COUNTY SANITATION DISTRICT NO. 2-3 OF SANTA CLARA COUNTY FINANCIAL STATEMENTS AND INDEPENDENT AUDITOR'S REPORT

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1 FINANCIAL STATEMENTS AND INDEPENDENT AUDITOR'S REPORT JUNE 30, 2017

2 JUNE 30, 2017 TABLE OF CONTENTS Page INDEPENDENT AUDITOR'S REPORT 1-2 MANAGEMENT'S DISCUSSION AND ANALYSIS (Required Supplementary Information) 3-7 BASIC FINANCIAL STATEMENTS Statement of Net Position 8 Statement of Revenues, Expenses, and Changes in Net Position 9 Statement of Cash Flows 10 Notes to the Basic Financial Statements INDEPENDENT AUDITOR'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND COMPLIANCE AND OTHER MATTERS BASED ON AN AUDIT OF BASIC FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE WITH GOVERNMENT AUDITING STANDARDS 16-17

3 th Street, Suite 200 Oakland, California Telephone: (510) Fax: (510) INDEPENDENT AUDITOR'S REPORT To the Board of Directors of County Sanitation District No. 2-3 of Santa Clara County San Jose, California Report on the Financial Statements We have audited the accompanying financial statements of the business-type activities of the County Sanitation District No. 2-3 of Santa Clara County (the "District") as of and for the year ended June 30, 2017, and the related notes to the financial statements, which collectively comprise the District's basic financial statements as listed in the table of contents. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 1

4 Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the respective financial position of the business-type activities of County Sanitation District No. 2-3 of Santa Clara County as of June 30, 2017, and the respective changes in financial position and, cash flows thereof for the year then ended in accordance with accounting principles generally accepted in the United States of America. Other Matters Required Supplementary Information Accounting principles generally accepted in the United States of America require that the management's discussion and analysis on pages 3-7 be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management's responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance. Summarized Comparative Information We have previously audited the District s June 30, 2016 financial statements, and we expressed an unmodified audit opinion on those audited financial statements in our report dated November 10, In our opinion, the summarized comparative information presented herein as of and for the year ended June 30, 2016 is consistent, in all material respects, with the audited financial statements from which it has been derived. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated September 21, 2017, on our consideration of County Sanitation District No. 2-3 of Santa Clara County's internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering County Sanitation District No. 2-3 of Santa Clara County's internal control over financial reporting and compliance. Oakland, California September 21,

5 MANAGEMENT'S DISCUSSION AND ANALYSIS This section of the County Sanitation District No. 2-3 of Santa Clara County's (the "District") annual financial report presents a discussion and analysis of the District's financial performance during the fiscal year ended June 30, Please read it in conjunction with the District's basic financial statements following this section. HISTORY AND ORGANIZATION County Sanitation District No. 2-3 of Santa Clara County, while a component unit of Santa Clara County, is a separate governmental entity established as a special district of the State of California. Being a dependent special district, the County Board of Supervisors sits as The District's governing Board of Directors. The District was consolidated in December 1977 by the merger of Districts 2 and 3, which were originally formed in May 1948 and May 1953, respectively. The District serves the unincorporated areas of East San Jose in the vicinity of the Alum Rock area (District 2) and unincorporated areas including the County Fairgrounds and environs southerly (District 3). The District provides sewage collection, treatment and disposal services for these areas comprising approximately 3.8 square miles with nearly 46 miles of sewer lines within the District boundary. Revenues are derived principally from sewer service charges collected annually with the property taxes from commercial and residential users. OPERATIONS AND MANAGEMENT The District's sewage flows are collected by District owned mains and then transmitted through joint use sewer mains owned by City of San Jose (the "City") to the San Jose-Santa Clara Regional Wastewater Facility for treatment and disposal. The District and City has entered into contractual agreement to co-share cost of expenses related to these joint use sewer mains. The current joint interceptor cost sharing agreement, which supplanted all prior agreements, was executed September 29, 1992 and provided for proportionate cost sharing, based on the agreed capacities and flows, between the City and the District for construction, operation and maintenance or rehabilitation of joint use sewer lines. This agreement expired on September 29, The District and City of San Jose is currently in negotiation for a new agreement. Although the agreement has not yet been executed, there will be a continual obligation by the District to pay City of San Jose. This amount has not yet been determined, but it is anticipated that the new amount would be lower than the original agreement amount. Once a new agreement is executed, District will pay its' obligation share to City of San Jose from September 29, 2009 onwards. Costs for capital improvements, operation and maintenance of wastewater treatment and disposal are based upon the terms of a Master Agreement between the Cities of San Jose and Santa Clara, owners of the Regional Wastewater Facility (RWF), with County Sanitation District No. 2-3, dated January 1, The agreement also includes a reimbursement to City for a long-term obligation for a proportionate share of the debt service on bonds issued in 1995 for the construction and expansion of the RWF to satisfy state and federal permit requirements. The outstanding balances of the bonds were refinanced in It is now anticipated that the proposed rehabilitation and improvements at the RWF will cost $1.4 billion over the next 10 years, which District will be responsible for prorate share (0.58%), estimated at $7,685,000. It is District's position that the 1985 agreement does not cover the cost, financing or implementation of the next 10 year capital improvement projects and a new agreement or an amendment to the 1985 agreement would be needed. The District and City of San Jose are in negotiation at this time. Under the 1985 agreement, the District has no ownership interest in the RWF, leases capacity and makes payments on a calculated schedule based on flow capacity. 3

6 MANAGEMENT'S DISCUSSION AND ANALYSIS The District's management is provided by contractual agreement with Mark Thomas & Company Inc., a private consultant responsible for day-to-day administration and operation of the District. Office of the County Executive provides management oversight of the District s activities. Repairs and maintenance activities are provided as scheduled or needed with outside contractors. For questions regarding this report, contact the District Administrative Office at (408) CHANGE IN NET POSITION Total net position for the end of fiscal years June 30, 2017 and 2016 were $8,442,991 and $8,653,482, respectively. Change in net position is $(210,491) or a decrease of (2.4)%. This is due primarily to decrease in cash position by $(235,625). This decrease is a result of District paying cash to City of San Jose for the San Jose- Santa Clara Wastewater Facility capital cost in lieu of a long term financing, District s FY Capital Project at a cost of $1,619,335 commencing from April 13, 2017 with anticipated completion by October 15, 2017, and no additional increase in revenue from sewer service charges. Statement of Net Position June 30, 2017 June 30, 2016 Amount Increase/ (Decrease) Percent Increase/ (Decrease) Current assets $ 7,563,548 $ 7,793,761 $ (230,213) (2.95)% Capital assets, net 1,863,172 1,671, , % Total assets 9,426,720 9,465,296 (38,576) (0.41)% Current and total liabilities 983, , , % Net investment in capital assets 1,863,172 1,671, , % Unrestricted net position 6,579,819 6,981,947 (402,128) (5.76)% Total net position $ 8,442,991 $ 8,653,482 $ (210,491) (2.43)% Capital assets increased by 11.5% over last fiscal year to $1,863,172. The increase of $191,637 is a result of two mains, eight laterals and four manholes rehabilitation. Current liabilities increased by 21.2% over last fiscal year to $983,729. Majority of current liabilities are in account payable, which at the end of fiscal year were recorded as expenses, but no payments have been made. The major account payable is for the District FY Capital Project cost from Devaney Engineering, Inc., Contractor, in the amount of $255, Unrestricted net position decreased by (5.8)% to $6,579,819 as compared to last FY of $6,981,947. This can be attributed primarily due to less cash on hand. The balance of $6.58 million in unrestricted net position will continue to allow District to pay cash for San Jose-Santa Clara Regional Wastewater Facility and the District s capital costs. 4

7 MANAGEMENT'S DISCUSSION AND ANALYSIS Changes in the District's net position can be determined by reviewing the following condensed Statements of Revenue, Expenses, and Changes in Fund Net Position. Condensed Statements of Revenues, Expenses, and Changes in Fund Net Position Year ended June 30, 2017 Year Ended June 30, 2016 Amount Increase/ (Decrease) Percent Increase/ (Decrease) Operating revenue $ 3,121,534 $ 3,120,673 $ % Non-operating revenue 37,521 64,053 (26,532) (41.42)% Total revenues 3,159,055 3,184,726 (25,671) (0.81)% Operating expenses 3,415,682 2,626, , % Total expenses 3,415,682 2,626, , % Change in fund net position (256,627) 558,059 (814,686) (145.99)% Fund net position, beginning (restated) 8,699,618 8,095, , % Fund net position, ending $ 8,442,991 $ 8,653,482 $ (210,491) (2.43)% REVENUES AND EXPENSES Operating revenue remains flat (increase of $861), which the primary source is from sewer service charges. There was no rate increase for this fiscal years The large increase in operating expenses of 30% ($3,415,682 as compared to last FY of $2,626,667) is from increases for the payment made to City of San Jose for the wastewater treatment ($1,987,512 as compared to last FY of $1,553,503) and District operations for rehabilitation of existing infrastructure ($1,708,373 as compared to last FY of $773,153). BUDGETARY HIGHLIGHTS As a dependent district, County Sanitation District 2-3 is subject to the County Budget Act which specifies the content and presentation of the budget information to the Board of Supervisors. The annual budget for the current fiscal year was adopted by the Board of Directors in June 2017, which outlines the major elements of forthcoming operations and capital projects. 5

8 MANAGEMENT'S DISCUSSION AND ANALYSIS CAPITAL ASSETS As of June 30, 2017, the District had net capital assets amounting to $1,863,172 representing investments in sewer substructure system consisting of subsurface mains and laterals. The following table summarizes the District's capital assets at historical cost for fiscal years ended June 30, 2017 and June 30, 2016: June 30, 2017 June 30, 2016 Amount Increase/ (Decrease) Percent Increase/ (Decrease) Sewer substructure system $ 4,166,526 $ 3,922,415 $ 244, % Less: accumulated depreciation (2,303,354) (2,250,880) (52,474) 2.3 % Capital assets, net $ 1,863,172 $ 1,671,535 $ 191, % RATES AND OTHER ECONOMIC FACTORS The District considers many factors when setting the fiscal year budget. Some of those factors are the economy, increased salary and benefits costs for both District's operations and the San Jose/Santa Clara Regional Wastewater facility s operations and maintenance, as well as increased capital improvement programs at the RWF and District's own capital needs. In addition, the District's operations are governed in part by the requirements and provisions of the State Water Resource Control Board that require adequate funding to cover the costs of operations, maintenance and recurring capital replacement (OM&R) to be in compliance with Sewer System Management Plan (SSMP). The District is not subject to general economic conditions such as increases or reductions in property tax values or other types of revenues, such as sales taxes, that vary with economic conditions. Accordingly, the District sets its rates to its users to cover the costs of OM&R, capital improvement projects, plus any increments for known or anticipated changes in program costs. Based on uncertainty with the financing of the San Jose-Santa Clara Regional Wastewater Facility and fact that the District is a dependent District of County of Santa Clara, District did not increase sewer services charges for this fiscal year. FUTURE CONSIDERATIONS There are still approximately 500 homes remaining for potential pocket annexations, but there is no current plan by City of San Jose to move forward with annexation. CSD 2-3 has filed a grievance against the City with other Tributary Agencies with TPAC (Treatment Plant Policy Committee) pertaining to a variety of issues related to the wastewater treatment Master Agreement. CSD 2-3 and other Tributary Agencies are working with City of San Jose to resolve outstanding issues. Moving forward, adjustment to the user s rate will need to factor in the outcome of this negotiation. CSD 2-3 and City of San Jose has not yet completed negotiation of a new agreement for the cost sharing of the joint interceptor. Refer to Page 3, Operations and Management section, for details. 6

9 MANAGEMENT'S DISCUSSION AND ANALYSIS REQUESTS FOR FINANCIAL INFORMATION This financial report is designed to provide our customers and creditors with a general overview of District finances, and demonstrate District fiscal accountability for the money it receives. If you have any questions about this report, or need additional financial information, contact the District Administrative Office, Stevens Creek Blvd., Ste 100, Cupertino, CA , Ph. (408)

10 STATEMENT OF NET POSITION PROPRIETARY FUND JUNE 30, 2017 (With comparative totals for June 30, 2016) Assets: Current Assets: Cash and investments $ 7,522,116 $ 7,757,741 Interest receivable 19,507 14,287 Prepaid expenses 21,925 21,733 Total Current Assets 7,563,548 7,793,761 Noncurrent Assets: Capital assets, net 1,863,172 1,671,535 Liabilities: Current Liabilities: Total Assets 9,426,720 9,465,296 Accounts payable 978, ,070 Other liabilities 4,949 2,744 Total Liabilities 983, ,814 Net Position: Net investment in capital assets 1,863,172 1,671,535 Unrestricted 6,579,819 6,981,947 Total Net Position 8,442,991 8,653,482 Total Liabilities and Net Position $ 9,426,720 $ 9,465,296 The accompanying notes are an integral part of these financial statements 8

11 STATEMENT OF REVENUES, EXPENSES, AND CHANGES IN FUND NET POSITION PROPRIETARY FUND (With comparative totals for year ended June 30, 2016) Operating Revenues: Sewer service charges $ 2,734,490 $ 2,736,129 Permits, inspection, and other fees 288,499 7,302 Miscellaneous income 98, ,242 Total Operating Revenues 3,121,534 3,120,673 Operating Expenses: Sewage treatment 1,585,085 1,553,503 County agenda fees 13,750 8,250 Management & engineering 102,461 87,920 Repairs & maintenance 1,460, ,153 Accounting & clerical 37,991 26,791 Legal services 88,448 56,317 Audit services 11,985 12,600 Office expenses 6,303 2,671 Depreciation 50,610 47,923 Membership fees 11,889 11,564 Insurance 46,031 45,754 Utilities Total Operating Expenses 3,415,682 2,626,667 Operating Income (294,148) 494,006 Non-Operating Revenues: Interest income 69,325 49,856 Unrealized gain/(loss) on investments fair value (31,804) 14,197 Total Non-Operating Revenues 37,521 64,053 Change in Net Position (256,627) 558,059 Net Position, Beginning 8,653,482 8,095,423 Restatement (Note 9) 46,136 Net Position, Beginning (Restated) 8,699,618 8,095,423 Net Position, Ending $ 8,442,991 $ 8,653,482 The accompanying notes are an integral part of these financial statements 9

12 STATEMENT OF CASH FLOW PROPRIETARY FUND (With comparative totals for year ended June 30, 2016) Cash Flows Provided/(Used) by Operating Activities: Cash received from customers and other sources $ 3,121,534 $ 3,120,673 Cash paid to suppliers and service providers (3,193,349) (2,471,905) Net Cash Provided/(Used) by Operating Activities (71,815) 648,768 Cash Flows Provided/(Used) by Investing Activities: Interest received 64,105 44,605 Acquisitions of capital assets (196,111) (413,449) Unrealized gain/(loss) on investments fair value (31,804) 14,197 Net Cash Provided/(Used) by Investing Activities (163,810) (354,647) Net Increase/(Decrease) in Cash (235,625) 294,121 Cash and Investments, Beginning 7,757,741 7,463,620 Cash and Investments, Ending $ 7,522,116 $ 7,757,741 Reconciliation of Operating Income to Net Cash Provided by Operating Activities: Operating income $ (294,148) $ 494,006 Adjustments to reconcile change in net position to cash flows from operating activities: Depreciation 50,610 47,923 (Increase) decrease in operating assets: Prepaid expenses (192) (102) Increase (decrease) in operating liabilities: Accounts payable 169, ,941 Other liabilities 2,205 Net Cash Provided by Operating Activities $ (71,815) $ 648,768 The accompanying notes are an integral part of these financial statements 10

13 NOTES TO FINANCIAL STATEMENTS NOTE 1: REPORTING ENTITY County Sanitation District 2-3 (the "District") of Santa Clara County, while a component unit of Santa Clara County, is a separate government entity established as a special district of the State of California. Being a dependent special district, the County Board of Supervisors sits as the District's governing Board of Directors. The District was consolidated in December 1977 by the merger of Districts 2 and 3, which were originally formed in May 1948 and May 1953, respectively. The District serves the unincorporated areas of East San Jose in the vicinity of the Alum Rock area (District 2) and unincorporated areas including the County Fairgrounds and environs southerly (District 3). The District provides sewage collection, treatment and disposal services for these areas comprising approximately 7.5 square miles with nearly 46 miles of sewer lines to maintain. Revenues are derived principally from sewer service charges collected annually with the property taxes from commercial and residential users within the District. NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Accounting Enterprise funds are accounted for using the accrual basis of accounting. Revenues are recognized when they are earned, and expenses are recognized when they are incurred. The financial statements of the District have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The Governmental Accounting Standards Board (GASB) is the accepted standard-setting body for establishing governmental accounting and financial principles. The District also applies Financial Accounting Standards Board (FASB) statements and Interpretations to its business-type activities provided they do not conflict with or contradict GASB pronouncements. The most significant of the District's accounting policies are described below. Fund Accounting Classification The financial statements of the District are presented as those of an enterprise fund under the broad category of funds called proprietary funds, which also include internal service funds. Enterprise fund account for operations that are financed and operated in a manner similar to private business enterprise, where the intent is that the costs (expenses, including depreciation) of providing goods or services to the general public on a continuing basis be financed or recovered primarily through user charges. The acquisition and capital improvement of the physical plant facilities required for providing these goods and services are financed from existing cash resources, cash flow from operations, the issuances of bonds, and contributed capital. Cash and Cash Equivalents For the purpose of the statement of cash flows, the District considers all highly liquid assets including cash, checking and savings accounts, money market accounts, and certificates of deposits with original maturities of three months or less to be cash equivalents. The carrying value approximates the fair value of the short maturity of these financial instruments. The District's cash and cash equivalents are part of the County's "commingled" investment pool and invested pursuant to the County of Santa Clara's Treasury Investment policy, which, among other provisions, stipulates the type, mix, quality, and duration of investments and requires financial dealers and institutions to be selected based on stringent criteria designed to minimize the risk of loss. 11

14 NOTES TO FINANCIAL STATEMENTS NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D) Capital Assets The costs of constructions and additions to sewer substructure system, and major replacements that will materially extend the life of these facilities are capitalized at historical cost. Donated capital assets received prior to June 15, 2015, are recorded at their estimated fair value at the date of donation and after that, recorded at acquisition value. Repairs, maintenance, and minor replacements are charged to expense. Depreciation is computed on a straight-line basis over the estimated useful life of for substructure systems which is 50 years and 20 years for equipment and pump stations. Sewer Service Charges The District receives the major portion of its revenue from sewer service charges that are collected on the Tax Roll twice a year, one-half in January and one-half in June. Sewer service charges are billed and collected, on behalf of the District, by Santa Clara County (the "County") as a separate component of semi-annual property tax billings. The County remits to the District all amount due. Sewer Connection Fees Sewer connection fees represent one-time charges, which are due upon connection to the system. The District collects these fees on behalf of the San Jose/Santa Clara Water Pollution Control Plant and forwards them by warrant to the City of San Jose (the "City") Treasurer. Equity Classifications In the government-wide and proprietary fund financial statements, equity is classified as net position and divided into three components: Net Investment in Capital Assets This category groups all capital assets into one component of net position. Accumulated depreciation and the outstanding balances of debt that are attributable to the acquisition, construction, or improvement of these assets reduce the balance in this category. Restricted Net Position Consists of net position with constraints placed on the use either by external groups such as creditors, grantors, contributors, or laws or regulations of other governments; or law through constitutional provisions or enabling legislation. The District has no restricted net position as of June 30, Unrestricted Net Position This category represents net position of the District, not restricted for any project or other purpose. Use of Estimates and Assumptions The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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 those estimates. 12

15 NOTES TO FINANCIAL STATEMENTS NOTE 3: CASH AND INVESTMENTS Cash and cash equivalents at June 30, 2017 consists of the following: Cash and investment $ 7,522,116 $ 7,757,741 Total $ 7,522,116 $ 7,757,741 The County maintains a cash and investment pool with various financial institutions and a safekeeping agent that is available for use by all funds. Statutes authorize the County to invest in obligations of the U. S. Treasury, agencies, and instrumentalities, commercial paper rated A-1 by Standard & Poor's Corporation or P-1 by Moody's Commercial Paper Record, banker's acceptance, repurchase agreements, and the State Treasurer's investment pool. The District authorized the Santa Clara County Treasurer to invest available monies in all its funds. The County's commingled pool consist of cash in bank, U.S. government and agency securities, corporate bonds, negotiable certificates of deposit, commercial paper, securities lending collateral, and deposits in the state Local Agency Investment Fund. The Pool's securities lending transactions/activities were also allocated to the District by the County but are not reflected in the accompanying financial statements. Additional information regarding the County's investment policy and cash and investments, including interest rate risk, credit risk, custodial credit risk categories, security lending transactions, and maturities of the different categories of investments, can be found in the County's notes to the financial statements. Governmental Accounting Standards Board, Statement No. 31, "Accounting and Financial Reporting for Certain Investment and for External Investment Pools" establishes accounting and financial reporting standards for all investments held by governmental external investment pools. The statement requires governmental entities to report investments at fair market value. As of June 30, 2017, fair market value of the District's cash and cash equivalents is $7,610,508. Fair market value is adjusted due to outstanding checks at the end of fiscal year. NOTE 4: CAPITAL ASSETS Capital Assets as of June 30, 2017: Balance July 1, 2016 Prior Period Adjustment Increase Decrease Balance June 30, 2017 Capital assets, being depreciated: Sewer substructure system $ 3,922,416 $ 48,000 $ 196,111 $ $ 4,166,527 Less: accumulated depreciation (2,250,881) (1,864) (50,610) (2,303,355) Total Capital assets, being depreciated, net $ 1,671,535 $ 46,136 $ 145,501 $ - $ 1,863,172 13

16 NOTES TO FINANCIAL STATEMENTS NOTE 5: ACCOUNTS PAYABLE Accounts payable has outstanding balance of $978,780 as of June 30, The bulk of the account is in maintenance and operation services payable to City of San Jose totaling $573,395 [See Note 7] originally accrued in FY No payment is expected until a new agreement is executed between CSD 2-3 and City of San Jose. NOTE 6: SEWER TREATMENT FACILITIES AND CAPACITY RIGHTS The District has an agreement, dated July 1, 1984, for wastewater treatment with the cities of San Jose and Santa Clara relating to the discharge of sewage into the San Jose/Santa Clara Water Pollution Control Plant. The agreement requires the District to pay the shared costs based on allocated flow capacity rights of the total plant capacity, and operation and maintenance based upon actual sewage flow and strengths. Prior year payments made in excess of actual expenditures are credited to the District in the third quarter each year. The City invoices the District quarterly for budgeted cost then reconciles the funds after yearend. The agreement also requires the District to pay their share of debt service on the bond issued for plant expansion and water recycling program. For the year ended June 30, 2017, the District's share of the sewage treatment costs is $1,585,085. NOTE 7: COMMITMENTS AND CONTINGENT LIABILITIES The joint agreement between the City of San Jose and the District executed on September 29, 1992, has expired on September 29, The District is currently in negotiation with the City of San Jose. It is anticipated that total payment to the City of San Jose for the joint usage of the City's trunk lines will be lower than the original agreement. NOTE 8: RISK MANAGEMENT The District is exposed to various risks of loss related to damage and destruction of property, errors and omissions, and natural disasters for which the District carries CSRMA Primary Insurance Program with American Alternative Insurance Corporation (AAIC). The District joined California Sanitation Risk Management Authority (the CSRMA) formed by a group of California local public entities who executed a certain Joint Exercise of Powers Agreement for the California Sanitation Risk Management Authority (the JEPA). In the interval since CSRMA was founded, CSRMA has developed and is presently operating risk management and loss prevention programs related to public liability, auto liability, public officials' errors and omissions, property losses, and workers' compensation risks in which CSRMA's local government entity members may and do participate. The District renews its insurance policy every year. NOTE 9: NET POSITION RESTATEMENT During the year ended June 30, 2017, the District reconciled the capital asset inventory listing as a result of which a prior period adjustment was made in the amount of $46,136 to restate net position correctly. 14

17 NOTES TO FINANCIAL STATEMENTS NOTE 10: SUBSEQUENT EVENTS The District has evaluated operations for the period of time from its year end June 30, 2017 through September 21, 2017, the date the financial statements were available to be issued and have determined that no adjustments are necessary to the amounts reported in the accompanying financial statements nor have any subsequent events occurred, the nature of which would require disclosure. 15

18 th Street, Suite 200 Oakland, California Telephone: (510) Fax: (510) INDEPENDENT AUDITOR'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MATTERS BASED ON AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE WITH GOVERNMENT AUDITING STANDARDS To the Board of Directors of County Sanitation District No. 2-3 of Santa Clara County San Jose, California We have audited, in accordance with the auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States, the financial statements of the business-type activities of County Sanitation District No. 2-3 of Santa Clara County (the "District") as of and for the year ended June 30, 2017, and related notes to the financial statements, which collectively comprise the District's basic financial statements, and have issued our report thereon dated September 21, Internal Control Over Financial Reporting In planning and performing our audit of the financial statements, we considered the District's internal control over financial reporting (internal control) to determine the audit procedures that are appropriate in the circumstances for the purpose of expressing our opinions on the financial statements, but not for the purpose of expressing an opinion on the effectiveness of the District's internal control. Accordingly, we do not express an opinion on the effectiveness of the District's internal control. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct misstatements on a timely basis. A material weakness is a deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. Our consideration of internal control was for the limited purpose described in the first paragraph of this section and was not designed to identify all deficiencies in internal control that might be material weaknesses or, significant deficiencies. Given these limitations, during our audit we did not identify any deficiencies in internal control that we consider to be material weaknesses. However, material weaknesses may exist that have not been identified. Compliance and Other Matters As part of obtaining reasonable assurance about whether the District's financial statements are free from material misstatement, we performed tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements, noncompliance with which could have a direct and material effect on the determination of financial statements amounts. However, providing an opinion on compliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliance or other matters that are required to be reported under Government Auditing Standards. 16

19 Purpose of this Report The purpose of this report is solely to describe the scope of our testing of internal control and compliance and the results of the testing, and not to provide an opinion on the effectiveness of the entity's internal control or on compliance. This report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the entity's internal control and compliance. Accordingly, this communication is not suitable for any other purpose. Oakland, California September 21,