)





temporary differences
previously flowed through to customers reverse. These temporary differences are primarily related to the difference between book and tax depreciation on property placed in service before the adoption by the regulatory authorities of full
normalization for rate making purposes.


The regulatory asset for income taxes recoverable through rates is net of the reduction expected in future revenues as deferred
taxes previously provided, attributable to the difference between the state and federal income tax rates under prior law and the current statutory rates, reverse over the average remaining service lives of the related assets.


Debt expense is amortized over the lives of the respective issues. Call premiums on the redemption of long-term debt, as well as unamortized debt expense, are deferred and amortized to
the extent they will be recovered through future service rates. Expenses of preferred stock issues without sinking fund provisions are amortized over 30 years from date of issue; expenses of issues with sinking fund provisions are charged to
operations as shares are retired.


Pension expense in excess of the amount contributed to the pension plans is deferred by certain subsidiaries. These costs will be
recovered in future service rates as contributions are made to the pension plan.


Postretirement benefit expense in excess of the amount recovered in rates through 1997
has been deferred by certain subsidiaries. These costs are now recognized in the rates charged for water service and will be fully recovered over a 20-year period ending in 2012 as authorized by the regulatory authorities.


Deferred treatment plant costs consist of operating expenses, including depreciation and property taxes, and the carrying charges associated with several water treatment plants and
related facilities from the time the assets were placed in service until recovery of such costs is allowed in future service rates. These costs have been recognized in the rates charged for water service and are being amortized over a 10-year period
as authorized by the regulatory authorities.


Deferred business services project expenses consist of reengineering and start-up activities for consolidated customer and
shared administrative service centers that began operations in 2001. These costs are being deferred as it is expected that these costs will be recovered in the rates charged for utility service in the future.


The Company has deferred the cost of additional security measures that were implemented to protect facilities after the terrorist attacks on September 11, 2001. These costs are being
deferred as it is expected that these costs will be recovered in the rates charged for utility service in the future.


Tank painting costs are generally deferred and
amortized to current operations on a straight-line basis over periods ranging from 4 to 20 years, as authorized by the regulatory authorities in their determination of rates charged for service.





Intangible Assets and Goodwill


Intangible assets and goodwill are associated with acquisitions made by American Water Services, the
Companys management services subsidiary. The intangible assets are management contracts with a life of approximately 11 years that were acquired in the acquisition of Azurix North America and Azurix Industrials Corp. that was completed on
November 7, 2001 and the acquisition of a former joint venture partners interest in EA2 Systems that was completed on September 20, 2001. $81,484 and $4,459 of the goodwill is associated with the Azurix and EA2 acquisitions respectively, and
the remaining $29,830 of goodwill is associated with the Companys December 31, 1999 acquisition of its joint venture partners interest in AmericanAnglian Environmental Technologies. In accordance with the provisions of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets (see New Accounting Standards on page 32, the goodwill associated with the Azurix and EA2 acquisitions is not being amortized and the goodwill associated with the
AmericanAnglian acquisition will no longer be amortized after December 31, 2001. The annual amortization of the tax deductible goodwill on the AmericanAnglian acquisition had been $1,657 and is deductible for tax purposes.





Other Investments and Accumulated Other Comprehensive Income


Other investments include primarily equity
securities of publicly and privately held companies. Investments in publicly traded securities are classified as available for sale and are recorded in the balance sheet at fair market value with the change in market value, net of the tax effect,
recorded as part of other comprehensive income. The cost basis of these publicly traded securities is $21,692 and the fair value of these investments is determined using quoted market prices. Investments in privately held companies are carried at
cost. The principal publicly traded investments are approximately 1,300,000 shares of Deutsche Telekom (NYSE:DT), 50,000 shares of SJW Corp. (AMEX: SJW) and 4,000,000 shares of ITC/\ DeltaCom, Inc. (NASDQ: ITCD). In 2001 a gain of $5,177 and related
tax expense of $2,019 were recognized on the sale of a portion of the Companys investment in Deutsche Telekom. The Company did not sell any of these securities during 2000 and 1999.


The components of accumulated other comprehensive income balances at December 31 are as follows:





2001


2000


1999Beginning balance

$
25,303


$
92,461


$
33,138Unrealized gains (losses) on securities


(32,684
)


(113,552
)


102,604Income taxes on other comprehensive income


13,0339



46,394



(43,281
)Ending balance

$
5,958


$
25,303


$
92,461





The Company also has equity investments in ITC Holding Company, Inc., and United
States Sugar Corporation. The cost basis of these securities, that are not publicly traded, was $9,554 at December 31, 2001.





Other Current
Liabilities


Other current liabilities at December 31, 2001 and 2000 include payables to banks of $29,076 and $17,288 respectively, which represent checks issued but not presented to banks
for payment, net of the related bank balance.




30




---




American Water Works Company, Inc. and Subsidiary Companies





---




Advances and Contributions in Aid of Construction


Utility subsidiaries may receive advances and contributions to fund construction necessary to extend service to new areas. As determined by the regulatory authorities, advances for construction are refundable for
limited periods of time as new customers begin to receive service. Amounts which are no longer refundable are reclassified to contributions in aid of construction. Utility plant funded by advances and contributions is excluded from rate base and is
generally not depreciated for rate making purposes. Generally, advances and contributions received during the period January 1, 1987 through June 12, 1996 have been included in taxable income and the related property is depreciable for tax purposes.
As a result of a tax law change, advances and contributions received subsequent to June 12, 1996 are excluded from taxable income and the related property is not depreciable for tax purposes.


On January 11, 2001 the Internal Revenue Service issued regulations that excluded lateral service lines from its definition of contributions in aid of construction that are not included in taxable income. These
customer connection fees are defined as the cost of installing a connection or service line from the Companys main lines to the lines owned by the customer. The regulations were effective immediately, and the Company is now paying tax on money
or property received for these connections.





Recognition of Revenues


Revenues of the
regulated utility subsidiaries include amounts billed to customers on a cycle basis and unbilled amounts based on estimated usage from the date of the latest meter reading to the end of the accounting period.


Revenue from American Water Services residuals management, underground infrastructure development, engineering and large multi-year operations and maintenance contracts is
recognized over the contract term based on the estimated percentage of services provided during the period compared to the total estimated services to be provided over the entire contract. Losses on contracts are recognized during the period in
which the loss first becomes known. Revenue recognized in excess of billings on service contracts are recorded as unbilled revenue. Billings in excess of revenues recognized on service contracts are recorded as a liability on the Companys
balance sheet until the above revenue recognition criteria are met. Changes in contract performance and related estimated contract profitability may result in revisions to costs and revenues and are recognized in the period in which revisions are
determined. For other water and wastewater treatment contracts and for time and material contracts, revenue is recognized as services are provided.





Income Taxes


Certain income and expense items are accounted for in different time periods for financial reporting than for income tax reporting purposes. Deferred income taxes
have been provided on the difference between the tax bases of assets and liabilities and the amounts at which they are carried in the financial statements. These deferred income taxes are based on the enacted tax rates to be in effect when such
temporary differences are expected to reverse. The utility subsidiaries also recognize regulatory assets and liabilities for the effect on revenues expected to be realized as the tax effects of temporary differences previously flowed through to
customers reverse.


Investment tax credits have been deferred by the utility subsidiaries and are being amortized to income over the average estimated service lives of
the related assets.





Allowance For Funds Used During Construction (AFUDC)


AFUDC is a
non-cash credit to income with a corresponding charge to utility plant which represents the cost of borrowed funds and a return on equity funds devoted to plant under construction. The utility subsidiaries record AFUDC to the extent permitted by the
regulatory authorities.





Environmental Costs


Environmental expenditures that relate to
current operations or provide a future benefit are expensed or capitalized as appropriate. Remediation costs that relate to an existing condition caused by past operations are accrued when it is probable that these costs will be incurred and can be
reasonably estimated.





Asset Impairment


Long-lived assets and certain identifiable
intangible assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets, on a separate entity basis, may not be recoverable. If the sum of the future cash
flows expected to result from the use of the assets and their eventual disposition is less than the carrying amount of the assets, an impairment loss is recognized. Measurement of an impairment loss is based on the fair value of the assets. A
regulatory asset is charged to earnings if and when future recovery in rates of that asset is no longer probable.





Earnings Per Share


The average number of shares used to calculate diluted earnings per share includes 14,142; 4,784 and 51,837 of potential common shares issuable in connection with the long-term incentive
program in 2001, 2000, and 1999, respectively, and 163,414 and 45,227 potential common shares for employee stock options in 2001 and 2000, respectively (see Note 9).





New Accounting Standards





| |  | Accounting for Derivative Instruments and Hedging Activities
|- |  | ------------------------------------------------------------

On January 1, 2001, the Company
adopted Statement of Financial Accounting Standards No. 133 Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended. This statement establishes accounting and reporting standards for derivative instruments and
hedging activities. SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. This new accounting standard did not have any effect
on the Companys financial position or results of operations. The Companys contracts that meet the definition of a derivative are for normal




31




---




---

Notes to Financial Statements





(Dollars in thousands, except per share amounts)





purchases and normal
sales, are expected to result in a physical delivery, and are of quantities expected to be used or sold over a reasonable period in the normal course of business. The Company has no hedging activities.





| |  | Business Combinations/Goodwill and Other Intangible Assets
|- |  | ----------------------------------------------------------

In June 2001, the Financial
Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations (SFAS 141) and No. 142, Goodwill and Other Intangible Assets (SFAS 142), collectively referred to as the
Standards. SFAS 141 supersedes Accounting Principles Board Opinion (APB) No. 16, Business Combinations. The provisions of SFAS 141 (1) require that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001, (2) provide specific criteria for the initial recognition and measurement of intangible assets apart from goodwill, and (3) require that unamortized negative goodwill be written off immediately as an extraordinary gain
instead of being deferred and amortized. SFAS 141 also requires that upon adoption of SFAS 142 the Company reclassify the carrying amounts of certain intangible assets into or out of goodwill, based on certain criteria. SFAS 142 supersedes APB 17,
Intangible Assets, and is effective for fiscal years beginning after December 15, 2001. SFAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. The provisions of SFAS 142
(1) prohibit the amortization of goodwill and indefinite-lived intangible assets, (2) require that goodwill and indefinite-lived intangible assets be tested annually for impairment (and in interim periods if certain events occur indicating that the
carrying value of goodwill and/or indefinite-lived intangible assets may be impaired), (3) require that reporting units be identified for the purpose of assessing potential future impairments of goodwill, and (4) remove the forty-year limitation on
the amortization period of intangible assets that have finite lives.


The provisions of the Standards also apply to equity-method investments made both before and after
June 30, 2001. SFAS 141 requires that the unamortized deferred credit related to an excess over cost arising from an investment that was accounted for using the equity method (equity-method negative goodwill), and that was acquired before July 1,
2001, must be written-off immediately and recognized as the cumulative effect of a change in accounting principle. Equity-method negative goodwill arising from equity investments made after June 30, 2001 must be written-off immediately and recorded
as an extraordinary gain, instead of being deferred and amortized. SFAS 142 prohibits amortization of the excess of cost over the underlying equity in the net assets of an equity-method investee that is recognized as goodwill.


The Company will adopt the provisions of SFAS 142 in its first quarter ended March 31, 2002. The Company is in the process of preparing for its adoption of SFAS 142 and is making the
determinations as to what its reporting units are and what amounts of goodwill, intangible assets, other assets and liabilities should be allocated to those reporting units. The Company expects that it will no longer record $1,657 of annual tax
deductible amortization relating to its existing goodwill associated with the 1999 acquisition of its joint venture partners interest in AmericanAnglian Environmental Technologies.


SFAS 142 requires that goodwill be tested annually for impairment using a two-step process. The first step is to identify a potential impairment and, in transition, this step must be measured as of the beginning of
the fiscal year. However, a company has six months from the date of adoption to complete the first step. The Company expects to complete that first step of the goodwill impairment test during the second quarter of 2002. The second step of the
goodwill impairment test measures the amount of the impairment loss (measured as of the beginning of the year of adoption), if any, and must be completed by the end of the Companys fiscal year. Intangible assets deemed to have an indefinite
life will be tested for impairment using a one-step process which compares the fair value to the carrying amount of the asset as of the beginning of the fiscal year, and pursuant to the requirements of SFAS 142 will be completed during the first
quarter of 2002. Any impairment loss resulting from the transitional impairment tests will be reflected as the cumulative effect of a change in accounting principle in the first quarter of 2002. The Company has not yet determined what effect these
impairment tests will have on the Companys earnings and financial position.





| |  | Accounting for Asset Retirement Obligations
|- |  | -------------------------------------------

In June of 2001, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, (SFAS 143) on the accounting for obligations associated with the retirement of long-lived assets. SFAS 143 requires
a liability to be recognized in the financial statements for retirement obligations meeting specific criteria. Measurement of the initial obligation is to approximate fair value with an equivalent amount recorded as an increase in the value of the
capitalized asset. The asset will be depreciable in accordance with normal depreciation policy and the liability will be increased, with a charge to the income statement, until the obligation is settled. SFAS 143 is effective for fiscal years
beginning after June 15, 2002. The Company is currently evaluating the effects that adoption of the provisions of SFAS 143 will have on its results of operations and financial position but does not expect them to be material.





| |  | Accounting for the Impairment or Disposal of Long-Lived Assets
|- |  | --------------------------------------------------------------

In August of 2001, the
Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (SFAS 144) that replaces Statement of Financial Accounting Standards No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. SFAS 144 requires that one accounting model be used for long-lived assets to be disposed of by sale and broadens discontinued operations
to include more disposal transactions. Under SFAS 144, operating losses of discontinued operations are recognized in the period in which they occur,




32




---




American Water Works Company, Inc. and Subsidiary Companies





---




instead of accruing future operating losses before they occur. SFAS 144 is effective for fiscal
years beginning after December 15, 2001. The Company is currently evaluating the effects that adoption of the provisions of SFAS 144 will have on its results of operations and financial position but does not expect them to be material.





Reclassification


Certain reclassifications have been made to conform previously reported data to the
current presentation.





Note 3: Merger Agreement with RWE


On September 16, 2001 the
Company entered into a merger agreement with RWE Aktiengesellschaft and Thames Water Aqua Holdings GmbH, which is RWEs holding company for its global water business, to merge with a subsidiary of RWE and become a wholly owned indirect
subsidiary of RWE. Under the terms of the merger agreement RWE will purchase all the outstanding shares of American Water Works Company common stock at a price of $46.00 per share in cash.


RWE is a global multi-utility company that does business through its subsidiaries and affiliates in over 120 countries. Its core businesses are electricity, gas, water, and waste and recycling. Upon completion of the
transaction, American Water will be combined with the U.S. operations of Thames Water Plc, RWEs London-based international water services business. American Water will manage the joint operations in North, Central and South America.


The transaction was approved at a special meeting of the stockholders of American Water Works Company on January 17, 2002. Before the transaction can be completed,
state and federal regulatory approvals are required. As of the end of January 2002, all of the applications for approval were filed where required by state regulatory authorities. The states where applications for approval have been filed are
Arizona, California, Hawaii, Illinois, Kentucky, Maryland, New Jersey, New Mexico, New York, Pennsylvania, Tennessee, Virginia and West Virginia. Approval of the state public utility agencies in Georgia, Indiana, Iowa, Michigan, Missouri, Ohio and
Texas is not required. Regulatory approval has not been requested in Connecticut, Massachusetts and New Hampshire since the sale of these operations is pending. On February 4, 2002, the Tennessee Regulatory Authority approved the transaction. As a
result of the time required to complete the approval process by the various regulatory agencies, the Company does not anticipate completion of the merger until the first half of 2003.


During 2001 the Company recorded a charge of $9,992 reflecting costs incurred in connection with the merger. The merger related costs have been reported on a separate line in the consolidated statement of income and
comprehensive income. No tax benefit was recognized for these investment banking and legal fees because it is not probable that these costs will be deductible for tax purposes.


On November 6, 2001 the Company and its financing subsidiary, American Water Capital Corp., executed a Note Purchase Agreement with RWE for up to $1,200,000 in senior unsecured notes at an interest rate of 4.92%. The notes were purchased at
par by RWE and mature on November 6, 2006.


The Company and its subsidiaries used the proceeds from the sale of the notes to acquire the common stock of Azurix North
America and Azurix Industrials, to fund the acquisition of the water and wastewater assets of Citizens Communications Company and to reduce outstanding short-term debt. Closing occurred in two tranches one on November 6, 2001 in the amount of
$298,500 and another on January 14, 2002 in the amount of $900,000.





Note 4: Acquisitions and Divestitures


Water and Wastewater Assets of Citizens Communications Company


On January 15, 2002 the Company and its subsidiaries completed their acquisition of all of
the water and wastewater assets of Citizens Communications Company (NYSE: CZN) for $859,000 in cash and $120,000 of assumed liabilities. The purchase price is subject to adjustment upon the completion of an audited closing statement of net assets.
The acquired operations provide water and wastewater service to 342,000 customers in Arizona, California, Illinois, Indiana, Ohio and Pennsylvania. Citizens also had developed a water supply project in Illinois with the possibility of additional
wholesale customers along the pipeline. For the latest fiscal year ended December 31, 2001, the operations being acquired had revenues of $140,000.


The purchase price
for these assets was consistent with the multiples paid in other similar transactions. The Company is in the process of obtaining third-party valuations of these assets, and thus has not completed the allocation of the purchase price.





National Enterprises Inc.


On June 25, 1999, the Company completed the acquisition of National
Enterprises Inc., a privately owned company, in a transaction valued at $700,000. The transaction was accomplished through a tax free exchange of 14,937,000 shares of the Companys stock for all of the outstanding shares of National Enterprises
and the assumption of $241,000 of debt. Subsidiaries of National Enterprises provided water service to approximately 504,000 customers in Missouri, Illinois, Indiana and New York. National Enterprises also had passive investments in the
telecommunications industry.


This business combination has been accounted for as a pooling of interests and, accordingly, the consolidated financial statements for
periods prior to the combination were restated to include the accounts and results of operations of National Enterprises.


During 1999 the Company recorded a charge of
$20,535 and related tax benefits of $7,630 reflecting the one-time costs incurred in connection with the merger. The merger related costs consist primarily of severance costs as well as vesting of certain benefits and other tax deductible costs. The
merger related costs have been reported on a separate line in the consolidated statement of income and comprehensive income.





Azurix North America And
Azurix Industrials


On November 7, 2001 the Company completed its acquisition of Azurix North America Corp. and Azurix Industrials Corp.




33




---




---

Notes to Financial Statements





(Dollars in thousands, except per share amounts)





for $153,300 in cash and
assumption of $6,500 of debt. Azurix North America and Azurix Industrials were wholly-owned subsidiaries of Azurix Corp. and provide a range of water and wastewater services, including operations and maintenance, engineering, carbon regeneration,
underground infrastructure rehabilitation and residuals management. Azurix North America and Azurix Industrials had revenues totaling approximately $134,000 in 2001.


This transaction enables the Company to offer a comprehensive portfolio of quality water management services to municipal and industrial customers. The acquisition also expands the Companys presence into the southeastern and
northwestern U.S. and three Canadian provinces.


The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of
the acquisition. The Company is in the process of completing valuations of these assets so the allocation of the purchase price is subject to refinement.





November 7, 2001Current assets

$
44,900Property, plant, and equipment


46,700Other long-term assets


4,700Intangible assets


22,300Goodwill


73,800Total assets acquired


192,400Current liabilities


(32,600)Long-term debt


(6,500)Total liabilities assumed


(39,100)Net assets acquired

$
153,300





The $22,300 of acquired intangible assets are assigned to management contracts
that have an 11-year life.





Water Utility Subsidiaries of United Water Resources Inc.


On
May 31, 2000, the Company completed its acquisition of five water utilities in Missouri, Indiana, Illinois and Virginia from United Water Resources Inc. for approximately $50,000 in cash. These water utilities provide service to 35,000 customers.





City of Coatesville Pennsylvania Water and Wastewater Systems


On March 22, 2001 the
Companys subsidiary in Pennsylva-nia completed the purchase of the City of Coatesville Authoritys water and wastewater utility systems for $48,200 million in cash. These systems provide water service to 8,600 customers and wastewater
service to 6,500 customers.





AmericanAnglian Environmental Technologies


On December 31,
1999, the Company finalized the purchase of its joint venture partner Anglian Waters interest in AmericanAnglian Environmental Technologies for $32,000 in cash. This business had revenues of approximately $31,000 in 1999.





New England Operations


On August 30, 2001 the Company and Kelda Group plc jointly announced that they
had reached an agreement whereby Keldas Aquarion Company subsidiary would acquire the Companys New England operations. The transaction price is approximately $118 million in cash plus the assumption of $115 million in debt. The
subsidiaries being sold serve a total of 65,000 customers and had revenues of $51 million in 2001. The sale, which is subject to regulatory approval is expected to be consummated during the second quarter of 2002.





Town of Salisbury Massachusetts Operating System


On September 28, 2001 the Company completed the sale under
threat of condemnation of its Salisbury Water Supply Companys operating system to the Town of Salisbury, Massachusetts for $11,500 in cash plus outstanding accounts receivables. The Salisbury system serves 3,000 customers and had annual
revenues of $1,900.





Note 5: Utility Plant


The components of utility plant by category at
December 31 are as follows:





2001

2000Water plantSources of supply

$
301,875

$
287,892Treatment and pumping


1,521,214


1,467,320Transmission and distribution


3,106,076


2,935,265Services, meters and fire hydrants


1,126,589


1,062,997General structures and equipment


564,664


476,632Wastewater plant


100,586


81,716Construction work in progress


156,029


167,3976,877,033


6,479,219Less-accumulated depreciation


1,418,124


1,276,386$
5,458,909

$
5,202,833





Note 6: Dividend Reinvestment and Stock Purchase Plan


Until September 17, 2001 the Companys Dividend Reinvestment and Stock Purchase Plan provided for optional cash purchases of newly issued common stock of the Company. In addition to permitting record holders of
common stock to have all or part of their dividends automatically reinvested in additional shares of common stock, the plan permitted stockholders to purchase up to five thousand dollars of common stock each month directly from the Company. This
plan was suspended in connection with the anticipated merger with RWE.





Note 7: Shareholders Rights Plan


On June 1, 2000 the Company announced that it had amended its Shareholder Rights Agreement. The Agreement provides for certain consequences if more than a stated percentage of the Companys common stock is
acquired by any person or group of persons without prior consent of the Companys Board of Directors. The amendment lowered that percentage, and the percentage of ownership that triggers the dilutive effect of the rights issued under the
Agreement, to 10% of the Companys outstanding common shares.




34




---




American Water Works Company, Inc. and Subsidiary Companies





---




Each Right under the amended plan entitles shareholders to buy one
share of the Companys common stock at an exercise price of $150. Each Right entitles its holder to purchase, at the Rights then-current exercise price, shares of the Companys common stock, or a number of shares of an acquiring
companys stock, which would have a market value of two times the exercise price. The Rights become exercisable if there is a public announcement that a person or group acquires, or commences a tender offer to acquire, 10% or more of the
outstanding shares of the Company. The Rights also become exercisable if the Company is acquired in a merger or a person or group acquires 10% or more of the outstanding shares of the Company.


The Rights are redeemable, in whole, but not in part, by the Company at a price of $.0005 per Right under certain circumstances. The Rights do not have voting or dividend rights and, until they become exercisable,
have no dilutive effect on the earnings per share of the Company.


In accordance with the RWE merger agreement, as of September 16, 2001, the Company amended the rights
agreement to provide that none of the approval, execution, delivery or performance of the merger agreement or the voting agreement or the completion of the transactions contemplated thereby will cause the rights under the rights agreement to be
adjusted or become exercisable. The amendment also provides that the rights will terminate immediately prior to the completion of the merger.





Note 8:
Employee Benefits


Pension and Other Postretirement Benefits


The Company maintains noncontributory defined benefit pension
plans covering substantially all associates employed in its regulated utility and shared services operations. Benefits under the plans are based on the associates years of service and compensation. The Companys funding policy is to
contribute at least the minimum amount required by the Employee Retirement Income Security Act of 1974. Pension plan assets are invested in a number of investments including equity mutual funds, United States Government securities, guaranteed
interest contracts with a major insurance company and publicly traded bonds.


The Company realized a $16,574 settlement gain in 2000 in connection with the purchase of
non-participating annuity contracts to cover vested benefits of certain retirees. These benefits had previously been provided through an immediate participation guarantee contract.


Pension expense in excess of the amount contributed to the pension plans is deferred by certain regulated subsidiaries pending future recovery in rates charged for water services as contributions are made to the plans
(see Regulatory Assets in Note 2). These subsidiaries have recorded their $12,742 portion of the settlement gain as a reduction of the regulatory asset. The remaining $3,832 of the settlement gain was recognized as pension income in 2000.


The Company also has several unfunded noncontributory supplemental non-qualified pension plans that provide additional retirement benefits to certain associates of the
Company and its subsidiaries.


The Company maintains postretirement benefit plans providing varying levels of medical and life insurance to eligible retirees. The
adoption of a new accounting standard for other postretirement benefits caused a transition obligation of $143,391 at January 1, 1993 which is being amortized over 20 years. The Companys policy is to fund postretirement benefit costs accrued.
Plan assets are invested in equity and bond mutual funds.





Pension Benefits


Other Postretirement Benefits2001


2000


2001


2000Change in benefit obligationBenefit obligation at January 1

$
423,463


$
548,074


$
240,193


$
204,441Service cost


15,963



14,198



7,391



6,728Interest cost


32,663



39,952



17,293



16,455Plan participants contributions










916



1,080Amendments


325







(10,389
)


637Actuarial (gain) loss


13,954



51,057



15,734



20,864Acquisitions






374







1,035Settlement






(212,660
)






Benefits paid


(9,609
)


(17,532
)


(11,024
)


(11,047
)Benefit obligation at December 31

$
476,759


$
423,463


$
260,114


$
240,193Change in Plan AssetsFair value of plan assets at January 1

$
380,773


$
598,302


$
150,347


$
148,014Actual return on plan assets


(6,406
)


7,404



(7,369
)


(3,341
)Employer contribution


1,172



1,109



18,207



15,641Plan participants contributions










916



1,080Settlement






(212,660
)






Acquisitions






374







Benefits paid


(9,609
)


(17,532
)


(11,024
)


(11,047
)Other






3,776







Fair value of plan assets at December 31

$
365,930


$
380,773


$
151,077


$
150,347Funded status at December 31

$
(110,829
)

$
(42,690
)

$
(109,037
)

$
(89,846
)Unrecognized net transition obligation (asset)


(1,394
)


(2,554
)


75,044



81,681Unrecognized prior service cost


6,184



7,356



(4,389
)


6,249Unrecognized net actuarial (gain) loss


43,684



(12,526
)


24,574



(12,014
)Net amount recognized

$
(62,355
)

$
(50,414
)

$
(13,808
)

$
(13,930
)Amounts recognized in the balance sheet consist of:Prepaid benefit cost

$
312


$
439


$



$
Accrued benefit liability


(62,667
)


(50,853
)


(13,808
)


(13,930
)Additional minimum liability


(945
)


(1,078
)






Intangible asset


945



1,078







Net amount recognized

$
(62,355
)

$
(50,414
)

$
(13,808
)

$
(13,930
)




35




---




---

Notes to Financial Statements





(Dollars in thousands, except per share amounts)





The projected benefit obligation and accumulated benefit obligation for pension plans with accumulated benefit obligations in excess of plan assets (the supplemental plans are unfunded) were $23,709 and $19,130, respectively, as of December
31, 2001, and $21,847 and $18,131, respectively, as of December 31, 2000.





2001


2000


1999Components of net periodic pension benefit costService cost

$
15,963


$
14,198


$
17,614Interest cost


32,663



39,952



41,151Expected return on plan assets


(33,921
)


(44,146
)


(46,387
)Amortization of transition asset


(1,161
)


(1,828
)


(2,159
)Amortization of prior service cost


1,496



2,405



2,312Recognized net actuarial (gain) loss


(1,927
)


(5,580
)


19Net periodic pension benefit cost


13,113



5,001



12,550Settlement gain






(16,574
)


Total pension (income) cost

$
13,113


$
(11,573
)

$
12,550Components of net periodic other postretirement benefit costService cost

$
7,391


$
6,728


$
7,581Interest cost


17,293



16,455



14,938Expected return on plan assets


(12,865
)


(11,976
)


(9,759
)Amortization of transition obligation


6,637



6,812



6,812Amortization of prior service cost


248



455



458Recognized net actuarial (gain) loss


(564
)


(2,407
)


213Net periodic other postretirement benefit cost

$
18,140


$
16,067


$
20,243





Pension Benefits


Other Postretirement Benefits2001


2000


2001


2000Weighted-average assumptions as of December 31Discount rate

7.25
%

7.50
%

7.25
%

7.50
%Expected return on plan assets

9.00
%

9.00
%

8.30
%

8.30
%Rate of compensation increase

4.75
%

4.75
%

4.75
%

4.75
%





The health care cost trend rate, used to calculate the Companys cost and
obligation for postretirement health care benefits, is a 10% annual rate in 2002 that is assumed to decrease gradually to a 5.0% annual rate in 2007 and remain at that level thereafter.


Assumed health care cost trend rates have a significant effect on the amounts reported for the other postretirement benefit plan. A one-percentage-point change in assumed health care cost trend rates would have the
following effects:





One-Percentage- Point
Increase

One-Percentage- Point DecreaseEffect on total of service and interest cost components

$
3,745

$
(3,142
)Effect on other postretirement benefit obligation

$
33,814

$
(29,053
)





Savings Plans for Employees


The Company
maintains 401(k) savings plans that allow associates to save for retirement on a tax-deferred basis. Compensation expense associated with these savings plans was $3,836 in 2001, $3,373 in 2000 and $3,491 in 1999.


Included in the above expenses were the Companys matching contributions to the primary savings plan totaling $3,398 for 2001, $2,958 for 2000 and $2,781 for 1999
that are invested in a fund of Company common stock.





Employees Stock Ownership Plan


The Company maintains an Employees Stock Ownership Plan which provides for beneficial ownership of Company common stock by associates who are not included in a bargaining unit. Each participating associate can elect to contribute an
amount that does not exceed 2% of their wages. In addition to the associates participation, the Company makes a contribution equivalent to 1/2% of each participants qualified compensation, and matches 100% of the contribution by each
participant. The Company recorded as an expense contributions of $1,721 for 2001, $1,765 for 2000 and $1,805 for 1999 that it made to the plan.





Note
9: Stock-Based Compensation


In May 2000 the Companys shareholders approved the 2000 Stock Award and Incentive Plan (2000 Plan). The Plan replaced the Companys previous
Long-Term Performance-Based Incentive Plan (Previous Plan) which had been in effect since 1994. Under the Previous Plan, awards could be paid in the form of cash, restricted shares of common stock, or a combination of both. The 2000 Plan allows the
Company to continue to grant long-term performance-based awards similar to those that could be paid under the Previous Plan, and also authorizes a broad range of other awards, including options, reload options, deferred stock, performance awards,
stock appreciation rights and other stock-based awards, as well as cash-based awards. Up to 4,276,551 shares of common stock may be issued under the 2000 Plan, of which approximately 3,300,000 shares were available to be granted at December 31,
2001.





Stock Options


In May 2000 the Board of Directors approved the issuance of
non-qualified stock options to executives and other key associates as permitted under the 2000 Plan. Under this plan the options generally are granted at prices not less than the market value of the stock at the date of grant, become exercisable
ratably over a three-year period beginning one-year from the date of grant, and expire ten years from the date of grant. The options immediately vest in the event of a change in control. The Company applies the intrinsic value-based methodology




36




---




American Water Works Company, Inc. and Subsidiary Companies





---




in accounting for stock options. Accordingly, no compensation expense has been recognized for
stock option awards. Had compensation cost for stock option awards under the 2000 Plan been determined by using the fair value at the grant date, the Companys net income and diluted earnings per share would have been the pro forma amounts
indicated below:





2001

2000Net income:As reported

$
161,483

$
161,061Pro forma


158,630


158,996Diluted earnings per share:As reported

$
1.61

$
1.61Pro forma


1.59


1.58





The foregoing impact of compensation cost was determined using a modified
Black-Scholes methodology and the following assumptions:





2001


2000Expected dividend yield

2.92
%

3.99
%Expected volatility

30.17
%

28.70
%Risk-free interest rate

4.75
%

6.58
%Weighted average expected life

7 years


7 years





The following table summarizes information about options for the years ended
December 31:





2001

2000Options to Purchase Shares


Weighted- Average Exercise Price

Options to Purchase Shares


Weighted- Average Exercise PriceOutstanding at beginning of year

781,631


$
22.58




$
Granted

163,892



28.67

809,806



22.58Exercised

(42,184
)


22.56





Cancelled/Expired

(7,588
)


25.91

(28,175
)


(22.56
)Outstanding at end of year

895,751


$
23.66

781,631


$
22.58Exercisable at year end

273,025


$
22.80

19,975


$
22.56





The weighted-average fair value of options granted during the year was $8.29 and
$6.54 for the years ended December 31, 2001 and 2000, respectively.


The following table summarizes information about fixed stock options outstanding at December 31,
2001:





Exercise Prices

Number Outstanding

Remaining Contractual Life

Weighted- Average Exercise Price

Number Exercisable

Weighted- Average Exercise Price$
22.56

723,916

7.9

$
22.56

258,259

$
22.5623.44

11,893

8.8


23.44

3,966


23.4428.19

133,050

8.5


28.19

10,800


28.1930.19 to 32.34

26,892

8.7


31.10










Options granted under the Companys long-term
incentive program were 163,892 and 195,706 for the three-year performance cycles beginning on January 1, 2001 and 2000, respectively. Also in 2000, all of the participants in the long-term incentive programs three-year performance cycles
beginning on January 1, 1998 and 1999 accepted the opportunity to relinquish their participation in those cycles in exchange for a total of 614,100 options.





Restricted Stock


Under the 2000 Plan and the Previous Plan, designated executives and other key associates are eligible to receive restricted stock awards if performance cycle
goals based on earnings-per-share growth and total return to Company shareholders in comparison to a designated peer group of companies are met. The fair value of the restricted stock is being charged to expense over each three-year performance
cycle. The Company awarded 19,796 shares with a value of $380 in 2000 and 30,788 shares with a value of $893 in 1999. The market value of the common stock expected to be awarded has been recorded as unearned compensation and is shown as a separate
component of common stockholders equity.





Note 10: General Taxes


Components of
general tax expense for the years presented in the consolidated statement of income and comprehensive income are as follows:





2001

2000

1999Gross receipts and franchise

$
42,975

$
43,425

$
41,839Property and capital stock


64,164


61,173


58,358Payroll


17,278


16,243


18,445Other general


5,116


4,378


4,032$
129,533

$
125,219

$
122,674





Note 11: Income Taxes


Components of income
tax expense for the years presented in the consolidated statement of income and comprehensive income are as follows:





2001


2000


1999State Income Taxes:Current

$
13,725


$
14,265


$
10,483DeferredCurrent


(49
)


30



199Non-current


3,457



3,158



3,600$
17,133


$
17,453


$
14,282Federal Income Taxes:Current

$
69,356


$
63,545


$
47,858DeferredCurrent


36



35



1,449Non-current


25,338



25,826



29,248Amortization of deferred investment tax credits


(1,539
)


(1,553
)


(1,437
)$
93,191


$
87,853


$
77,118




37




---




---

Notes to Financial Statements





(Dollars in thousands, except per share amounts)





A reconciliation of income tax expense at the statutory federal income tax rate to actual income tax expense is as follows:





2001


2000


1999Income tax at statutory rate

$
95,132


$
93,228


$
80,622Increases (decreases) resulting from  State taxes, net of federal taxes


11,136



11,345



9,283Flow through differences


1,359



1,736



1,708Amortization of investment tax credits


(1,539
)


(1,553
)


(1,437
)Subsidiary preferredDividends


1,046



1,088



1,144Other, net


3,190



(538
)


80Actual income tax expense

$
110,324


$
105,306


$
91,400





The following table provides the components of the net deferred tax liability at
December 31:





2001


2000


1999Deferred Tax Assets:Advances and contributions

$
198,574


$
197,390


$
185,424Deferred investment tax credits


15,558



16,324



16,731Other


40,518



31,932



32,637254,650



245,646



234,792Deferred Tax Liabilities:Utility plant, principally due to depreciation differences


729,825



700,627



647,964Income taxes recoverable through rates


93,975



93,307



93,167Other comprehensive income


3,538



16,180



62,574Other


51,761



40,875



41,547879,099



850,989



845,252$
(624,449
)

$
(605,343
)

$
(610,460
)





No material valuation allowances were required on deferred tax assets at December
31, 2001 and 2000.





Note 12: Leases


The Company has entered into operating leases
involving certain facilities and equipment. Rental expenses under operating leases were $17,579 for 2001, $16,532 for 2000 and $15,192 for 1999. Capital leases currently in effect are not significant.


At December 31, 2001, the minimum annual future rental commitment under operating leases that have initial or remaining noncancellable lease terms in excess of one year are $10,268 in
2002, $8,472 in 2003, $6,944 in 2004, $5,895 in 2005, $4,896 in 2006 and $5,777 thereafter.





Note 13: Revolving Credit Agreements


In June 2000 the Company completed the formation of a new wholly owned subsidiary, American Water Capital Corp., a special purpose corporation that serves as the primary funding vehicle for American Water
Works Company and its regulated subsidiaries. American Water Works has fully and unconditionally guaranteed the securities of American Water Capital.


American Water Capital has a 364-day $500,000 revolving credit agreement with a group of ten domestic and international banks. The renewal date for this facility is June 25, 2002. Borrowing
under the revolving credit line, at the Companys option, bears interest at a rate based upon either a defined base rate or the London Interbank Offered Rate (LIBOR). The Company pays a commitment fee of 15 basis points on the entire amount of
the commitment (whether borrowed or not borrowed) and a usage fee of 40 basis points (50 basis points if borrowings exceed $167). These fees may fluctuate based upon the Companys current bond rating. Under the credit agreement, the Company
must maintain certain financial ratios and meet certain balance sheet tests. No compensating balances are required under the agreement.


American Water Works Company
and its subsidiaries also maintain lines of credit with various banks. Borrowings under such lines of credit generally are payable on demand and bear interest at variable rates. Agreements with lending banks generally do not have compensating
balance requirements.


American Water Capital had $395,561 and $170,367 outstanding under commercial paper borrowings at December 31, 2001 and
2000, respectively, all of which was classified as short-term debt. American Water Capitals revolving credit agreement supports these borrowings. Commercial paper borrowings at December 31, 2001 and 2000 had weighted-average interest rates of
2.35% and 7.31%, respectively.


At December 31, 2001 and 2000, there was $18,522 and $241,812 of short-term bank debt outstanding, respectively. The weighted average
interest rate on these borrowings was 3.52% and 7.02%, respectively.


The total of the unused lines of credit and commercial paper borrowings at December 31, 2001 was
$120,749.





Note 14: Segment Information


The Company has identified Regulated Utility
Services and Unregulated Services as its two reportable segments. The Company has organized its business based upon the products and services provided and based upon similar environments. Prior to the November 2001 acquisition of Azurix North
America and Azurix Industrials Corp. the Companys unregulated operations had not been reflected as a reportable segment due to their limited scope and impact on the financial results of the Company. The results of operations reported by
segment include costs allocated by American Water Works Service Company. The other items include corporate costs of American Water Works Company and intersegment eliminations.




38




---




American Water Works Company, Inc. and Subsidiary Companies





---




The Regulated Utility Services segment includes 26 subsidiaries that
provide water and wastewater to customers in 23 states. All of these companies are subject to both federal and state regulation regarding the quality of water distributed and the discharge of waste residuals. With the exception of one company that
serves 4,000 customers, the utility subsidiaries also function under economic regulations prescribed by state regulatory commissions. A subsidiary which owns a treatment plant in Massachusetts that is leased to an affiliated utility subsidiary is
also included in this segment.


The Unregulated Services segment includes American Water Services and its subsidiaries and American Water Resources. American Water
Services provides a broad range of water and wastewater services including operations and maintenance, residuals management, underground infrastructure development and engineering throughout the U.S. and Canada. American Water Resources currently
offers a consumer protection program for residential water service lines and a service to regenerate granular activated carbon that is used by water utilities in the filtration process. Intersegment revenues include carbon regeneration services and
leased equipment and office space.


The following table presents information about the Companys reportable segments beginning with the formation of American Water
Services on January 1, 2000:





Regulated Utility Services

Unregulated Services


Other Items


Consolidated2001Revenues from external customers

$
1,376,637

$
62,250


$



$
1,438,887Intersegment revenues





6,980



(6,980
)


Depreciation and amortization


178,120


6,959



132



185,211Earnings before interest, taxes, depreciation and amortization (EBITDA)


669,332


5,976



(25,768
)


649,540Interest expense


173,213


1,829



17,480



192,522Income before income taxes


317,999


(2,812
)


(43,380
)


271,807Net income


196,097


(2,362
)


(32,252
)


161,483Total assets


6,316,667


313,080



(22,648
)


6,607,099Capital expenditures


365,259


15,883



17



381,1592000Revenues from external customers

$
1,310,116

$
40,474


$



$
1,350,590Intersegment revenues





6,510



(6,510
)


Depreciation and amortization


162,182


3,570



136



165,888Earnings before interest, taxes, depreciation and amortization (EBITDA)


644,753


1,060



(21,775
)


624,038Interest expense


172,216


850



18,717



191,783Income before income taxes


310,355


(3,360
)


(40,628
)


266,367Net income


189,892


(2,357
)


(26,474
)


161,061Total assets


6,016,568


98,775



19,455



6,134,798Capital expenditures


371,741


5,372



104



377,217





Note 15: Fair Values of Financial Instruments


The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:


Current assets and current
liabilities: The carrying amount reported in the balance sheet for current assets and current liabilities, including revolving credit debt due to the short-term maturities and variable interest rates, approximates their fair values.


Preferred stocks with mandatory redemption requirements and long-term debt: The fair values of the Companys preferred stocks with mandatory redemption requirements and
long-term debt are estimated using discounted cash flow analyses based




39




---




---

Notes to Financial Statements





(Dollars in thousands, except per share amounts)





on the Companys
current incremental financing rates for similar types of securities.


The carrying amounts and fair values of the Companys financial instruments at December 31
are as follows:





2001

Carrying Amount

Fair ValuePreferred stocks of subsidiaries with mandatory redemption requirements

$
30,474

$
32,679Long-term debt of the Company


309,000


307,907Long-term debt of subsidiaries


2,404,137


2,436,153





2000

Carrying Amount

Fair ValuePreferred stocks of subsidiaries with mandatory redemption requirements

$
32,902

$
34,395Long-term debt of the Company


211,000


211,211Long-term debt of subsidiaries


2,218,644


2,267,171





Note 16: Commitments and Contingencies


Construction programs of subsidiaries for 2002 are estimated to cost approximately $500,000. Commitments have been made in connection with certain construction programs.


The Company is routinely involved in condemnation proceedings and legal actions relating to several utility subsidiaries. In the opinion of management, none of these matters will have a material adverse effect, if
any, on the financial position or results of operations of the Company.





Note 17: Quarterly Financial Data (Unaudited)


Summarized quarterly financial data for 2001 and 2000 are as follows:





2001

First Quarter

Second Quarter

Third Quarter

Fourth QuarterOperating revenues

$
316,427

$
363,878

$
394,956

$
363,626Operating income


87,933


125,868


148,198


97,595Net income


23,461


49,381


55,777


32,864Net income to common stock


23,315


49,235


55,631


32,718Basic and diluted earnings per common share

$
0.24

$
0.50

$
0.56

$
0.332000

First Quarter

Second Quarter

Third Quarter

Fourth QuarterOperating revenues

$
307,759

$
346,409

$
364,125

$
332,297Operating income


90,448


120,011


136,135


109,584Net income


27,083


45,139


50,731


38,108Net income to common stock


26,087


44,143


49,735


37,396Basic and diluted earnings per common share

$
0.27

$
0.45

$
0.51

$
0.38




40




---

---

Company Information





Range of Market Prices AWK is the trading symbol of American Water Works Company, Inc. The Companys common stock is traded on the New York Stock Exchange. The Companys preferred and preference stocks were redeemed on
March 1, 2002.





Common Stock

5% Preferred Stock

5% Preference StockNewspaper listing

AmWtrWks

A Wat pr

A Wat pf2001

High



Low

High



Low

High



Low1st quarter

$
33.50




$
25.50

$
22.00




$
18.00

$
22.25




$
18.502nd quarter


33.40





29.05


22.50





21.45


22.00





20.003rd quarter


42.50





28.81


22.50





21.25


23.50





20.554th quarter


42.00





39.25


24.00





22.35


25.00





22.25Quarterly dividend paid per share




$
.235







$
.3125







$
.3125Number of shareholders at December 31, 2001





38,665








164








5452000

High



Low

High



Low

High



Low1st quarter

$
24.50




$
18.94

$
18.00




$
17.00

$
18.75




$
16.002nd quarter


25.75





21.13


19.50





17.00


20.50





17.003rd quarter


27.88





23.75


19.50





17.50


19.50





17.754th quarter


29.38





23.31


19.50





18.00


19.50





17.75Quarterly dividend paid per share




$
.225







$
.3125







$
.3125Number of shareholders at December 31, 2000





41,391








172








590


The common and 5% preferred stocks have voting rights.





Options TradingOptions for Company stock (AWK) are traded on the Philadelphia Stock Exchange (Newspaper listing: PB).





Dividend Reinvestment and Optional Stock Purchases The Company suspended further participation in its Dividend Reinvestment and Stock Purchase Plan effective September 17, 2001.





Shareholder Information Inquiries regarding shareholder stock ownership, dividends or transfer/reissuance of shares can be addressed to our Transfer Agent, EquiServe Trust Company, N.A., P. O. Box
43010, Providence, RI 02940-3010 or call toll-free (877) 987-9757 (877-WTR-WRKS), or (781) 575-3100. Transfer requests sent by mail should provide the appropriate instructions. Other shareholder inquiries should be directed to W. Timothy Pohl, Esq.,
General Counsel and Secretary, P. O. Box 1770, Voorhees, NJ 08043, telephone (856) 346-8200.





Investor RelationsInvestors desiring information
about the Company can contact James E. Harrison, Vice President Investor Relations, P. O. Box 1770, Voorhees, NJ 08043, or call (856) 346-8207. Additional news and information about the Company can be found on our website (http://www.amwater.com).





Annual Meeting The 2002 Annual Meeting of American Water Works Company shareholders will be held on Thursday, May 2, 2002 at 9 a.m. at The
Mansion on Main Street, Kresson and Evesham Roads, Voorhees, NJ.




41