TOWN OF ORO VALLEY WATER UTILITY COMMISSION WATER RATES ANALYSIS REPORT OCTOBER 7, 2009

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1 TOWN OF ORO VALLEY WATER UTILITY COMMISSION WATER RATES ANALYSIS REPORT OCTOBER 7, 2009 EXECUTIVE SUMMARY The functions and duties of the Oro Valley Water Utility Commission include reviewing and developing recommendations for water revenue requirements, water rates and fee structures. The Commission annually evaluates staff recommendations based on a rates analysis to assure the recommendations meet Town policies and bond covenants. The Utility has based its financial analysis on the American Water Works Association (AWWA) Cash Needs Approach. The AWWA is the largest national organization that develops water and wastewater policies, specifications and rate setting guidelines accepted by both government-owned and private water and wastewater utilities worldwide. This Water Rates Analysis Report contains detailed information on the three funds that comprise the Oro Valley Water Utility: Enterprise Fund Alternative Water Resources Development Impact Fee Fund Potable Water System Development Impact Fee Fund Each fund is individually analyzed with regard to revenue and revenue requirements. There were significant changes in assumptions used to prepare this Report than what has been used in the past. The changes include water use trends, vacant homes and/or disconnected meters, growth trends and debt service coverage requirements. All of these will be addressed individually within this Report. The Preferred Financial Scenario includes five year projections for each fund. This allows the Utility to evaluate the impact of future costs and the revenue sources that will be required to meet those costs. Based on the data contained within the Preferred Financial Scenario, the Water Utility Commission has made recommendations on water rates and fees that the Utility will assess in FY Those recommendations are as follows: Increase the base rates for both the potable and reclaimed water rates by 2.0%. Increase the commodity rates for the potable water rates o Tier 1 increase of 1.0% o Tier 2 increase of 1.5% o Tier 3 increase of 2.0% o Tier 4 increase of 2.5% - 1 -

2 Increase the commodity rate for the reclaimed rates by 1.0%. The construction rate for potable water will increase from $6.25 to $6.38 per 1,000 gallons. The construction rate for reclaimed water will increase by 1.0% and will remain equal to the reclaimed commodity rate. The water use contained within specific tiers will remain the same. Increase the Groundwater Preservation Fee by $0.20, from $0.55 to $0.75 per 1,000 gallons for the potable water use. Increase the Groundwater Preservation Fee by $0.10, from $0.30 to $0.40 per 1,000 gallons for the reclaimed water use. Increase the existing new service establishment fees to recover labor and material costs. Increase the existing reconnection fees to recover labor and material costs. Increase the existing backflow permit fees to recover labor and material costs. Increase the existing refundable security deposits to minimize bad debt write off. Increase the existing meter installation fees to recover labor and material costs. The Water Rates Analysis Report also includes an Alternate Financial Scenario for the Council s consideration. The Alternate Financial Scenario does not propose any increase in the base rates or the commodity rates for FY but does include an increase in the Groundwater Preservation Fee of $0.20 for potable water use and $0.10 for reclaimed water use. The Alternate Financial Scenario incorporates most of the same basic assumptions as the Preferred Financial Scenario. More discussion on the specific assumptions used in the Alternate Financial Scenario may be found on page XX of this report. The Commission presents this Rates Analysis Report for the review and consideration of the Mayor and Council. The Commission and Water Utility Staff are available to discuss this report in greater detail at the Council s request. Utility Staff are planning to request Council s approval of a Notice of Intent on October 7, 2009 which will set a Public Hearing on November 18, 2009 and make the report available for public review. The Notice of Intent initiates the process and does not approve any changes or increases in water rates. Approval of any rate increases would be considered by Town Council at the Public Hearing on November 18, The Oro Valley Water Utility Commission is proud to serve the Town of Oro Valley, it citizens and the customers of its water utility. The Commission extends their appreciation to the Mayor and Council for their consideration and guidance and looks forward to their continued direction

3 TOWN OF ORO VALLEY WATER UTILITY COMMISSION WATER RATES ANALYSIS REPORT OCTOBER 7, 2009 INTRODUCTION The Oro Valley Water Utility was established in 1996 as a self-supporting enterprise of the Town. The Utility is comprised of three separate funds that have been established for specific purposes. The Funds are as follows: Enterprise Fund Alternative Water Resources Development Impact Fee Fund Potable Water System Development Impact Fee Fund The Enterprise Fund is the operating fund for the Utility. The expenditures managed from this fund include personnel, operations and maintenance for both potable and reclaimed water systems, capital costs for existing potable water system improvements and related debt service. Revenue for this fund includes water sales, service fees and miscellaneous charges and interest income. The Utility does not receive any funds from the Town General Fund. The Alternative Water Resources Development Impact Fee Fund was established in 1996 to manage capital expenditures related to alternative water resources including reclaimed water and Central Arizona Project (CAP) water. Expenditures include acquisition of water rights required for growth and capital costs, including debt service, to deliver reclaimed water and CAP water to the Town. Revenue for this fund is received from impact fees collected at the time water meters are purchased and from interest income. Additionally, the Groundwater Preservation Fees, which are collected through the Enterprise Fund, are transferred to the Alternative Water Resources Development Impact Fee Fund to pay for capital costs and debt service. The Potable Water System Development Impact Fee Fund was established in 1996 to manage capital expenditures related to expansion or growth-related potable water capital projects and related debt service. These projects include wells, pump stations, reservoirs and mains for the potable water system. Revenue for this fund is received from impact fees collected at the time water meters are purchased and from interest income. The revenue and expenditures of all three funds are combined primarily to determine if the Utility meets the debt service coverage requirement established in the Mayor and Council Water Policies and the 2003 Bond Covenants. Otherwise, each fund is independent with regard to revenue and expenses. The revenue from the individual funds may not be consolidated nor used for any purpose other than for which they were originally established

4 Each fund is addressed in more detail in the report. Figure 1 illustrates the relationship between the three funds. Figure 1 Enterprise Fund Rev: Water sales, service fees and charges Exp: Operating costs, existing system capital improvements and debt service AWRDIF Fund Rev: AWRDIF impact fees & Groundwater Preservation Fees Exp: Alternative water resources (CAP & reclaimed water), related capital improvements & debt service PWSDIF Rev: PWSDIF impact fees Exp: Growth related potable water capital improvements and related debt service Summary of All Funds The Utility combines all funds to determine the overall debt service coverage ratio required by Town Policy & bond covenants. There were changes in key assumptions used to prepare this Report other than what had been used in the past. The changes include water use trends, vacant homes and/or disconnected meters, growth trends and debt service coverage requirements. All of these will be addressed individually within this Report as they have a significant impact on the analysis and projected water rate increases. WATER USE TRENDS The Utility has experienced an overall reduction in water use, both potable and reclaimed, over the last two years. The chart below illustrates a 4.7% reduction in water use from calendar year 2007 to This data is based on actual water use for both years. The 2009 reduction in water use is projected using actual water use for January through August of 2009 and estimating the same water use as in 2008 for the months of September through December. The reduction in water use for 2009 is estimated at 2.1% less than in The combined 2 year reduction in water use is estimated to be 6.9%. The reduction in water use is a result of a combination of occurrences including conservation, reduction in growth, vacant homes and/or disconnected meters. The average single family residential customer - 4 -

5 with a 5/8 x 3/4-inch water meter reduced their monthly water use to 8,093 gallons. Likewise, monthly water use was reduced in all other customer classifications. Revenue projections for this analysis included this reduction in water use. 3,450,000,000 3 YEAR WATER USE HISTORY Potable & Reclaimed Water 3,300,000,000 3,289,420,000 GALLONS 3,150,000,000 3,135,575,000 3,070,722,000 (estimated) 3,000,000,000 2,850,000, YEAR VACANT HOMES AND/OR DISCONNECTED METERS To ascertain why water use has declined, the Utility s customer base was analyzed. The analysis revealed that 238 meters were disconnected or had the water service turned off and locked as of August 20, The following is the classification of those meters: Residential 160 Commercial 9 Irrigation 59 Construction 10 Each account was categorized by user classification and meter size and then analyzed to project if and when the water service would be restored. It was assumed that 20% of all residential meters would be re-activated annually beginning in FY After review, it was determined that all construction meters were homes that were under construction when the water service was disconnected thus it was assumed that 20% of these meters would also be re-activated annually. Analysis of the commercial accounts revealed that it was highly unlikely that any of these meters would be re-activated. Likewise, the majority of irrigation meters were for common areas which are not likely to be re-activated in the near future. These meters are not being billed; therefore, there is a negative impact to water sales revenue. This impact was factored into the 5 year projections as a reduction in water sales and Groundwater Preservation Fees (GPF) revenue. As the meters are projected to be reactivated, the reduction in revenue is minimized proportionate to the number of meters, meter - 5 -

6 size and projected water rates on an annual basis. The following table shows the financial impact on an annual basis: Fiscal Year Water Sales Revenue Reduction GPF Revenue Reduction Total Annual Revenue Reduction $161,338 $31,281 $192, $146,244 $35,911 $182, $142,911 $37,282 $180, $135,162 $35,983 $171, $128,514 $33,901 $162,415 GROWTH TRENDS The Utility s growth rates have decreased significantly over the past several years. The growth projections used for this Report were provided by the Town s Finance Director and are consistent with the Town s overall financial planning. The chart below illustrates the Utility s growth rate over the last 4 years plus the projected growth for FY It is projected that growth rates will increase to 75 new metered connections annually from FY through FY which is also consistent with the Town s financial planning. 5 YEAR GROWTH RATES 600 NEW METERED CONNECTIONS FISCAL YEARS - 6 -

7 DEBT SERVICE COVERAGE REQUIREMENTS During this water rates analysis process, staff modified the method for calculating the debt service coverage ratio pursuant to Town Financial Policies adopted by the Town Council in The adopted policy with respect to debt service coverage ratios states the following: When utility revenues are pledged as debt service payments, the Town will strive to maintain a 1.3 debt service coverage ratio or the required ratio in the bond indenture (whichever is greater) to ensure debt coverage in times of revenue fluctuation. The Water Utility currently pays debt service on a number of outstanding debt issuances and loans. For the Series 2003 Senior Lien Water Revenue Bonds, the 2007 WIFA Loan, and the anticipated 2009 WIFA Loan, water utility revenues are specifically pledged as the repayment source for these obligations at 1.3 times coverage per the Town s adopted financial policy. The remaining outstanding debt obligations of the Water Utility are excise tax pledged obligations meaning that the Town s unrestricted sources of sales taxes, fines, permit fees and state shared revenues are pledged as the repayment sources for these bonds in the bond indentures. Even though the bond indentures pledge these excise taxes as the repayment source, the Water Utility will continue to be responsible for and budget for these debt service payments at a calculated debt service coverage ratio of 1.0, rather than the 1.3 times coverage. It is important to note that the bond indentures for the excise tax-backed bonds require that the Town s excise tax collections each fiscal year total at least 2.5 times the annual debt service requirements in order to avoid having to fund a debt service reserve fund. These conditions have been met annually in the past and are expected to continue in the future. This methodology of segregating the water utility revenue-pledged debt from the excise taxpledged debt in the rates analysis process is an accepted practice in the industry and has been reviewed by the Town s Finance Director and the Town s financial advisors with Stone and Youngberg. The debt service coverage ratio is determined by dividing the annual net operating revenue by the annual debt service payments. Using the methodology described above is in accordance with the 2008 policy and reduces the amount of the debt service coverage requirement amount. ENTERPRISE FUND REVENUE The Enterprise Fund had a cash balance of $10.4 million at the beginning of FY On July 1, 2009 the Utility paid off the Series 1999 Bonds in the amount of $1.9 million - 7 -

8 leaving a balance of $8.5 million for FY expenditures. Enterprise funds may be used for operating costs including personnel, operations and maintenance, capital improvements for the existing potable water system and debt service. The following table provides the Utility s budgeted revenue compared to the actual revenue for : Revenue Source Budgeted Actual Difference Over (Under) Water Sales $ 11,547,900 $ 11,434,787 ( $ 113,113) Service Fees/Charges $ 553,000 $ 617,858 $ 64,858 Interest Income $ 275,000 $ 138,333 ( $ 136,667) Total $ 12,375,900 $ 12,190,978 ( $ 184,922) The reduction in water sales resulted in the Utility not meeting the budgeted revenue amount. The $64,000 received in excess of the service fees budget is due largely to the increase the Utility received for providing sewer billing services for Pima County Wastewater Reclamation Department. The reduction in interest income is a result of lower interest rates experienced with the downtown in the economy. Revenues projected for FY were based on anticipated annual growth in the customer base of 60 single family residential customers and water consumption patterns similar to calendar year (CY) Analysis of the water use trends for CY 2008 indicated the average monthly use for a single family residence with a 5/8 x 3/4 inch water declined from 9,000 gallons to 8,093 gallons per month. For this analysis, 8,000 gallons per month was used to project water sales revenue. This reduction may be a result of increased water conservation by our customers coupled with the number of homes that are currently vacant, commercial and irrigation meters that have been disconnected. The reductions in water use, along with the vacant and/or disconnected metered accounts, were taken into consideration when projecting future water sales revenue. The following table indicates the amount of water sales revenue that would be realized with the existing rate structure and no water rate increase: Actual Water Sales Revenue FY Projected Water Sales Revenue Difference Increase (Decrease) $11,434,787 $10,768,200 ( $ 666,587 ) Under the existing rate structure, the projected revenue decrease is a result of a projected reduction in water sales

9 REVENUE REQUIREMENTS The following table is a comparative summary of operating expenses for the Water Utility Enterprise Fund. Actual expenses (excluding depreciation and amortization) for are compared to the projected expenses for FY used in the financial analysis: OVWU Expenditures Actual FY Projected Change Increase(Decrease) Personnel $ 2,447,642 $ 2,517,450 $ 69,808 O & M $ 3,094,147 $ 3,512,446 $ 418,299 CAP Allotment $ 185,490 $ 154,575 ( $ 30,915 ) CAP Recharge $ 632,870 $ 475,000 ( $ 157,870 ) CAGRD $ 834,035 $ 616,117 ( $ 217,918 ) Debt Service $ 3,597,312 $ 3,261,863 ( $ 335,449 ) Subtotal Expenditures $10,791,496 $10,537,451 ( $ 254,045 ) Capital Outlay $ 2,747,860 $ 4,790,000 $ 2,042,140 Total Expenditures $13,539,356 $15,327,451 $ 1,788,095 Projected personnel costs do not include any new personnel, no merit increases and no Cost of Living Allowances (COLA). In, some vacant positions were filled resulting in partial-year salaries and benefits for those affected employees. In FY , those positions will be at full-year salaries and benefits thus the increase of $69,000 for personnel. The projected operations and maintenance costs include the O&M costs for both the potable water system and the reclaimed water system. Although CAP capital costs, CAP Recharge costs and CAGRD costs are included in the O&M budget for the Enterprise Fund, they are segregated above because of the significant costs of each line item. To appropriately manage the Utility s financial and water resources, the Utility is limited in amount of control it has over these specific costs. The rates are set by the Central Arizona Project and the Central Arizona Groundwater Replenishment District on an annual basis with projections for 4 years in the future. The Central Arizona Project (CAP) capital costs will be less as a result of a rate decrease by Central Arizona Project. The CAP recharge costs are projected to decrease based on the volume of water that will be recharged at the Kai Farms Groundwater Water Savings Facility and the Central Arizona Water Conservation District Facilities. In FY , the Utility is proposing to recharge 4,000 AF. The projected decrease in costs for the Central Arizona Groundwater Replenishment District (CAGRD) is a result of the reduction in water use and continued management of water and - 9 -

10 financial resources. The Utility will use Long Term Storage (LTS) credits to offset a portion of the costs charged by the CAGRD through permitted recovery wells. In addition, the recent purchase of groundwater extinguishment credits will help to reduce payment obligations to the CAGRD. There are a number of other annual O&M expenses that the Utility has the least control over and therefore is unable to reduce anticipated expenditures. In addition to the CAP and CAGRD costs, some of the other expenses that the Utility has the least control over include: electrical power for pumping, water quality testing, chemicals for disinfection, potable and reclaimed water purchased from other providers, software maintenance on existing software, regulatory permits, insurance, office lease, services provided by other Town departments and costs directly related to billing. The billing costs include printing of the billing forms, envelopes, postage, outsource vendor for bill insertion and delivery to post office, lockbox and other bank charges for processing payments. Where applicable, the materials and/or services have been bid to assure the lowest price. The O&M expenses that the Utility has minimal control over include maintenance on production and distribution facilities such as wells, boosters, reservoirs, and water mains. The Utility includes know preventative maintenance costs in the budget as well as contingency funds for unknown repairs and maintenance. The majority of these facilities are underground which allows for unforeseen malfunctions. Additionally, water mains develop leaks that must be repaired immediately. The Utility budgets for these specific items based on historical data; however, it is difficult to predict the exact amount in any given year. The O&M expenses that the Utility has the most control over include office supplies, field supplies, memberships & subscriptions, printing, telecommunications, uniforms, rentals, training, conservation education and outside professional services. The Utility reduced most of these costs in the FY budget as compared to last year s budget. Although the Utility plans on incurring additional debt in FY , projected debt service will decrease for FY as a result of paying off the Series 1999 Bonds on July 1, Need to add more information here : Debt service payments are established for any given fiscal year unless funds are available to pay off the debt like the Utility did in July. The chart below illustrates the O&M costs with regard to the level of control the Utility has over these costs

11 Budgeted Expenses for FY (excluding capital projects) O&M MinimalControl $533,018 5% O&M Least Control $3,946,008 35% O&M Most Control $267,125 2% Personnel $2,517,450 22% Debt Service $4,126,248 36% Projected capital projects for existing system improvements in FY include drilling and equipping 1 replacement well, construction of a 3 million gallon reservoir, water main replacements and relocations. Capital outlay also includes the purchase of water meters, security equipment and other minor assets. Projected expenditures in the Enterprise Fund are proposed to be funded with revenue generated from water rates, fees, charges, cash reserves and a loan from the Water Infrastructure Finance Authority of Arizona (WIFA). ALTERNATIVE WATER RESOURCES DEVELOPMENT IMPACT FEE FUND REVENUE The Alternative Water Resources Development Impact Fee Fund (AWRDIF) is projected to have a cash balance of $1.6 million at the beginning of FY AWRDIF funds may be used for capital expenditures related to alternative water resources including reclaimed water and CAP water. The revenue sources for the AWRDIF Fund are from impact fees collected when a water meter is purchased and from interest earned on cash balances. The Groundwater Preservation Fees (GPF) collected through the Enterprise Fund are transferred to the AWRDIF Fund to help repay outstanding debt for the reclaimed water delivery system and for future debt on the CAP water delivery system. The following table provides the budgeted revenue for compared to the actual revenue for :

12 Revenue Source Budgeted Actual Difference Over(Under) Impact Fees $ 632,580 $ 812,740 $ 180,160 GPF $ 1,656,560 $ 1,323,549 ($ 333,011 ) Interest Income $ 15,800 $ 24,422 $ 8,622 Total $ 2,304,940 $ 2,160,711 ($ 144,229 ) The Town Council adopted new impact fees in The increase in impact fee revenue occurred as a result of the number of large commercial meters that were purchased as well as the increase in the impact fees. The decrease in GPF revenue is a result of customers using less water. The water use trends are discussed in more detail on page 4 of this report. Revenues projected for FY were based on anticipated annual growth in the customer base of 60 new connections or 90 Equivalent Dwelling Units (EDUs). An EDU is equivalent to one single family residence with a 5/8 x 3/4 inch meter. For impact fee projections, the Utility converts the estimated new connections to EDUs at a ratio of 1.50 EDUs to 1 new connection based on ten year historical trends. The following table indicates the amount of impact fee and GPF revenue that would be realized with the current impact fees and with and without a GPF increase: FY Revenue Projection With GPF Increase FY Revenue Projection Without GPF Increase Difference Impact Fees $ 298,920 $ 298,920 $ 0 GPF $2,038,641 $1,500,048 $ 538,593 REVENUE REQUIREMENTS The AWRDIF Fund was allocated a portion of the Series 2003 Bond proceeds to finance construction for the first phase of the reclaimed water system. The second phase of the reclaimed water system was financed by a loan through the Water Infrastructure Finance Authority of Arizona (WIFA). The acquisition of 3,557 AF of CAP water rights in will continue to be funded through the AWRDIF Fund over the next three years. The final payment on the water rights will be made in December The costs associated with this acquisition are the capital costs to build the CAP canal plus interest from inception of the repayment schedule to the date of

13 acquisition by the Town. This additional water will be necessary to meet the demands of future customers and as such will be paid from this Fund. The following table is a comparative summary of expenditures for the AWRDIF Fund. The following table provides the budgeted expenditures for compared to the actual expenditures for : Expenditures Budget Actual Change Under(Over) Professional Services $ 396,000 $ 159,064 $ 236,936 Capital Improvements $ 737,000 $ 706,181 $ 30,819 Debt Service $ 1,752,010 $ 1,752,010 $ 0 Total $ 2,885,010 $ 2,617,255 $ 267,755 The professional services are expenses incurred for renewable water studies including the CAP water pilot study for treatment techniques and the pipeline routing studies for delivery of CAP water. The capital improvements in represent the completion of construction costs for the second phase of the reclaimed water system. The debt service is repayment of the portion of the Series 2003 Bonds used to finance Phase 1 of the Reclaimed Water Delivery System and the 2007 WIFA loan used to finance Phase 2 of the Reclaimed Water Delivery System. Projected expenditures in the AWRDIF Fund are proposed to be funded with revenue generated from impact fees, groundwater preservation fees and interest income. In the table below, actual expenses for are compared to the projected expenses for FY used in the financial analysis. Expenditures Actual FY Projected Change Increase(Decrease) Professional Services $ 159,064 $ 273,200 $ 114,136 Capital Improvements $ 706,181 $ 0 ( $ 706,181 ) Debt Service $ 1,752,010 $ 1,700,630 ( $ 51,380 ) Total $ 2,617,255 $ 1,973,830 ( $ 643,425 ) The Utility s FY budget included $3 million for capital improvements related to land acquisition and engineering and design services for the CAP treatment and delivery system. It is unlikely that these costs will be incurred in FY ; therefore, the costs

14 were not included in the 5 year projection for this Report. When the Utility incurs costs related to the CAP treatment and delivery system, it is assumed that the project will be financed through WIFA or the sale of bonds. A partial year of debt service for the project has been included in FY of this Report. POTABLE WATER SYSTEM DEVELOPMENT IMPACT FEE FUND REVENUE The Potable Water System Development Impact Fee Fund (PWSDIF) is projected to have a cash balance of $8.9 million at the beginning of. The PWSDIF Fund was allocated a portion of the Series 2003 Bond proceeds to finance construction of growthrelated potable water system improvements and the refinancing of the Series 2000 Bond issue. Revisions to the capital improvement plan due to reduced growth have left sufficient bond proceeds available to construct the needed improvements for FY Growthrelated improvements after this time will be paid for with cash. The revenue sources for the PWSDIF Fund are from impact fees collected when a water meter is purchased and from interest earned on cash balances. The Town Council adopted new impact fees in These new fees became effective in September The following table provides the budgeted revenue compared to the actual revenue for FY : Revenue Source Budget Actual Difference Over(Under) Impact Fees $ 800,900 $ 1,588,084 $ 787,184 Interest Income $ 315,200 $ 122,903 ( $ 192,297 ) Total $ 1,116,100 $ 1,710,987 $ 594,887 The increase in impact fee revenue in is a result of numerous new commercial connections during Revenues were projected for FY based on anticipated annual growth in the customer base of 60 new connections or 90 EDUs. An EDU is equivalent to one single family residence with a 5/8 x 3/4 inch meter. For impact fee projections, the Utility converts the estimated new connections to EDUs at a ratio of 1.50 EDUs to 1 new connection base on ten year historical trends. The following table indicates the amount of impact fee revenue that is projected for FY compared to actual revenue received in : Actual Revenue FY Projected Revenue Difference Increase(Decrease) $ 1,710,987 $ 154,020 ($ 1,556,967)

15 The estimated decrease in impact fee revenue is a result of significantly fewer commercial connections projected for FY and in general, a lower projected growth rate for FY In the actual growth rate was 615 EDUs. REVENUE REQUIREMENTS Growth-related potable water system improvements are managed through the PWSDIF Fund. These improvements include new potable water reservoirs, pump stations, water mains and wells that are required to meet the demands of new customers. The following table is a comparative summary of expenditures for the PWSDIF Fund. The following table provides the budgeted expenditures compared to the actual expenditures for : Expenditures Budgeted Actual Change Under(Over) Capital Improvements $ 570,000 $ 0 $ 570,000 Debt Service $ 637,646 $ 637,646 $ 0 Total $ 1,207,646 $ 637,646 $ 570,000 The capital improvements budgeted in were not constructed because with slowed growth, the demands of new development were diminished. In the table below, actual expenses for are compared to the projected expenses for FY used in the financial analysis. Expenditures Actual FY Projected Change Increase(Decrease) Capital Improvements $ 0 $ 1,920,000 $ 1,920,000 Debt Service $ 637,646 $ 634,021 ( $ 3,625 ) Total $ 637,646 $ 2,554,021 ( $ 1,916,375) The capital improvements for FY include the construction of a 3-million gallons reservoir and related piping. This project was designated at 50% existing system improvement and 50% expansion related. As such, the total project cost is split with the Enterprise Fund. Projected expenditures in the PWSDIF Fund are proposed to be funded with the remaining Series 2003 bond proceeds and cash reserves generated from impact fees. The debt service payments are pursuant to the repayment schedule provided by the bond underwriters

16 PREFERRED FINANCIAL SCENARIO Prior to developing financial forecasts, financial considerations were evaluated relating to significant short and long term capital expenditures, the Utility s existing cash reserves, existing outstanding debt, proposed future debt and the related debt service payments. To arrive at a Preferred Financial Scenario, the goals of the Commission were to ensure that all existing rate setting policies were met, cash reserves were utilized to minimize future debt and proposed rate increases would not result in rate shock. In prior years, a key component in the rate setting process was the calculation of the debt service coverage ratio. A 1.3 debt service coverage ratio was established by Council policy with the adoption of Resolution No. (R) With the implementation of the new methodology to calculate the debt service coverage ratio, the required debt service coverage ratio is not as difficult to achieve, resulting in lower rate increases than previously projected. The Commission s finance subcommittee and Utility Staff evaluated different financial scenarios prior to forwarding a recommendation to the Commission. With regard to the Preferred Financial Scenario, the following are key assumptions used to develop the financial projections. The entire set of assumptions may be found in Appendix A. Annual growth is estimated at 60 new connections annually which equates to 90 EDUs for FY Projected growth for future years has been estimated at 75 new connections annually which equates to 112 EDUs annually. Reduction in water sales for FY remains constant throughout the 5 year period. Vacant homes and/or disconnected residential meters will be re-activated at 20% per year beginning in FY The Utility will use cash reserves and a WIFA loan to fund existing system capital improvements in FY The Utility will continue to use cash reserves to finance existing system capital improvements through FY The Utility will finance future existing system capital improvements beginning in FY All 18-hole golf courses will be delivered reclaimed water throughout the 5 year projection period. Debt service for CAP water development begins in FY Projected operating costs in FY are similar to the Utility s budget request. Future years include annual inflation factors after one time expenditures have been deducted. Projected operating costs for direct delivery of CAP water begin in January The Potable Water System Development Impact Fees are not projected to increase within the 5 year projection period. The Alternative Water Resources Development Impact Fees were increased to $4,982 per EDU. This increase was effective in December These fees are not projected to increase within the 5 year projection period

17 Analysis of the Preferred Financial Scenario indicates that the Enterprise Fund can utilize cash reserves to finance a portion of the proposed existing system capital improvements for FY but will need to finance $3.4 million to complete all the improvements. The Preferred Financial Scenario proposes using cash to finance capital improvements in FY and FY New debt is proposed in FY This financing assumption results in a steady decline of the Utility s projected cash balance ranging from $6.5 million in FY to $2.6 million in FY The projected average ending cash balance of the 5 year period is $4.4 million. The Preferred Financial Scenario includes increases in the base and commodity rates in each year throughout the 5 year projection period. The operating and maintenance costs for direct delivery of CAP water will be paid through water rates; however, the capital costs to construct the CAP water delivery system will be funded with revenue derived from Groundwater Preservations Fees and Alternative Water Resources Development Impact Fees The financial projections detailed in the Preferred Financial Scenario for the AWRDIF Fund include assumptions that the repayment of capital costs for the reallocation of 3,557 AF of CAP water will be funded through the AWRDIF Fund. These payments for the reallocation began in FY and continue through FY Construction of the CAP water delivery system will be managed through the AWRDIF Fund. It is estimated that debt service for this project will begin in FY To help meet the revenue requirements of this Fund, it has been assumed that the Groundwater Preservation Fees will increase annually for the five year projection period. The Alternative Water Resources Development Impact Fees were increased pursuant to Ordinance No. (O) adopted in The financial projections detailed in the Preferred Financial Scenario for the PWSDIF Fund include assumptions for growth related capital improvements as detailed in the Potable Water System Master Plan adopted by the Town Council in In order to pace water infrastructure construction with new growth demands, some of these projects have been delayed over the last several years resulting from a growth rate slower than projected. As such, there are 2003 bond proceeds remaining to fund the capital improvements for FY The Potable Water System Development Impact Fees were increased pursuant to Ordinance No. (O) adopted in The projections for the Enterprise Fund, AWRDIF Fund and the PWSDIF Fund were combined to evaluate the overall debt service coverage at the end of each fiscal year. Analysis indicates that, under the Preferred Financial Scenario, the Utility will meet the debt service coverage requirement established by the Mayor and Council Water Polices and Bond Covenants for all five years. Proformas for the Preferred Financial Scenario may be found in Appendix B. RECOMMENDATION ON WATER RATES, FEES & CHARGES After reviewing the analysis of the three Funds and their respective revenue requirements for the next five years, the Water Utility Commission is recommending:

18 Increase the Groundwater Preservation Fee by $0.20, from $0.55 to $0.75 per 1,000 gallons for the potable water customers. Increase the Groundwater Preservation Fee by $0.10, from $0.30 to $0.40 per 1,000 gallons for the reclaimed water customers. Increase the commodity rates for the potable water rates o Tier 1 increase of 1.0% o Tier 2 increase of 1.5% o Tier 3 increase of 2.0% o Tier 4 increase of 2.5% Increase the commodity rate for the reclaimed rates by 1.0%. The construction rate for potable water will continue to be $1.00 greater than the highest tiered rate and will increase from $6.25 to $6.38 per 1,000 gallons. The construction rate for reclaimed water will increase by 1.0% and will remain equal to the reclaimed commodity rate. The water use contained within specific tiers will remain the same for each meter size. Increase the existing new service establishment fees to recover labor and material costs. Increase the existing reconnection fees to recover labor and material costs. Increase the existing backflow permit fees to recover labor and material costs. Increase the existing refundable security deposits to minimize bad debt write off. Increase the existing meter installation fees to recover labor and material costs. The detailed schedule of the proposed water rates may be found in Appendix C. The following table illustrates the proposed water rate changes for a single family residential customer with a 5/8 x 3/4 inch water meter. Other water providers in the region are included for comparison. Water Provider Monthly Base Rate Tier 1 Cost Per 1,000 Gals. Tier 2 Cost Per 1,000 Gals. Tier 3 Cost Per 1,000 Gals. Tier 4 Cost Per 1,000 Gals. Oro Valley Current Oro Valley Proposed Metro Water Marana Water Tucson Water Oro Valley Water, Tucson Water and Metro Water no longer include water usage in their base rates; however, Marana Water includes 1,000 gallons. Oro Valley, Metro and Marana all base their rates on 1,000 gallons. Tucson Water s commodity rates are based on the use of 100 cubic feet which is the equivalent of 748 gallons. To simplify the comparison, the rates for Tucson Water have been converted to represent the charge for 1,000 gallons. For

19 the most part, the tiered rate structures for all the Water Utilities are similar. A table providing proposed rates for all Oro Valley Water Utility meter sizes may be found in Appendix C. Appendix C also contains tables that calculate the dollar increase and the percentage increase that a customer would experience on a monthly bill under the proposed rates. Monthly bill amounts are calculated in 1,000 gallon increments for the 5/8 x 3/4 inch meters and a variety of increments for larger meter sizes. For comparison purposes, the following table provides a calculation of a monthly bill amount for a single family residential customer with a 5/8 x 3/4 inch meter for the water utilities surrounding the Oro Valley Water Utility service area. Direct comparison of raw base rates and commodity rates is less effective because of the varying rate structures of each utility. A better comparison is to calculate the cost for specific consumption levels during a summer month. Please note that these charges only reflect water use fees and specifically exclude taxes, Groundwater Preservation Fees and similar renewable water resource fees charged by other water providers. Water Utility Cost for 8,000 Gallons Cost for 15,000 Gallons Cost for 25,000 Gallons Cost for 40,000 Gallons Oro Valley - Current Oro Valley - Proposed Metro Water Marana Water Tucson Water A typical single family residential customer averages 8,000 gallons of water per month over the course of one year. Based on this water use, they would experience an increase of $0.43 per month for water used and an increase of $1.60 for Groundwater Preservation Fees. The total monthly increase for 8,000 gallons of water used in a month would be $2.03. This represents an 5.6% increase of which 1.2% is for water use and 4.4% is for the GPF. Each individual customer s increase in their monthly bill will depend on the volume of water they use. Tables that calculate the dollar increase and the percentage increase that a customer would experience on a monthly bill under the proposed rates may be found in Appendix C. The following table illustrates the proposed impact for the 5 year projection period: Preferred Financial Scenario FY FY FY FY FY Water Rates 1.2% 1.2% 1.7% 2.0% 2.5% GPF 4.4% 4.2% 3.0% 2.0% 1.9% Total Impact 5.6% 5.4% 4.7% 4.0% 4.4%

20 Monthly Bill Monthly Increase $38.58 $40.65 $42.57 $44.26 $46.19 $2.03 $2.07 $1.92 $1.69 $1.93 The proposed increase in the GPF will help repay the debt on the reclaimed water system, the capital charges associated with the reallocation of 3,557 AF of CAP water and ultimately, repay the debt for the costs to construct the CAP water delivery system. It is proposed that the GPF be increased gradually over a five year period. In keeping with the Town Council s direction in prior years, the reclaimed water customers will pay a reduced rate for the GPF. ALTERNATE FINANCIAL SCENARIO Appendix D presents an Alternate Financial Scenario to allow for a comparison with the Preferred Financial Scenario. Both scenarios used identical assumptions for growth, water use trends and operating costs. A significant difference is the timing of the proposed future debt. In the Alternate Financial Scenario, it is assumed that the Utility would borrow money for capital projects in FY and FY and use cash for all FY This financing assumption results in the Utility maintaining approximately $5 million projected cash balance in all years except FY in which the projected cash balance would drop to $2.2 million. The projected average ending cash balance of the 5 year period is $4.9 million. The only other difference between the two scenarios is that there are no increases in the base and commodity water rates. The proposed increases to the GPF are the same in both scenarios. The Alternate Financial Scenario includes the following: Increase the Groundwater Preservation Fee by $0.20, from $0.55 to $0.75 per 1,000 gallons for the potable water customers. Increase the Groundwater Preservation Fee by $0.10, from $0.30 to $0.40 per 1,000 gallons for the reclaimed water customers. Increase the existing new service establishment fees to recover labor and material costs. Increase the existing reconnection fees to recover labor and material costs. Increase the existing backflow permit fees to recover labor and material costs. Increase the existing refundable security deposits to minimize bad debt write off. Increase the existing meter installation fees to recover labor and material costs. Given the current economic conditions, the Water Utility Commission and Utility Staff wanted to provide an option for the Council to consider with regard to water rates. The Alternate Financial Scenario proposes a no rate increase for the base rates and the commodity rates in FY as opposed to the 1.2% rate increase that is proposed in the Preferred Financial Scenario. The Alternate Financial Scenario does not have the rate increases that will generate needed revenues and therefore further reduces the ending cash balance

21 The following table illustrates the proposed impact of the Alternate Financial Scenario during the 5 year projection period for proposed rate increases, GPF increases, the total financial impact and the projected monthly bill for a single family residential customer using 8,000 gallons of water per month. Alternate Financial Scenario FY FY FY FY FY Water Rates 0.0% 0.0% 0.0% 2.5% 2.8% GPF 4.4% 4.2% 3.0% 2.0% 1.9% Total Impact 4.4% 4.2% 3.0% 4.5% 4.7% Monthly Bill $38.12 $39.72 $40.92 $42.78 $44.79 Monthly Increase $1.60 $1.60 $1.20 $1.86 $2.01 Both the Preferred Financial Scenario and the Alternate Financial Scenario meet all revenue requirements and debt service coverage requirements. OTHER SERVICE FEES & CHARGES Both the Preferred and Alternate Financial Scenarios include the same increases in other service fees and charges as listed below. The schedules for these proposed increases are included in Appendix F. NEW SERVICE ESTABLISHMENT FEES New service establishment fees provide the Utility a means of recovering labor and material costs related to performing new service establishment procedures. The costs related to new service establishment procedures include staff labor, printed forms and travel time. It is recommended that the new service establishment fees be increased to recover the costs to provide the service. RECONNECTION FEES Reconnection fees provide the Utility a means of recovering labor and material costs related to performing delinquent turn off procedures. The costs related to delinquent account turn off procedures include staff labor, printed forms, out-source mailing expenses and postage. BACKFLOW PERMIT FEES Backflow permit fees provide the Utility a means of recovering labor and material costs related to inspect new backflow assembly installations, maintain a backflow data base, notification to owner of testing requirements and following up to insure that the testing was completed and is in compliance with State regulations. The costs related to backflow permit fees include staff labor, travel, printing costs and postage

22 SECURITY DEPOSITS Security deposits are required of all new customers establishing water service with the Utility for the first time and are refundable after one year if the account has not been delinquent. Security deposits are also required if and existing account become delinquent. Currently, the same deposit amount is required regardless of the customer classification. Recent trends indicate that the majority of customers closing accounts without paying their final water bill are tenants. These customers frequently have delinquent accounts prior to leaving, thus the amount owned is typically more than one month s water use. METER INSTALLATION FEES There are currently over 18,000 water meters in the water distribution system. Water meters are the equipment that measure the volume of water used in order to bill each customer for their specific water use. Water sales revenue represents 93% of the total revenue collected for the Enterprise Fund. This amount does not include Groundwater Preservation Fees and Impact Fees that are accounted for in separate Funds. The meter installation fees need to be increased to recover the labor and material costs related to meter installations. No other adjustments to service fees and charges are necessary at this time; however, the Commission recommends that the service fees and charges continue to be reviewed on an annual basis. CONCLUSION The Commission presents this Water Rates Analysis Report for the review and consideration of the Mayor and Council. The Commission and Water Utility Staff are available to discuss this report in greater detail at Council s request. Utility Staff are planning to request Council s approval of a Notice of Intent on October 7, 2009 and approval of any rate increases at a Public Hearing on November 18, The Oro Valley Water Utility Commission is proud to serve the Town of Oro Valley, it citizens and the customers of its water utility. The Commission extends their appreciation to the Mayor and Council for their consideration and guidance and looks forward to their continued direction