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HomeMy WebLinkAbout2010-10-12 - AGENDA REPORTS - AUDIT OF WASTE HAULERS (2)Agenda Item: CITY OF SANTA CLARITA AGENDA REPORT UNFINISHED BUSINESS City Manager Approval. Item to be presented by: Travis Lange DATE: October 12, 2010 SUBJECT: PRESENTATION OF THE RESULTS OF THE FINANCIAL AUDITS OF THE RESIDENTIAL AND COMMERCIAL WASTE HAULERS PERFORMED BY HF&H CONSULTANTS, LLC DEPARTMENT: Public Works RECOMMENDED ACTION 1. City Council receive the presentation regarding the results of the third party financial audits performed by Hilton, Farnkopf & Hobson Consultants, LLC (HF&H) of the solid waste commercial franchise held by Burrtec Waste Industries (Burrtec) and the solid waste residential franchise held by Blue Barrel Disposal/Waste Management (Waste Management). 2. Direct staff to work with the commercial and residential waste haulers to address the results of the audit and return to the City Council at a later date to address issues raised. . 3. Finalize the solid waste audits conducted by HF&H. BACKGROUND Both franchised waste haulers, Burrtec for commercial services and Waste Management for residential services, requested a financial audit to analyze impacts to their services and rates in accordance with Section 8.3.5 of the Franchise Agreements. Pursuant to Section 8.3.5 of the Franchise Agreements, the cost for the preparation of their financial statements and the audit shall be borne completely by the respective franchisee. Each hauler paid $41,902. The scope of the audit was developed by City staff in consultation with the waste haulers. The RFP, released on July 20, 2009, was sent to four firms and an additional 21 firms accessed the RFP via the City's website. The City Council awarded the contract to HF&H on January 27, 2009, APP' VED The final scope of work included analysis of the following items: • Evaluate the cost of service and profit margin for Waste Management and Burrtec and compare their profitability to industry averages. • Determine the financial impact to both Waste Management and Burrtec as it relates to the planned recycling facility not being available for use. • Evaluate Waste Management's and Burrtec's fuel cost increases over the most recent three years ending December 31, 2009. • Evaluate Waste Management's valuation of estimated average annual unrealized landfill profit. On September 21, 2010, a representative from HF&H presented the findings of the audits to the members of the Waste Diversion Committee, including committee members Mayor Weste and Mayor Pro Tem McLean. The presentation outlined the key factors that contributed to the haulers' revenue losses. An outline of the revenue losses are attached in a matrix. The factors included the following items: • Inaccurate cost estimates during the franchise bidding process • Associated costs for the development of a local recycling facility • Availability of a local recycling facility • Fluctuations in fuel costs • Unrealized landfill revenue After reviewing the audit, the waste haulers are requesting City staff meet with them to discuss potential solutions going forward to address revenue losses. City staff is recommending that City Council direct staff to meet with representatives from the respective waste haulers to determine potential solutions to address the findings of the audit and return to City Council at a later date to present the solutions for consideration. Staff is recommending the City Council finalize the audit reports completed by HF&H unless there are additional concerns City Council wants addressed. The current contracts expire June 2013. A satisfactory resolution is key to the City, either beginning the process to bid or extending the existing franchises. ALTERNATIVE ACTIONS Other action as determined by the City Council. FISCAL IMPACT There is no fiscal impact to the City. ATTACHMENTS HF&H Executive Summary of Burrtec Financial Audit HF&H Executive Summary of Waste Management Financial Audit Matrix of Audit Results HF&H Financial Audit of Burrtec Waste Industries HF&H Financial Audit of Waste Management/Blue Barrel Z SECTION I EXECUTIVE SUMMARY „ OlJecilve :_= Finding 1. Evaluate the cost of service and profit 1A. BWI reported operating losses of $618,000 margin for BWI and compare profitability for calendar year ("CY") 2007 and to industry averages. $478,000 for CY 2008;14% and 10% of total revenues, respectively, primarily as a result of inacctu•aLe cost estimates during the proposal process and the lack of availability of a local MRF. 1B. BVVI operated at a net adjusted loss of ` $24,000 for CY 2007 or 1 % of total revenues and a net adjusted profit of $56,000 for CY 2008 or 1% of total revenues, if "excess costs" are excluded. 1C: BWI's profitability in Santa Clarita is below industry averages, Industry profitability in the last three years has ranged from 5 % to 12%, 2. Determine the financial impact of the 2A. Based on the data provided by BM, the planned MRF not being available for use. annual impact of not having a local MRF during CY 2007 and CY 2008 is approximately $296,000 per year or 7% of average annual rate revenues. 2B. BWI incurred approximately $1,029,000 in un -reimbursed costs related to development of the MRF site. Amortized over the remaining three years of the Agreement, these costs would be approximately $343,000 annually or 8% of CY 2008 rate revenues, 3. Evaluate the fuel cost vlereases over the 3. The percentage change in BWI's fuel cost most recent three years ending December is lower than the change in the Producer 31, 2008. Price Index - No. 2 Diesel Fuel that is used to adjust rates. Cihj of Santa Chita, Burrtec Waste Industries May 6, 2010 3 SECTION I EXECUTIVE SUMMARY Ohlectzve" Frridingiq 1 Evaluate the cost of service and profit 1A: IAM reported operating losses of $2,522,000 margin for WM and compare profitability to for calendar year ("CY") 2007 and $2,021,000 for industry averages, CY 2008; 22% and 17% of Total Revenues, respectively. The losses were primarily the result of inaccurate cost estimates by jNM at the time of their proposal to the City and the lack of availability of the local MRF that was to be developed by Burrtec. 113:1A7M operated at an adjusted net loss of $803,000 for CY 2007 and $536,000 for CY 2008; 7% and 4% of Total Revenues, respectively, if "excess costs" are excluded. 10 ANM's profitability in Santa Clarita is below industry averages. Industry profitability in the last three years has ranged from 5% to 12%. 2• Determine the financial impact of the 2: Based on the data provided by W -M, the planned MRF not being available for use. annual impact of not having a local MRF is approximately $1,783,000 per year or 16.4% of rate revenues. 3. -Evaluate the rate of impact of fuel cost 3A: An increase in the cost of fuel in the amount increases. of $225,000 was not captured by the rate adjustment formula during the period from the first.quarter of 2003 through December 2005, the same period that 1ATM agreed to freeze'their collection rates. 3B: WM's fuel cost exceeded the reasonably anticipated fuel cost for January 1, 2004 through April 15, 2006 by approximately $467,000 during the period when WM agreed to lower rates from $18.64 to $16.25 per home per month. 4. Review and evaluate )NM's valuation of 4: Estimated average annual unrealized landfill estimated average annual unrealized.landfill profits, related to the waste stream anticipated profit• from a thud -party agreement with -Burrtec Waste Industries regarding the construction and operation of the Santa Clarita MRF, total $292,000 per year, Cihj of Santa Clarita, Waste Management 1 May 7, 2010 City of Santa Clarita Summary of Solid Waste Audit Results (1) 7% in transportation costs and 8% in unreimbursed MRF development costs Waste Management Burrtec Waste Industries I. Actual Loss as a % of Gross Revenue* 2007 -22% -14% 2008 -17% -10% II. Estimated loss without Excess Costs 2007 -7% -1% 2008 -4% 1% III. Impact on 2008 Rates to Recover: A. Higher Cost from No Local MRF 16% 150//0(1) B. Fuel Costs not Passed Through in Rate Adjustment Formula 3% n/a C. Estimated Unrealized Landfill Profits 3% 'n/a (1) 7% in transportation costs and 8% in unreimbursed MRF development costs CITY OF SANTA CLARITA Solid Waste Audit of Burrtec Waste Industries FINAL REPORT May 6, 2010 Prepared by: HF&H Consultants, LLC 3990 Westerly Place, Suite 195 Newport Beach, California 92660-2311 Phone: 949/251-8628 Facsimile: 949/251-9741 3990 Westerly Place, Suite 195 Newport Beach, California 92660 Telephone: 949/251-8628 Fax: 949/251-9741 www. hfh-consu ltan ts. com May 6, 2010 Mr. Travis Lange, R.E.H.S. Environmental Services Manager City of Santa Clarita 23920 Valencia Boulevard, Suite 300 Santa Clarita, California 91355-2196 FINAL REPORT Solid Waste Audit of Burrtec Waste Industries Dear Mr. Lange: 1 to Municipal Management Robert D. Hilton, CMC John W. Farnkopf, PE Laith B. Ezzet, CMC Richard J. Simonson, CMC Marva M. Sheehan, CPA We have completed the solid waste audit of Burrtec Waste Industries ("BWI"), the commercial refuse hauler for the City of Santa Clarita. Our findings are documented in the enclosed report. We are pleased to have had the opportunity to assist the City with the solid waste audit. If you have any questions, please call Laith Ezzet at 949/251-8902 or Darrell Bice at 949/251-0231. Very truly yours, i Laith B. Ezzet, CMC Darrell L. Bice Senior Vice President Director of Solid Waste & Recycling Audits City of Santa Clarita Solid Waste Audit of Burrtec Waste Industries TABLE OF CONTENTS SECTION DESCRIPTION PAGE I Executive Summary 1 II Study Background, Objectives and Scope of Work 2 III Findings 4 EXHIBITS Exhibit 1 Summary of Rate Revenues, Costs and Profit Margin for Calendar Years 1 Ended December 31, 2007 and 2008 Exhibit 2A Loads and Tons Delivered by Route Truck by Facility - Calendar Year Ended December 31, 2007 Exhibit 2B Loads and Tons Delivered by Route Truck by Facility - Calendar Year Ended December 31, 2008 Exhibit 3 Solid Waste Facilities Used as of February 2009 Exhibit 4 Monthly Fuel Cost Exhibit 5 Number of Routes and Route Hours as of February 2009 Exhibit 6 Inflation Indices - Labor, Fuel, Equipment and All Other Expenses Exhibit 7 Weighted Average Indices for Truck Operating Costs Exhibit 8 Calculation and Analysis of Inflation -Adjusted Costs Exhibit 9A Impact of No Local MRF- Calendar Year Ended December 31, 2007 Exhibit 9B Impact of No Local MRF - Calendar Year Ended December 31, 2008 1 SECTION I EXECUTIVE SUMMARY 1. Evaluate the cost of service and profit 1A. BWI reported operating losses of $618,000 margin for BWI and compare profitability for calendar year ("CY") 2007 and to industry averages. $478,000 for CY 2008; 14% and 10% of total revenues, respectively, primarily as a result of inaccurate cost estimates during 2. Determine the financial impact of the planned MRF not being available for use. 3. Evaluate the fuel cost increases over the most recent three years ending December 31, 2008. City of Santa Clanta, Burrtec Waste Industries the proposal process and the lack of availability of a local MRF. 1B. BWI operated at a net adjusted loss of $24,000 for CY 2007 or 1% of total revenues and a net adjusted profit of $56,000 for CY 2008 or 1% of total revenues, if "excess costs" are excluded. 10 BWI's profitability in Santa Clarita is below industry averages. Industry profitability in the last three years has ranged from 5% to 12%. 2A. Based on the data provided by BWI, the annual impact of not having a local MRF during CY 2007 and CY 2008 is approximately $296,000 per year or 7% of average annual rate revenues. 2B. BWI incurred approximately $1,029,000 in unreimbursed costs related to development of the MRF site. Amortized over the remaining three years of the Agreement, these costs would be approximately $343,000 annually or 8% of CY 2008 rate revenues. 3. The percentage change in BWI's fuel cost is lower than the change in the Producer Price Index - No. 2 Diesel Fuel that is used to adjust rates. May 6, 2010 SECTION II STUDY BACKGROUND, OBJECTIVES AND SCOPE OF WORK STUDY BACKGROUND The City of Santa Clarita has two franchised haulers. Waste Management ("WM") provides service to residential customers in the City and Burrtec Waste Industries ("SWI") provides service to business customers. The Agreement between WM (USA Waste of California; Inc. DBA Blue Barrel Disposal) for Residential Solid Waste Management Services ("WM Agreement") was effective April 16, 2006 and expires June 30, 2013. The Agreement between BWI for Commercial Solid Waste Management Services ("SWI Agreement") was effective August 1, 2004 and expires June 30, 2013. Both haulers have requested an extraordinary rate increase per the guidelines outlined in their franchise agreements with the City. The City desires for a third -party expert to audit the financial information of both haulers. The remainder of this report describes the study results for BWI. The results for WM are described in a separate report. OBJECTIVES The study objectives were as follows: 1. Evaluate the cost of service and profit margin for BWI and compare profitability to industry averages. 2. Determine the financial impact of the planned material recovery facility ("MRF"). not being available for use. 3. Evaluate the fuel cost increases over the most recent three years ending December 31, 2008. SCOPE OF WORK In order to achieve the study objectives, we performed the following tasks: 1. Reviewed background documents provided by City staff, including the current franchise agreements and any amendments, and the historical rate adjustment documentation. City of Santa Carita, Burrtec Waste bidustries 2 May 6, 2010 to F> 2. Prepared for and conducted a kickoff meeting with City staff on February 25, 2009 to confirm the project approach, roles of the study participants, schedule, and discuss key issues. 3. Conducted an initial meeting with BWI and City staff on February 25, 2009 to confirm the project approach and schedule, and discuss the initial data request. 4. Reviewed the data submitted by BWI in response to our data and document request. 5. Conducted a site visit at the BWI's offices to verify reported information to source documents such as accounting records, disposal records, MRF records, truck operating records, and other information. We interviewed management regarding accounting and cost allocation procedures, and obtained explanations for any unusual data observed. City of Santa Clarita, Burrtec Waste Industries 3 May 6, 2010 SECTION III FINDINGS Objective #1: Evaluate the cost of service and profit margin for BWI and compare profitability to industry averages. Finding #1A: BWI reported operating losses of $618,000 for calendar year 2007 and $478,000 for calendar year 2008; 14% and 10% of total revenues, respectively, primarily as a result of inaccurate cost estimates during the proposal process and the lack of availability of a local MRF.. BWI provided a summary of revenues and operating costs for CY 2007 and 2008, as shown in Table 1. Total revenues for CY 2007 were $4,478,000 with a net loss of $618,000 or 14%. Total revenues for CY 2008 were $4,743,000 with a net loss of $478,000 or 10% of total revenues. Table 1: Summary of Operating Loss for Calendar Years 2007 and 2008 Deserrptton k • ,,, _,,, W 2007 ... w(in thansand§), "/4of Total r Revenues 2008 m thousands .-;`• 4>.. { ) :Reuenuesx. `% of Totat '. Revenues Rate Revenues $ 4,356,000 97% $ 4,448,000 94% Other Revenues 122,000 3% 295,000 6% 4,478,000 100% 4,743,000 100% Total Revenues Operating Costs: Direct Costs 3,547,000 79% 3,600,000 76% Indirtect Costs 1,371,000 31% 1,502,000 32% (440,000) -10% (359,000) .-8% Net Profit (Loss) from Operations Other Income/Expenses 178,000 4% 119,000 2% $ 618,000 -14% $(478,000 -10% Net Income Loss (1) See Exhibit 1. A portion of the company's net loss in 2007 is due to transfer, processing and disposal costs which exceed the amount of compensation for such costs included in the rates. For example, as shown in Exhibit 8, company compensation was $1,204,000 for these categories of costs, and actual costs paid by the company were $1,506,000, a difference of $302,000. However, in 2008, company compensation for transfer, processing and disposal cost was $11,000 higher than actual costs ($1,246,000 in compensation and $1,235,000 in costs, as shown in Exhibit 8). The reason for the large decline in actual costs for transfer, processing and disposal costs in 2008 compared to 2007 was that the company delivered 9,502 fewer tons in 2008 for processing to the Community Resource and Recycling Recovery, Inc. ("CRRR1") MRF (including 595 fewer tons of food waste and 8,,907 tons of mixed waste, as shown in Exhibit 2B) and instead delivered those tons to the landfill which has lower tipping fees. The processing fees in 2008 at the CRRRI MRF were $48.00 per ton for mixed refuse and recyclables and $45.00 per ton for food waste, compared to a landfill fee at Chiquita Canyon of $30.02 per ton. City of Santa Clarita, Burrtec Waste Industries 4 May 6, 2010 Finding #1B: BWI operated at a net adjusted loss of $24,000 for CY 2007 or 1% of total revenues and a net adjusted profit of $56,000 for CY2008 or 1% of total revenues, if "excess costs," are excluded. As shown in Table 1, BWI reported a 14% loss for the Santa Clarita commercial contract for CY 2007 and a 10% loss for CY 2008. BWI's net loss for CY 2007, as adjusted for excess costs (defined below), is $24,000 or 1% of Total Revenues. BWI's net profit for CY 2008, as adjusted for excess costs, is $56,000 or 1% of Total Revenues. Table 2: Adjusted Net Profit or (Loss) for CY 2008, "Excluding Excess Costs" Table 3 compares the actual costs for CY 2007 and CY 2008 to the inflation-adjusted total costs in BWI's 2003 proposal for commercial refuse services. The 2003 Proposal costs are inflated to 2007 and 2008 dollars using various published price indices in order to compare the CY 2007 and CY 2008 costs for reasonableness. Since the 2003 Proposal costs assumed the availability of a local MRF, the actual CY 2007 and CY 2008 costs are adjusted for the impact of not having the use of a local MRF (See Finding #2). As shown in Table 3, actual costs for CY 2007 and CY 2008, adjusted for the MRF impact, exceed the inflation-adjusted 2003 Proposal costs by $594,000 and $534,000, respectively. Details of the calculation of inflation-adjusted costs for CY 2007 and CY 2008 are presented in Exhibit 8. These differences are primarily due to inadequate estimates of the indirect costs and other expenses in the 2003 proposal to the City. According to the BWI Agreement, Section 6.6 - Extraordinary Adjustments, states that extraordinary adjustments "shall not include... inaccurate estimates by the Company of its proposed cost of operation..." Table 3: Comparison of Inflation -Adjusted 2003 Proposed Total Costs to Actual Total Costs for CY 2007 and CY 2008* Total Direct Costs (Exhibit 8, Table 8-1) $ 3,008,000 $ 3,547,000 $ 3,143,000 $ 3,600,000 Total Indirect Costs (Exhibit 8, Table 8-2) 1,186,000 1,549,000 1,259,000 1,621,000 4,194,000 5,096,000 4,402,000 5,221,000 Total Operating Costs Less Impact of No Local MRF (Table 5) 308,000 285,000 $ 4,194,000 4,788,000 $ 4,402,000 4,936,000 Total Operating Costs, Less Impact of No Local MRF Proposed 2003 Costs Adjusted for Inflation Total Operating Costs in Excess of Proposed 2003 Costs Adiusted for Inflation 4 ,,. 4,194,000 $ 594,000 4,402,000 $ 534,000 * See Exhibit 8 for details of the calculation of inflation-adjusted costs for CY 2007 and CY 2008 City of Santa Clarita, Burrtec Waste Industries 5 May 6, 2010 13 Finding #1C: BWI's profitability in Santa Clarita is below industry averages. Industry profitability in the last three years has ranged from 5% to 12%. Based on the industry data for the last three years shown in Table 4, average industry profitability ranged from 5% to 12%. Table 4: Industry Profitability for Last Three Years (1) Data are averages of operational data from 2005 to 2007 annual financial reports. (2) The Risk Management Association Annual Statement Studies 2008-2009 - NAICS 562111 (SIC #4212) - Adnnn and Waste Management Services - Solid Waste Collection Objective #2: Determine the financial impact of the planned MRF not being available for use. Finding #2A: Based on the data provided by BWI, the average annual impact of not having a local MRF during CY 2007 and CY 2008 is approximately $296,000 per year or 7% of average annual rate revenues. Based on BWI's truck operating cost for calendar year 2008 and the routes and route hours as of February 2009, BWI's' truck operating cost per route hour is approximately $58. Additionally, as a direct result of not having a local MRF, BWI's ability to cost- effectively divert the required waste was impeded. Table 5 shows the estimated impact (incremental cost) of not having the use of a local MRF. The MRF impact was estimated to be $308,000 for CY 2007 and $285,000 for CY 2008, including the penalty of $40,000 each year for not achieving the diversion requirement. (As a result of not meeting the 50% diversion requirement, SWI incurred a penalty paid to the City of $10,000 per quarter as required in Section 4.2.5 (Minimum Recycling Requirements) of the BWI Agreement.) City of Santa Clarita, Burrtec Waste Industries 0 May 6, 2010 1 A u,AH RMA Data �2? to Income Data A1l�ied t1j Republic 1�1 Mana ement 11): g from Apr1�1 2007` w to h c 2008 Mar 31 Itki-- z: Profit Before Taxes 7% 12% 11% 5% (1) Data are averages of operational data from 2005 to 2007 annual financial reports. (2) The Risk Management Association Annual Statement Studies 2008-2009 - NAICS 562111 (SIC #4212) - Adnnn and Waste Management Services - Solid Waste Collection Objective #2: Determine the financial impact of the planned MRF not being available for use. Finding #2A: Based on the data provided by BWI, the average annual impact of not having a local MRF during CY 2007 and CY 2008 is approximately $296,000 per year or 7% of average annual rate revenues. Based on BWI's truck operating cost for calendar year 2008 and the routes and route hours as of February 2009, BWI's' truck operating cost per route hour is approximately $58. Additionally, as a direct result of not having a local MRF, BWI's ability to cost- effectively divert the required waste was impeded. Table 5 shows the estimated impact (incremental cost) of not having the use of a local MRF. The MRF impact was estimated to be $308,000 for CY 2007 and $285,000 for CY 2008, including the penalty of $40,000 each year for not achieving the diversion requirement. (As a result of not meeting the 50% diversion requirement, SWI incurred a penalty paid to the City of $10,000 per quarter as required in Section 4.2.5 (Minimum Recycling Requirements) of the BWI Agreement.) City of Santa Clarita, Burrtec Waste Industries 0 May 6, 2010 1 Table 5: Estimated Impact of Not Having a Local MRF �Descnption E ., - G'alendai �. 2007 Year 2008 � hexa e A g , Incremental Hours (Exhibits 9A & 913) 4,617 4,221 4,419 Average Truck Operating Cost* $ 58 $ 58 $ 58 Estimated MRF Impact** $ 268,000 $ 245,000 $ 256,000 40,000 40,000 40,000 Penalty for Not Achieving Diversion Goal $ 308,000 $ 285,000 $ 296,000 Total Estimated MRF Impact $ 4,356,000 $ 4,448,000 $ 4,402,000 Rate Revenues MRF Impact as a Percent of Rate Revenues 7% 6% .7% * Based on CY 2008 truck operating costs and February 2009 route hours. Data was not available to estimate truck operating cost per hour for CY 2007. ** Rounded to thousands. 2B: SWI incurred approximately $1,029,000 in unreimbursed costs related to development of the MRF site. Amortized over the refraining three years of the BWI Agreement, these costs would be approximately $343,000 annually or 8% of CY 2008 rate revenues. The BWI Agreement with the City requires BWI to construct and operate a material recovery facility (MRF). Since the inception of the BWI Agreement, three sites have been identified and none were approved. After proposing its third MRF site, Burrtec withdrew its proposal after members from the community expressed concerns about the traffic, zoning and proximity to residential housing. Through December 31, 2008, BWI incurred $4,494,000 in accumulated costs for the latest MRF site (See Table 6), including approximately $3,465,000 in land costs and $1,029,000 in permitting, consulting and interest costs. The lost value to BWI is the total accumulated MRF cost, less the sales price of the property. The property was acquired prior to the current downturn in the real estate market. Accordingly, it is likely that the actual value of the land is less than the $3,465,000 land purchase price reflected in Table 6. However, the cost of the land may be recovered in whole or in part depending on the selling price of the property, and the land cost is not included in the rate impact calculation. Table 6: Summary of Accumulated MRF Costs Purchase Cost $ 3,465,000 Consulting Fees and Engineering 593,000 Capitalized Interest and Loan Costs 298,000 City Fees and Permits 138,000 Permitting, Consulting and Interest Costs 1,029,000 Total Accumulated MRF Cost $ 4,494,000 Cihj of Santa Clarita, Burrtec Waste Industries 7 May 6, 2010 f5 The permitting, consulting and interest costs incurred, if amortized over the remaining three years of the BWI Agreement would be approximately $343,000 per year or 8% of CY 2008 rate revenues. Objective #3: Evaluate the fuel cost increases over the most recent three years ending December 31, 2008. Finding #3: The percentage change in BM's fuel cost is lower than the change in the Producer Price Index - No. 2 Diesel Fuel that is used to adjust rates. Section 6.4 of the BWI Agreement establishes the methodology for adjusting rates. The Producer Price Index #WPU057303 (Fuels and Related Products and Power, #2 Diesel Fuel) is identified and used for the adjustment of the fuel cost component for fiscal year 2007 and fiscal year 2008. BWI uses compressed natural gas vehicles to provide commercial refuse services in the City. HF&H calculated and charted the percentage change in BWI's fuel cost and the PPI for No. 2 Diesel Fuel from August 2004 through December 2008 (Chart #1). Chart #1 shows the change in BWI fuel cost and the PPI for No. 2 Diesel Fuel from August 2004 to December 2008. As shown in Chart #1 and Table 7, the percentage change in BWI fuel cost is lower than the change in the PPI for No. 2 Diesel Fuel that is used in the rate adjustment formula when the entire period of analysis in considered. The percentage changes in the annual averages for PPI for No. 2 Diesel and Natural Gas are reflected in Exhibit 6. For comparative purposes, we also graphed the PPI for natural gas. Table 7: Comparison of the BWI Fuel Cost and PPI Indices Percentage Change Actual C64"6r PPI Index � 08f01/04� 12%31/©8 Pe centa . g Change Actual Monthly Fuel Cost $ 13,918 $ 13,742 -1.3% PPI No. 2 Diesel Fuel (Monthly Index) (1) 135.1 171.5 26.9% PPI Natural Gas(Monthly Index (z) 249.8 242.0 -3.1% (1) PPI - Fuels and Related Products and Power, No. 2 Diesel Fuel - WPU057303 (2) PPI - Fuels and Related Products and Power, Natural Gas - WPU0531 City of Santa Clarita, Burrtec Waste hidustries May 6, 2010 1 v �I li O/ q® ^L W AEA+ Av W 0 -J O O N V/ CD E 0 T !0 U- r_ CD r_ m v 0 0 0 0 0 O O O O O O O Ltd o LO o Ln Lo N N � T- N 0 m v co v CD v v M C C 7 V m co co co r co O M coIn co M co M M O co CD coN O Lo N N M CNN N N N co r O V M N O m co r LLi O C 0 (-7 H 00 '0 �o O Vr O n �r) 00 N 00 N O O L� O d! 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O W [� M N ri M h N N to H 00 M 00 N N Lr) d� dl cV M 0 0 0 0 0 o o -O - 0 0 0 17=0= N Ln 10 t V N O M hm i --i Cn M N N 0 0 0 0 0 0 0 0 0 0 o 0 0 0 0 0 0 0 0 0 0 0 O Ln M ll N 1.0 h o7 r -i d+ d� h OO d ra <\ Lr) Lr) N � M LO (V N 00 -11, LO N 10 \D O M O, M Dl N MW ClS') M vD m o 00 i o O < 0 0 0 o 8IR0 0 0 0 0 0 am m oo d� .i ra N M N m N _ ci y N w O 0 0 0 0 0 o o -O - 0 0 0 17=0= N Ln 10 t V N O M hm i --i Cn M N N y v o 00 i o O < ti N N N am oo o N _ ci y N w O o i m O cov O N y> O N r U U m 3 ori•� x y p N od y N to Q) Q X r0 Ol rt \ N > .d C v r" ro N , N � O �.J 4.1 �' QD R n o d y G v U > b U 5 M c c o Q o o y ... r N ._. 4i z y rn 7 m ~ M r Y p .rm, t R+ O V O O N y ° U rn M ayi c ti Cc, '-� 3 �" r m '" �" y W v -o O v It 7 r c z o CS) G yell m� O v Lf) _o w�C- U z c.U w w u � UO u ►• 0 0 0 0 00 Lri O N 0 0 0 00 d+ O� di O 00 r -r �.o r-4 C 0 0 0 O 00 d! 0 0 0 Ll� \.o L' r-4 L-� Uf r-+ N c--+ OR o° O O O O 0 0 0 0 25 0 0 Calculation and Analysis of Inflation -Adjusted Costs Direct Costs Exhibit 8 In Table 8-1, direct costs submitted in BWI's 2003 proposal to the City for commercial refuse service are adjusted for inflation to 2007 and 2008 dollars in order to compare the CY 2007 and CY 2008 actual costs for reasonableness. As shown in Table 8-1, CY 2007 direct costs exceed the adjusted 2003 proposed costs by $539,000 and CY 2008 direct costs exceed the adjusted 2003 proposed costs by $457,000. A substantial part of these differences are explained by the impact of not having a local MRF, which is quantified in Table 5 and discussed in Finding #2. Table 8-1: Summary of Direct Costs and Other Operational Costs for the 2003 Proposal and Calendar Years 2007 and 2008 c °/n�Change 2003 ` CY 2007 "I Change`. 2003 CY 2008 Mob $escn tron� Y ; 2003 Pro >n Prrce Ad casted 1 Actual s-. m Pnc2 Adjusted ; Actual osal P Indrees to 2007 Indices •k to 2008 Ma,. } Direct Costs: Truck OperatingCostd) $1,396,000 14.4% $1,597,000 $1,471,000 20.6% $1,684,000 $1,690,000 Transfer/Disposal/ProcessingCosts)z) 1,036,000 16.2% 1,204,000 1,506,000 20.3% 1,246,000 1,235,000 Container Depreciation/Amortizationo) 179,000 15.5% 207,000 349,000 18.9% 213,000 414,000 Other Direct Costs°) 14.4% 221,000 20.6% 261,000 Subtotal: Direct Costs $2,611,000 $3,008,000 $3,547,000 1 $3,143,000 $3,600,000 Actual Total Direct Costs in Excess of Inflation -Adjusted 2003 $ 539,000 $ 457,000 (1) Percentage change is based on the weighted average index - see Exhibit 7 (2) Percentage change is based on the CPI - All Urban Users, All Items - U.S. City Average. (3) Percentage change is based on the PPI for Heavy Duty Truck Manufacturing - PCU336120331201, which is used in the arale adjustment formula for all equipment. ' 2003 Proposal adjusted by percentage change in annual average of respective indices to 2007 dollars. " 2003 Proposal adjusLect by percentage change in annual average of respective, indices to 2008 dollars. Indirect Costs and Other Expenses In Table 8-2, the indirect costs submitted in BWI's commercial proposal are adjusted for inflation from 2003 to 2007 and 2008 in an effort to provide an equivalent comparison. As shown in Table 8-2, Indirect Costs and Other Expenses for CY 2007 and CY 2008 exceed the inflation-adjusted data for 2003 by approximately $363,000 and $362,000, respectively. A portion of the difference is reflected in the Corporate Overhead Charge. The Corporate Overhead Charge was .projected in the 2003 proposal at $78,000. The CY 2007 adjusted Corporate Overhead Charge is $91,000 and the CY 2008 adjusted Corporate Overhead Charge is $94,000. The actual Corporate Overhead Charge for CY 2007 and CY 2008, as shown in Table 8-2, is $180,000 for each year, approximately twice as much as the inflation-adjusted charge. The remaining differences of approximately $274,000 for CY 2007 and $276,000 for CY 2008 are primarily due to inadequate estimates of the indirect costs and other expenses in the 2003 proposal. City of Santa Clarita, Burrtec Waste Industries ROM May 6, 2010 Z6 Exhibit 8 Table 8-2: Summary of Indirect Costs and Other Expenses for the 2003 Proposal and Calendar Years 2007 and 2008 Local General and Admiuustrative Cost 1 $ 526,000 1 16.2% 1 $ 611,000 1 $ 707,000 1 3.5% 1 $ 633,000 1 $ 790,000 Corporate Overhead Q) 78,000 16.2% 91,000 180,000 3.5% 94,000 180,000 Franchise Fees/Other City Fees 412,000 Actual 484,000 484,000 Actual 532,000 532,000 1,016,000 1,186,000 1,371,000 1,259,000 1,502,000 Subtotal: Indirect Costs Other Expenses: Interest Expense 160,000 101,000 Other Expenses 18,000 18,000 - 178,000 - 119,000 Total Other Income/ Expenses $1,016,000 $1,186,000 $1,549,000 $1,259,000 $1,621,000 Total Indirect and Other Expenses Actual Total Indirect Costs in Excess of 1 Inflation -Adjusted 2003 $ 363,000 $ 362,000 (1) CPI - All Urban Consumers, All Items, Los Angeles -Riverside Orange Co. - 2003 to 2007 - (217.338 + 187.000 =16.2%). (2) CPI - All Urban Consumers, All Items, U.S. City Average - 2007 to 2008 - (225.008 + 217.338 = 3.5%). (3) Allocation of $6,500 in 2003 proposal and $15,000 per month in CY 2007 and CY 2008. City of Santa Clarita, 77 Bun•tec Waste Industries 8-2 May 6, 2010 Z. 0 0 ^' o H y _ O N N 00 O 00 110 `0 1�0 di 0O0 00 cr) a\ et+ O O Lo N lC N ^\ O H ` ON * LO Lf) m oo0\ O 000 00 � � O H 0 0 -- o00 00 00 0 cl c N � � m m j ,M 0�0 cr � v � O � C:) o oho oqo og O� N N N N N (7) e�j v 0 000 - �0 H a� LO O �.c o 0 a cC of 5 w� O UN 01 �� > U QUO ;4Ucn�� C7U�0 C7 0 0 00 0 0 N r1 V U a Q v O O m N N N rl N 000 LO d cin O di N H N c � O O H v ) cN � m , , v H Om N\0 M 44 m 110 00 N O r -i O\ O \.O M cn N e— N d� Lr) �\ n m 0 E� 0 0 -- o00 00 0 0 ON m m m m cm cc H cc o �oqLq oq OC) 3 O O m N N �+ O cq O v � O O o 0 0 0 0 0 0 O O O C:) O O O O O O O O O O - � N I N m O\ � 000 d It 00 c0 00 N O M M rti a nom/ w cz H v H O U P4 w cu 94U0 9uUn) C7UP40 C5 �l O H O CITY OF SANTA CLARITA Solid Waste Audit of Waste Management FINAL REPORT May 7, 2010 Prepared by: HF&H Consultants, LLC 3990 Westerly Place, Suite 195 Newport Beach, California 92660-2311. Phone: 949/251-8628 Facsimile: 949/251-9741 LSF' 30 sory Services to Municipal Management 3990 Westerly Place, Suite 195 Newport Beach, California 92660 Telephone: 949/251-8628 Fax: 949/251-9741 www. hfh-consul tan ts. com May 7, 2010 Mr. Travis Lange, R.E.H.S. Environmental Services Manager City of Santa Clarita 23920 Valencia Boulevard, Suite 300 Santa Clarita, California 91355-2196 FINAL REPORT Solid Waste Audit of Waste Management Dear Mr. Lange: Robert D. Hilton, CMC John W. Farnkopf, PE Laith B. Ezzet, CMC Richard J. Simonson, CMC Marva M. Sheehan, CPA We have completed the solid waste audit of Waste Management Industries ("WM"), the residential refuse hauler for the City of Santa Clarita ("City"). Our findings are documented in the enclosed report. We are pleased to have had the opportunity to assist the City with the solid waste audit. If you have any questions, please call Laith Ezzet at 949/251-8902 or Darrell Bice at 949/251-0231. Very truly yours, la 4-11*' Laith B. Ezzet, CMC Darrell L. Bice Senior Vice President Director of Solid Waste & Recycling Audits 31 City of Santa Clarita Solid Waste Audit of Waste Management TABLE OF CONTENTS SECTION DESCRIPTION PAGE I Executive Summary 1 II Study Background, Objectives and Scope of Work 2 III Findings 4 EXHIBITS Exhibit 1 Summary of Rate Revenues, Costs and Profit Margin for Calendar Years 3z- Ended December 31, 2007 and 2008 Exhibit 2 Loads and Tons Delivered by Route Truck by Facility - Calendar Year Ended December 31, 2008 Exhibit 3 Disposal Sites, Mileage and Trip Time Exhibit 4 Supporting Fuel Cost Calculations Exhibit 5 Number of Routes and Route Hours as of February 2009 Exhibit 6 Inflation Indices - Labor, Fuel, Equipment and All Other Expenses Exhibit 7 Weighted Average Indices for Truck Operating Costs Exhibit 8 Santa Clarita Population and Housing Estimates Exhibit 9 Calculation and Analysis of Inflation -Adjusted Costs 3z- SECTION I EXECUTIVE SUMMARY Objectives Finding`s 1. Evaluate the cost of service and profit 1A: WM reported operating losses of $2,522,000 margin for WM and compare profitability to for calendar year ("CY") 2007 and $2,021,000 for industry averages. CY 2008; 22% and 17% of Total Revenues, respectively. The losses were primarily the result of inaccurate cost estimates by WM at the time of their proposal to the City and the lack of availability of the local MRF that was to be developed by Burrtec. 1B: WM operated at an adjusted net loss of $803,000 for CY 2007 and $536,000 for CY 2008; 7% and 4% of Total Revenues, respectively, if "excess costs" are excluded. 1C: WM's profitability in Santa Clarita is below industry averages. Industry profitability in the last three years has ranged from 5% to 12%. 2. Determine the financial impact of the 2: Based on the data provided by WM, the planned MRF not being available for use. annual impact of not having a local MRF is approximately $1,783,000 per year or 16.4% of rate revenues. 3. Evaluate the rate of impact of fuel cost 3A: An increase in the cost of fuel in the amount increases. of $225,000 was not captured by the rate adjustment formula during the period from the first quarter of 2003 through December 2005,.the same period that WM agreed to freeze their collection rates. 3B: WM's fuel cost exceeded the reasonably anticipated fuel cost for January 1, 2004 through April 15, 2006 by approximately $467,000 during the period when WM agreed to lower rates from $18.64 to $16.25 per home per month. 4. Review and evaluate WM's valuation of 4: Estimated average annual unrealized landfill estimated average annual unrealized landfill profits, related to the waste stream anticipated profit. from a third -party agreement with Burrtec Waste Industries regarding the construction and. operation of the Santa Clarita MRF, total $292,000 per year. City of Santa Clarita, Waste Management 1 May 7, 2010 SECTION II STUDY BACKGROUND, OBJECTIVES AND SCOPE OF WORK STUDYBACKGROUND- The City of Santa Clarita has two franchised haulers. Waste Management ("WM") provides service to residential customers in the City and Burrtec Waste Industries ("BWI") provides service to the business customers. The Agreement between WM (USA Waste of California, Inc. DBA Blue Barrel Disposal) for Residential Solid Waste Management Services ("WM Agreement") was effective April 16, 2006 and expires June 30, 2013. The Agreement between BWI for Commercial Solid Waste Management Services ("BWI Agreement") was effective August 1, 2004 and expires June 30, 2013. The WM Agreement (Section 6.2:1) required WM to reduce its residential rates under the previous residential contract effective January 1, 2004 and maintain those rates until April 15, 2006. On April 16, 2006, the residential rates would decrease to the rates provided in the new WM Agreement and would remain unchanged until July 1, 2007, the effective date of the first allowed rate adjustment. The standard residential rates and the effective dates (periods) are as follows: Standard Residential Rates Effective Dates (Periods) $18.64 1 $16.25 1 $16.62 1 $17.28 Both haulers have requested an extraordinary rate increase per the guidelines outlined in their franchise agreements with the City. According to City staff, both haulers agreed to allow the City to release a Request For Proposals (RFP) to retain a third -party expert to audit the financial information of the haulers. The remainder of this report describes the study results for WM. The results for BWI are described in a separate report. City of Santa Clarita, Waste Management 2 May 7, 2010 3 OBJECTIVES The study objectives were as follows: 1. Evaluate the cost of service and profit margin for WM and compare profitability to industry averages. 2. Determine the financial impact of the planned MRF not being available for use. 3. Evaluate the rate of impact of fuel cost increases. 4. Review and evaluate WM's valuation of estimated average annual unrealized landfill profits. SCOPE OF WORK In order to achieve the study objectives, we performed the following tasks: Reviewed background documents provided by City staff, including the current franchise agreements and any amendments, and the historical rate adjustment documentation. 2. Prepared for and conducted a kickoff meeting with City staff on February 25, 2009 to confirm the project approach, roles of the study participants, and schedule, and discuss key issues. 3. Conducted an initial meeting with WM and. City staff on February 25, 2009 to confirm the project approach and schedule, and discuss the initial data request. 4. Reviewed the data submitted -by WM in response to our data and document request. Conducted a site visit at WM's offices to verify reported information to source documents such as accounting records, disposal records, MRF records, truck operating records, and other information. We interviewed management regarding accounting and cost allocation procedures, and obtained explanations for any unusual data observed. City of Santa Clarita, Waste Management 3 May 7, 2010 �3S SECTION III FINDINGS Objective #1: Evaluate the cost of service and profit margin for WM and compare profitability to industry averages. Finding #1A: WM reported operating losses of $2,522,000 for CY 2007 and $2,021,000 for CY 2008; 22% and 17% of Total Revenues, respectively. A little more than half of the excess costs resulted from the lack of availability of the local MRF that was to be developed by Burrtec and the remainder were the result of inaccurate cost estimates by WM at the time of their proposal to the City. WM provided a summary of revenues and operating costs for calendar years 2007 and 2008, as shown in Table 1. Total revenues for calendar year 2007 were $11,256,000 with a net loss of $2,522,000 or 22% of total revenue. Total revenues for calendar year 2008 were $12,123,000 with a net loss of $2,021,000 or 17% of total revenue. Table 1: Summary of Operating Loss for Calendar Years 2007 and 2008(1) bescrrptibn ZOi)i R °7a of 1 otalFlo Revenue " 2R o£ Tcitah? Revenues $ 1,783,000 51% m... ,,. $ 1,783,000 55% Rate Revenues $ 10,477,000 93 % $ 10,899,000 90 % Recycling and Other Revenue 779,000 7% 1,224,000 10% $ 11,256,000 100 % $ 12,123,000 100% Revenues Operating Costs: Direct Costs: 10,973,000 97 % 11,154,000 92% Indirect Costs: 2,805,000 25% 2,990,000 25% $ 2,522,000 (22) % $ (2,021,000)1 (17) Net Profit Loss from Operations (1) Exhibit 1 The losses were caused by operating costs in excess of amounts projected in WM's 2003 proposal. Of this amount, slightly more than half was the result of the lack of availability of a local MRF (See Table 2). Table 2: Summary of Excess Costs Descnphon 2007 % 2008. �.. '.. .. ,,.. $ 1,783,000 51% m... ,,. $ 1,783,000 55% Impact of No Local MRF Inaccurate Cost Estimate in 2003 Proposal 1,719,000 49% 1,485,000 45% $ 3,502,000 100% $ 3,268,000 100% Total Excess Costs See Findings #1B and #2 for a detailed discussion of the causes of the operating losses. City of Santa Clarita, Waste Management 4 May 7, 2010 Finding #1B: WM operated at an adjusted net loss of $803,000 for CY 2007 and $536,000 for CY 2008; 7% and 4% of Total Revenues, respectively, if "excess costs" are excluded. As shown in Table 1, WM reported a 22% loss for the Santa Clarita residential contract for calendar year 2007 and a 17% loss for calendar year 2008. WM's adjusted net loss for CY 2007 is $803,000 or 7% of Total Revenues (See Table 2), as adjusted for excess costs (defined below) of $1,719,000. WM's adjusted net loss for CY 2008 is $536,000 or 4% of Total Revenues (See Table 2), as adjusted for excess costs of $1,485,000. Table 2: Adjusted Net Loss for CY 2007 and CY 2008 Table 3 compares the actual costs for CY 2007 and CY 2008 to the inflation-adjusted total costs in the WM 2003 Proposal for residential refuse services. The 2003 Proposal costs are inflated to 2008 dollars using various indices in order to compare the CY 2007 and CY 2008 costs for reasonableness. Since the 2003 Proposal costs assumed the availability of a local MRF, the actual CY 2007 and CY 2008 costs are adjusted for the impact of not having the use of a local MRF (See Finding #2). As shown in Table 3, actual costs for CY 2007 and CY 2008, adjusted for the MRF impact, exceed the inflation-adjusted 2003 Proposal costs by $1,719,000 and $1,485,000, respectively. Details of the calculation of inflation-adjusted costs for CY 2007 and CY 2008 are presented in Exhibit 9. These differences are primarily due to inadequate estimates of the indirect costs and other expenses in the 2003 Proposal. According to the WM Agreement, Section 6.6 Extraordinary Adjustments states that extraordinary adjustments "shall not include... inaccurate estimates by the Company of its proposed cost of operation..." City of Santa Clarita, Waste Management 5 May 7, 2010 37 Table 3: Comparison of Inflation -Adjusted 2003 Proposed Total Costs to Actual Total Costs for CY 2007 and CY 2008* al Direct Costs (Exhibit 9, Table 9-1) al Indirect Costs (Exhibit 9, Table 9-2) Total Operating Costs s Impact of No Local MRF (Table 5) Total Operating Costs, Less Impact of No Local MRF posed 2003 Costs Adjusted for Inflation Total Operating Costs in Excess of Proposed 2003 Costs Adjusted for Inflation $ 7,327,000 $10,973,000 $ 7,697,000 $11,154,000 2,949,000 2,805,000 3,179,000 2,990,000 10,276,000 13,778,000 10,876,000 14,144,000 1,783,000 1,783,000 $10,276,000 11,995,000 $10,876,000 12,361,000 ..� 10,276,000 10,876,000 $ 1,71 * See Exhibit 9 for details of the calculation of inflation-adjusted costs for CY 20U% and CY 2UU8. Finding #1C: WM's profitability in Santa Clarita is below industry averages. Industry profitability in the last three years has ranged from 5% to 12%. Based on the industry data for the last three years shown in Table 4, average industry profitability ranged from 5% to 12%. Table 4: Industry Profitability for Last Three Years (1) Data are averages of operational data from 2005 to 2007 annual financial reports. (2) The Risk Management Association Annual Statement Studies 2008-2009 - NAICS 562111 (SIC #4212) - Admin and Waste Management - Solid Waste Collection Objective #2: Determine the financial impact of the planned MRF not being available for use. Finding #2: Based on the data provided by WM, the anconal impact of not having a local MRF is approximately $1,783,000 per year or 16.4% of rate revenues. Based on WM's truck operating cost for calendar year 2008 and the routes and route hours as of February 2009 and WM's truck operating cost of $71 per route hour (Table 5), the estimated impact of not having a local MRF is approximately $1,783,000 annually, including the penalty of $40,000 for not achieving the diversion requirement, or 16.4% of rate revenues. As a result of not meeting the 50% diversion requirement, WM incurred a penalty paid to the City of $10,000 per quarter as required in Section 4.2.6 (Minimum Recycling Requirements) of the WM Agreement. City of Santa Clarita, Waste Management 0 May 7, 2010 38 UP r RMA&Data p Waste Al1 Companies Income Data AIl}ed t11 R bhc (1} =from Aprr11 2007 = t J Manag'einentfI to March 31 2008'a, t2} Profit Before Taxes 7% 12% 11% 5% (1) Data are averages of operational data from 2005 to 2007 annual financial reports. (2) The Risk Management Association Annual Statement Studies 2008-2009 - NAICS 562111 (SIC #4212) - Admin and Waste Management - Solid Waste Collection Objective #2: Determine the financial impact of the planned MRF not being available for use. Finding #2: Based on the data provided by WM, the anconal impact of not having a local MRF is approximately $1,783,000 per year or 16.4% of rate revenues. Based on WM's truck operating cost for calendar year 2008 and the routes and route hours as of February 2009 and WM's truck operating cost of $71 per route hour (Table 5), the estimated impact of not having a local MRF is approximately $1,783,000 annually, including the penalty of $40,000 for not achieving the diversion requirement, or 16.4% of rate revenues. As a result of not meeting the 50% diversion requirement, WM incurred a penalty paid to the City of $10,000 per quarter as required in Section 4.2.6 (Minimum Recycling Requirements) of the WM Agreement. City of Santa Clarita, Waste Management 0 May 7, 2010 38 Table 5: Estimate of Annual Impact of Not Having a Local MRF Incremental Hours (Exhibit 3) 24,545 Average Truck Operating Cost per Hour (Exhibit 5)* $ 71 Estimated Annual MRF Impact (Exhibit 3)** $ 1,743,000 Penalty for Not Achieving Diversion Goal 40,000 Total Estimated Annual MRF Impact 1,783,000 Rate Revenues $ 10,899,000 MRF Impact as a Percent of Rate Revenues 16.4%' * Based on CY 2008 truck operating costs and February 2009 route hours. ** Rounded to thousands. As shown in Table 6, if the estimated annual impact of not having a local MRF and the excess costs are deducted, WM would have had an estimated adjusted net profit of $980,000 for CY 2007 and $1,247,000 for CY 2008, 9% and 10% of total revenues, respectively. Table 6: Estimated Adjusted Net Profit for CY 2007 and CY 2008, Excluding the Estimated Annual MRF Impact and Excess Costs Net Loss (Table 1) $ (2,522,000) $ (2,021,000) Estimated Annual MRF Impact 1,783,000 1,783,000 Net Loss, Excluding Estimated Annual MRF Impact (739,000) (238,000) Excess Costs (Table 3) 1,719,000 1,485,000 Estimated Adjusted Net Profit - 980,000 1,247,000 Total Revenues (Table 1) 11,256,000 12,123,000 Adjusted Net Profit as a Percentage of Total Revenues 9%1 10% Objective #3: Evaluate the rate of impact of fuel cost increases. Finding #3A: An increase in the cost of fuel in the amount of $225,000 was not captured by the rate adjustment formula during the period from the first quarter of 2003 through December 2005, the same period that WM agreed to freeze their collection rates. The new WM Agreement began April 16, 2006 with the first rate adjustment to be effective July 1, 2007. Based on the rate adjustments approved and implemented since the effective date of the WM Agreement, WM received adjustments for the increases in the PPI for No. 2 diesel fuel of 2.53% for the change from December 2005 to December 2006. (effective July 1, 2007) and 33.9% for the change from December 2006 to December 2007 (Effective July 1, 2008). Based on the rate adjustment formula, the fuel component adjustment for July 1, 2009 would be based on a decrease in the PPI fuel index of 37% from December 2007 to December 2008. These rate increases (decreases) do not account City of Santa Clarita, Waste Management 7 May 7, 2010 3- for the extraordinary increase in fuel prices that occurred during the period from WM's 2003 Proposal to the inception of the WM Agreement on April 16, 2006. As shown in Table 7, the adjustment, based on the increase in the PPI for No. 2 diesel fuel from the " first quarter of 2003 (when the WM proposal was being prepared) to December 2005 (the first measuring period in the rate adjustment calculations provided in the WM Agreement), is $225,000 or 2.1% of 2008 rate revenue ($225,000 - $10,899,000). Table 7: Analysis of Increase in Fuel Cost at the Start of the WM Agreement Estimated Fuel Cost per 2003 Proposal(l) $ 430,000 PPI - No. 2 Diesel Fuel - December 2005 (2) 198.0 PPI - No. 2 Diesel Fuel - Average 1st Quarter 2003 116.9 PPI - No. 2 Diesel Fuel - Average 1st Quarter 2003, adjusted for typical inflation to December 2005(3) 130.0 Percentage Increase in Fuel Price -1st Quarter 2003 to December 2004 52% Estimated Increase in Fuel Cost $ 225,000 (1) Fuel cost is estimated at 5% of the revenue requirement provided in WM's 2003 proposal, based on the fuel component in the rate adjustment methodology. (2) The first rate adjustment under the WM Agreement was effective July 1, 2007, based on the rate adjustment methodology using various price indices from December 2005 to December 2006. (3) Assuming 3.6% inflation per year for 3 years - see Exhibit_ 4 Finding #3B: WM's fuel cost exceeded the reasonably anticipated fuel cost for January 1, 2004 through April 15, 2006 by approximately $467,000 during the period when WM agreed to lower rates from $18.64 to $16.25 per home per month. As noted in Section 6.2.1 of the Agreement, as of January 1, 2004, WM lowered the residential refuse rates as required and maintained those rates through April 15, 2006. Although WM rates were frozen for the period, it is reasonable to expect that fuel costs would increase. Fuel cost increased at a significantly higher rate than would have been reasonably anticipated at the inception of the Agreement. In order to determine the reasonably anticipated fuel increases for the period that residential rates were frozen at the inception of the Agreement, HF&H calculated the average annual rate increase for the three years prior to January 1, 2004 (CY 2001 through CY 2003). As shown in Table 7 and calculated in Exhibit 4, diesel fuel prices increase at an average rate of 3.6% per year from CY 2001 through CY 2003. In order to determine the extraordinary increase in fuel cost, HF&H compared WM's actual fuel cost to the anticipated fuel cost for January 1, 2004 through April 15, 2006. As reflected in Table 8, WM incurred fuel cost of $467,000 over the anticipated fuel cost during the period that WM agreed to freeze residential rates. If WM were to recover these costs from future rate increases over the remaining four years of the WM City of Santa Clarita, Waste Management 8 May 7, 2010 40 Agreement, the adjustment would be 1.1% of 2008 rate revenue ($467,000 - 4 years $10,899,000 =1.1%). Table 8: Calculation of Excess Fuel Cost Incurred During the Period Residential Rates Were Frozen ��2003 X2004{1) �2005��1 i'2006j11 Tot 1-2004 to Calendar Year Eropos�al Actua] Actual Actual 44 5 2006 _.. ..... Calculation of Changes in Actual Fuel Cost Actual Fuel Cost per WM $ 430,000 $ 574,000 $ 713,000 $ 799,000 Annual Percentage Chane 33% 24% 12 1_1-2006 toj 4-15-2006„! Estimated Fuel Cost for Eleven Weeks Ended April 15,2006 (2) $ 169,000 Average Annual Rate Change 2001-2003 Exhibit 4 3.6% 3.6% 3.6 Estimated Fuel Cost $ 430,000 $ 445,000 $ 461,000 $ 101,000 Actual Fuel Cost Over Estimated Fuel Cost $ 129,000 1 $ 252,000 $ 68,000 Actual Fuel Cost Over Estimated Fuel Cost - Inflation-Ad'usted I $ 138,000 1 $ 261,000 $ 68,000 1 $ 467,000 (1) WM fuel cost was allocated between City and County operation for CY 2004, CY 2005 and CY 2006 (2) WM fuel cost for CY 2006 was annualized for the period from January 1, 2006 through April 15, 2006 (eleven weeks). Objective #4: Review and evaluate WM's valuation of estimated average annual unrealized landfill profits. Finding #4: Estimated average annual unrealized landfill profits related to the waste stream anticipated from a third -party agreement with Burrtec Waste Industries . regarding the construction and operation of the Santa Clarita MRF total $292,000 per year. On November 20, 2003, WM and BWI entered into a third -party Solid Waste Transfer, Transport and Disposal Agreement ("Transfer Agreement"). The Transfer Agreement assured both parties of a disposal facility for the Santa Clarita refuse tonnage from the transfer facility to be constructed and operated as outlined in BWI's Agreement with the City. The Transfer Agreement specified the terms under which BWI would transfer, transport and dispose of WM and BWI Santa Clarita refuse tonnage at a WM landfill. WM's assertion is that had the recycling and transfer station been constructed and operated in accordance to the BWI Agreement with the City, certain refuse tonnage would have been received at a WM landfill. Additionally, had the WM landfill- received such tonnage, the facility would have recognized a profit from the revenue stream. Table 9 provides the calculation estimating the annual unrealized landfill profit of approximately $292,000 per year as a result of the recycling and transfer station not being constructed and operated as planned or 2.7% of 2008 rate revenue ($292,000 $10,899,000). City of Santa Clarita, Waste Management 9 May 7, 2010 Table 9: Estimated Lost Annual Landfill Profit Refuse Tons Total Refuse Tons (CY 2008) Less Refuse Direct -Hauled to WM Landfill Total Refuse Tons to Third -Party Landfill Average Rate per Toe') Estimated Unrealized Revenue Assumed Landfill Profit Percentage�1 Total Estimated Unrealized Annual Landfill Profit 62,036 31,118 93,154 30,189 30,189 31,847 31,118 62,965 $ 22.06 $ 1,389,000 21% $ 292,000 (1) See WM Annual Report for 2008, Notes to Financial Statement #20 (2) Per the Solid Waste Transfer, Transportation and Disposal Agreement between Burrtec Waste Industries and USA Waste of California, a Waste Management company, dated November 20, 2003, Section 5.1, the initial rate was $19 per ton to be effective August 1, 2004, with adjustment each July thereafter. The rate is adjusted by the CPI -All Urban Consumer - U.S. City Average. The incrase from July 2004 to July 2008 =16.1 % (219.964 =189.4 =16.1 %). 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R v Si yy °W N '- N N tC Z_ Z.Z r � d r •D �' � �.R .' st z- "<'Ysr'$xw cC d � Calculation and Analysis of Inflation -Adjusted Costs Direct Costs Exhibit 9 In Table 9-1, direct costs submitted in WM's 2003 Proposal to the City for residential refuse service are adjusted for inflation to 2007 and 2008 dollars in order to compare the CY 2007 and CY 2008 actual costs for reasonableness. As shown in Table 8-1, CY 2007 direct costs exceed the adjusted 2003 proposed costs by $3,646,000and CY 2008 direct costs exceed the adjusted 2003 proposed costs by $3,457,000. A substantial part of these differences are explained by the impact of the lack of a local MRF, which is quantified in Table 5 and discussed in Finding #2. Table 9-1: Summary of Direct Costs and Other Operational Costs for the 2003 Proposal and Calendar Years 2007 and 2008 ick Operating and Other Direct Costs(i) $ 3,235,000 20.5% )erational Support Costs - 20.5 infer/Disposal/Processing Costs(2) 2,323,000 16.2% ntainer Depreciation/ Amortization (3> 632,000 15.5% Total: Direct and Other Operational Costs $ 6,190,000 tual total Direct Costs in Excess of lation-Adjusted 2003 $ 3,898,000 $ 6,509,000 28.3% $ 4,151,000 $ 6,802,000 1,074,000 28.3% $ 988,000 2,699,000 2,666,000 20.3 % 2,795,000 2,658,000 730.000 724.000 18.9% 751,000 706,000 (1) Percentage change is based on the weighted average index - see Exhibit 7 (2) Percentage change is based on the CPI - All Urban Users, All Items - Los Angeles, Riverside, Orange County (3) Percentage change is based on the PPI for Heavy Duty Truck Manufacturing - PCU336120331201, which is used in the rate adjustment formula for all equipment. 2003 Proposal adjusted by percentage change in annual average of respective indices to 2007 dollars. "2003 Proposal adjusted by percentage change in annual average of respective indices to 2008 dollars. Indirect Costs and Other Expenses In Table 9-2, the indirect costs submitted in WM's residential proposal are adjusted for inflation from 2003 to 2007 and 2008 in an effort to provide an equivalent comparison. The inflation adjusted 2003 Indirect Costs for CY 2007 and CY 2008 exceed the reported data for CY 2007 and CY 2008 by approximately $144,000 and $189,000, respectively. Gfij of Santa Clarita Waste Management 9-1 May 7, 2010 u'V Exhibit 9 Table 9-2: Summary of Indirect Costs and Other Expenses for the 2003 Proposal and Calendar Years 2007 and 2008 Local General and Administrative $ 1,506,000 16.2% $ 1,750,000 $ 824,000 20.3% $ 1,812,000 $ 842,000 Corporate Overhead (3) 16.2% 782,000 20.3% 781,000 Franchise Fees/ Other City Fees 914,000 Actual 1,199,000 1,199,000 Actual 1,367,000 1,367,000 Total Indirect Costs $ 2,420,000 $ 2,949,000 2,805,000 $ 3,179,000 2,990,000 Actual Total Indirect Costs in Excess of hnflation-Adjusted 2003 $ (144,000) $ (189,000) " CPI - All Urban Consumers, All Items, Los Angeles -Riverside Orange Co. - 2003 to 2007 - (217.338 + 187.000 =162%). ** CPI - All Urban Consumers, All Items, Los Angeles -Riverside Orange Co. - 2003 to 2007 - (225.008 =187.000 = 20.3%). City of Santa ClaYlta Waste Management 9-2 May 7, 2010 . s 2,