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MANAGEMENT'S DISCUSSION AND ANALYSIS SEPTEMBER 30, 2007 As management of the City of San Marcos, we offer readers of the City of San Marcos' financial statements this narrative overview and analysis of the financial activities for the City of San Marcos for the fiscal year ended September 30, 2007. We encourage readers to consider the information presented here in conjunction with additional information that we have furnished in our letter of transmittal, which can be found on pages iii — viii of this report. FINANCIAL HIGHLIGHTS • The assets of the City of San Marcos exceeded its liabilities at the close of the fiscal year ending September 30, 2007, by $189 million (net assets). Of this amount, $110.8 million (unrestricted net assets) may be used to meet the government's ongoing obligations to citizens and creditors. • As of September 30, 2007, the City of San Marcos' governmental funds reported combined ending fund balances of $63.8 million, an increase of $27.0 million in comparison with the prior fiscal year. • At the end of the current fiscal year, unreserved fund balance for the General Fund was $14.5 million, or 46.5% of total General Fund expenditures. • The City's total debt increased by $39.98 million during the current fiscal year. The City issued $34.19 million in Combination Tax and Revenue Certificates of Obligation and $13.15 million in Water and Wastewater System revenue bonds. OVERVIEW OF THE FINANCIAL STATEMENTS The discussion and analysis serves as an introduction to the City of San Marcos' basic financial statements. The City of San Marcos' basic financial statements are comprised of three components: 1) government -wide financial statements, 2) fund financial statements, and 3) notes to the financial statements. The comprehensive annual financial report (CAFR) also contains other supplementary information in addition to the basic statements themselves. Government -wide financial statements. The government -wide financial statements are designed to provide readers with a broad overview of the City of San Marcos' finances, in a manner similar to a private- sector business. The statement of net assets presents information on all of the City of San Marcos' assets and liabilities, with the difference between the two reported as net assets. Over time, increases or decreases in net assets may serve as a useful indicator of whether the financial position of the City of San Marcos is improving or deteriorating. 3