Santa Barbara County 1998-99 Grand Jury Report

Los Alamos Community
Services District

Released March 23, 1999

INTRODUCTION

The Los Alamos Community Services District (LACSD) was formed in October 1956 under Section 61000 of the California State Government Code for the purpose of providing water to the community. The district relies exclusively on the existing water table to supply the water needs of the district. To mitigate the potential for groundwater contamination, the County of Santa Barbara required the district to build a wastewater treatment facility before any additional growth would be permitted. In April 1985 the district was awarded a Federal EPA grant and a grant from the California State Government Water Resources Control Board to design and build a wastewater treatment plant. This grant covered the entire development cost of the facility. As of December 1998, the district was providing both water and sanitary services for 361 customers.

The Grand Jury was contacted by a group of Los Alamos citizens who expressed concerns about a recent increase in their sewer service charges, generous pay increases to district staff and imprudent spending on the part of the board of directors. They were also concerned about the availability of future water supplies for the district.

OBJECTIVE

The Grand Jury’s objective was to study the LACSD's operational structure, financial structure and reliability of future water supplies in order to determine if the citizens’ concerns were justified.

PROCEDURE

While conducting its investigation, members of the Grand Jury met with local citizens, past and present members of the LACSD board, LACSD staff, the Santa Barbara County Auditor-Controller, County Legal Counsel, a representative of the Local Agency Formation Commission (LAFCO) and several elected officials. LACSD’s audited financial statements for 1994 through 1998, auditor's management letters, budgets, minutes of board meetings for the previous thirty months and five-year plan for both water and wastewater were also examined.

OBSERVATIONS

Structure and Operation

The LACSD has a five-person board of directors, elected at large by the electorate within the district boundaries. Board vacancies created by members who resign mid-term are filled by appointment or by special elections in compliance with law. Because of the small size of the district, there is no full-time general manager solely responsible to the board. To provide administrative support to the district an office manager serves as secretary to the board and performs general office duties. There is also a part-time office assistant. In addition to the office personnel there are three employees who service the water and wastewater facilities. One of those employees, a Classified Operations Manager, serves as the manager of field operations.

In 1995 the district paid for in-depth studies of both the water and wastewater services. These reports, prepared by Dennis Bethel and Associates, Inc., of Santa Maria, were designed to provide the district with an analysis of the existing status of each service function and a five-year plan for the future. The studies provided guidelines for estimated rate increases based on projected growth in the district as well as an analysis of future capital improvements and maintenance required by each service. The study called for the wastewater fee rates to cover the costs associated with the operation and maintenance of the plant and the payment of the outstanding bond issue.

However, despite a recent increase in sewer fees, the wastewater function is operating at a loss. Last year, 1998, the wastewater revenue was $137,000 and the expenses were $286,000. This year the revenue is projected to be $139,000 and the budgeted expenses for 1998-99 for wastewater total $302,000.1

With regard to water revenue, currently the LACSD has the third lowest water rates in the county. A basic service fee of $11.40 a month is charged and after that the rate for water is $1 per unit.

Additional revenues are generated by the district through new construction buy-in fees for water and sewer service. These fees generate $5,200 per new unit and are earmarked for a capital improvement fund. Currently the fund balance is approximately $40,000. The rate at which the connection fees are accruing is not adequate to fund the $170,000 depreciation expense accruing each year.

The Bethel plans were specific about water and wastewater rate increases, scheduling a series of increases over the five-year period. Even though the district paid for these five-year studies to be performed for both water and wastewater services, the board has not taken steps to implement suggestions for increasing revenues through rate or connection increases

LACSD Audits

All special districts are required to file an audited financial statement each year with the Auditor-Controller of Santa Barbara County. The Auditor-Controller is required to note the receipt of the audited report. The only responsibility the County Auditor-Controller has with respect to independent special districts is to ensure they file the specified annual statements with the County. Beyond that, there is no obligation to comment on the financial stability of a district. The voters of the district have the sole responsibility of electing competent board members who in turn are responsible for the fiscal viability of the district.

The comments accompanying the audited financial report for the year ending June 30, 1998, indicate that LACSD faces serious financial challenges. The following comments are excerpted from the report.

"The accompanying financial statements have been prepared assuming that the Company [LACSD] will continue as a going concern. As discussed in Note 8 to the financial statements, the Company has suffered recurring operating losses which raise doubt about its ability to continue as a going concern. Management's plans regarding those matters also are described in Note 8. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

"As shown in the accompanying financial statements, the Company incurred a substantial net loss in the current year, as well as losses totaling $326,483 over the prior three years. It is expected that the rate increase (Note 7) will have a positive effect on the financial condition of the Company. Management is evaluating methods to reduce costs and improve results of operations. It is uncertain if these methods will alleviate the current operating losses. The financial statements do not include any adjustments that might result from the outcome of this uncertainty."2

As a part of the investigation by the Grand Jury, the Auditor-Controller was asked for comments on the fiscal condition of the LACSD. The Santa Barbara County Auditor-Controller issued the following response:

"However, the 1997-98 audit contains a going concern paragraph in the audit opinion. This is a significant ‘red flag’ concerning District operations. The reason for the going concern is that the District has incurred operating losses for at least the last four years. The audit firm considers this a significant issue.

"The problem is that the District has been operating on a flow of current resource basis (the District spends all the revenue it collects in the same year). The rate structure generates revenues for operations and some capital expenditures (equipment, facilities, renovations, etc.). The rate structure is not set in a manner that covers replacement reserves or what ‘may be’ sufficient maintenance of capital facilities.

"Water and Sewer funds should operate on a flow of economic resource basis (full cost recovery). This requires long-term reserves, long-term replacement plans, and a rate structure to support and replace the plant and equipment long term.

"In the FY88-89 Grand Jury report (ten years ago), similar concerns were expressed at that time.

"Because of the reluctance by the Board to increase rates, it is difficult to make the change from current year budget balancing to a long-term budget outlook."3

Expenses and Other Concerns

The County of Santa Barbara extended loans totaling $181,000 to LACSD over a period of four years from 1982 through 1986. The district was unable to repay these loans and the County of Santa Barbara forgave the obligation in 1988.

In 1978 the district received a $275,000 loan with interest at 5% from the Farmer’s Home Administration. In 1987 the district issued and sold $474,242 in general obligation bonds with interest rates ranging from 7.65% to 8.35%. As of June 30, 1998, a total of $379,000 was still owed on this long-term debt. The district has been able to remain current on loan repayments and bond obligations.

To continue to operate as a going concern, LACSD needs to maintain tight control over expenses as well as identifying sources of future revenues. However, the Grand Jury could find no indication that significant board meeting time is devoted to discussion of financial issues. It was reported that a two-member subcommittee composed of selected board members does the majority of the financial planning and reports to the board. However, the Grand Jury concluded that current board members, including members of the Finance Committee, were unfamiliar with the true picture of the district’s finances. They had no knowledge of the auditor’s management letter, although that letter was available as part of the annual audit since July 31, 1998.

Grand Jury members attending district board meetings noted that the board generally felt that the district was in a sound financial position and little time was devoted to financial discussions. The perception of financial good health was due to the board’s practice of excluding depreciation expense from bottom line figures and looking at only operational cash flow. This practice, while having no impact on day-to-day operations, impedes the district’s ability to plan for future capital improvements that include replacement of worn or out-of-date equipment and deferred maintenance. At the January 1999 meeting of the LACSD, the district's auditor reported to the board members that expenses have exceeded revenues for each of the last three years and, without modifications to expenses (including depreciation charges) and revenues, the district expenses will again exceed revenues.

Some observations were made when reviewing the expenses of the district. Over the last two years the district’s salary expenses have increased by approximately 19% overall and two key employees have received salary increases of 45%. A health-care insurance program that includes vision and dental care covers staff members and dependents at district cost. In addition, the board has recently elected to participate in the Public Employees Retirement System (PERS), providing retirement benefits for employees, which adds additional costs to the salary expenses for the district. Board members receive close to the statutory maximum stipend for each meeting plus vision and dental insurance.

The Grand Jury compared various district expenses to like-size jurisdictions. They found that legal, accounting and insurance expenses were well above the average as a percentage of revenue for like districts. Many districts do not provide full health benefits for their employees, nor do they pay the board members stipends for meeting.

Monthly public meetings of the board are not well attended, and there is infrequent public input. This may, in part, be due to the placement and display of meeting agendas and minutes at the local Post Office. Due to space limitations the minutes are not always displayed in full, and the customers cannot access the minutes directly.

The Grand Jury considered the final concern raised in the initial complaint: adequacy of the water supply. The San Antonio Creek groundwater basin underlies the entire district and provides the water for the district wells. Two wells are currently operational and have proven to be quite reliable. The district is considering drilling another well when the need arises, possibly in 2001. The cost is estimated at $120,000. Several projects are approved for the Los Alamos area and will place an additional burden on the services provided for the district. With the possibility of new growth, this is the optimum time for the district to consider raising connection fees to offset additional costs associated with growth.

FINDINGS AND
RECOMMENDATIONS

Finding #1:

The revenue generated by LACSD is not sufficient to meet the financial obligations of the district.

Recommendation #1:

Board members should undertake a thorough analysis of expenditures with a view toward reducing costs. At the same time consideration should be given to increasing water, sewer and connection fees.

Finding #2:

There is no general manager at the district to manage all routine operations and provide guidance to the board. Board members may not always be experienced or prepared to oversee all aspects of running a special services district.

Recommendation #2:

The district should explore options for sharing administrative services with neigh-boring districts or for being annexed by a larger nearby district with greater resources.

Finding #3:

Insufficient funds are being set aside for capital improvements and deferred maintenance.

Recommendation #3:

The board should augment the existing capital account by a required contribution schedule to address future maintenance needs, capital expenditures and other long-term financial obligations.

Finding #4:

The Santa Barbara Auditor-Controller does not review, on a regular basis, audited financial reports submitted annually by independent special districts.

Recommendation #4:

The Auditor-Controller should review the financial reports submitted by all independent special districts and, when a letter of going concern accompanies any statement, the Auditor-Controller should issue a public notice regarding the financial position of the district.

SUMMARY

LACSD has created a formula for economic decline by not addressing the need to reduce expenses to a minimum and adjust rates to meet expense levels. The board has been reluctant to increase water and wastewater rates regularly for a variety of reasons. However, under the current rate structure, additional growth will only exacerbate the decline. When one sells a product for less than the full cost of production, increased demand only elevates the loss. In addition, to attract and retain employees and directors, the board has been generous with salaries and benefits without a thorough analysis of the financial consequences for the district in the future.

Ultimately, the customers of LACSD should take a greater interest in the affairs of their district.

The Grand Jury would like to thank the employees and board members of LACSD for the cooperation shown to the Grand Jury during this investigation.

AFFECTED AGENCIES

Board of Directors, Los Alamos Community Service District

Findings: 1, 2, 3

Recommendations: 1, 2, 3

Auditor-Controller

Finding: 4

Recommendation 4