MANAGEMENT’S DISCUSSION AND ANALYSIS

As management of the Town of Cary, we offer readers of the Town’s financial statements this narrative overview and analysis of the financial position and activities of the Town as of and for the fiscal year ended June 30, 2006. We encourage readers to consider the information presented here in conjunction with additional information that we have furnished in our letter of transmittal in the front of this report.

Financial Highlights

• The Town’s assets exceeded its liabilities at the close of the fiscal year by approximately $954.1 million (net assets). Of this amount, $207.8 million (unrestricted net assets) may be used to meet the Town’s ongoing obligations to citizens and creditors.
• The Town’s total net assets increased by $105.6 million in fiscal year 2006. $29.5 million of the increase resulted from governmental activities, and $76.1 million resulted from business-type activities. Of the $76.1 increase in business-type net assets, $39.4 million resulted from a merger of the Town of Cary’s water and sewer utility system with the Town of Morrisville water and sewer utility system. On April 1, 2006, Cary assumed responsibility for providing water and sewer service for all Morrisville customers. The transfer of responsibility included the transfer of assets and some of the liabilities of the Morrisville utility. The remaining increases in net assets are the result of General Fund and the Utility Systems Enterprise Fund revenues that exceeded expenses and the increase in capital assets, both from Town constructed assets and the donation of infrastructure from developers.
• As of the close of the fiscal year, the Town’s governmental funds reported combined ending fund balances of approximately $128.1 million, a decrease of $20.1 million from the prior year. The total fund balance in the General Fund and special revenue funds increased $3.1 million and total fund balance in the Capital Project Fund decreased $23.1 million as funds designated for capital projects were spent as intended. Approximately 78.5% of total governmental funds fund balance, or approximately $100.2 million, is available for spending at the Town’s discretion (unreserved fund balance). $33.2 million of the unreserved fund balance is designated for capital projects and $4.4 million is designated for fiscal year 2007 spending.
• At the end of the current fiscal year, unreserved fund balance for the General Fund was $53.1 million, or 61.9% of total general fund expenditures for the 2006 fiscal year.
• The Town’s total debt decreased by $10.2 million (5%) during the current fiscal year. No additional bonds were issued during the year. The Town drew $2.4 million from the State Revolving Loan for the year’s construction expenses on the biosolids dryer and the regional plant design loan. The Town repaid $12.6 million of bond principal and installment financing principal during the year. The Town maintained its outstanding AAA bond ratings from all three major rating agencies.
• The Town’s total investment earnings during the year were $8.7 million with an average investment yield of 3.44% compared to a prior year yield of 2.43%. Investment earnings increased $2.5 million from the prior year.

Overview of the Financial Statements

This discussion and analysis is intended to serve as an introduction to Town of Cary’s basic financial statements. The Town’s basic financial statements consist of three components: 1) entity-wide financial statements, 2) fund financial statements, and 3) notes to the financial statements. This report contains other supplemental information in addition to the basic financial statements themselves.

Entity-Wide Financial Statements

The entity-wide financial statements, a statement of net assets and a statement of activities, are designed to provide readers with a broad overview of the Town’s finances in a manner similar to a private-sector business. These statements have been presented since Fiscal Year 2002 in accordance with the implementation of Governmental Accounting Standards Board Statement 34.

The statement of net assets presents all of the Town’s assets and liabilities, with the difference between the two reported as net assets. This statement combines and consolidates current financial resources with capital assets and long-term obligations. Over time, increases or decreases in net assets may serve as a useful indicator of whether the financial position of the Town is improving or deteriorating. The Town’s net assets have increased steadily since fiscal year 2002 when net assets were $786.8 million.

The statement of activities presents information showing how the government’s net assets changed during the most recent fiscal year. All changes in net assets are reported as soon as the underlying event giving rise to the change occurs, regardless of the timing of related cash flows. Thus, revenues and expenses are reported in this statement for some items that will only result in cash flows in future fiscal periods, for example, uncollected taxes or earned but unused vacation leave.

Both of the entity-wide financial statements distinguish functions of the Town that are principally supported by taxes and intergovernmental revenues (governmental activities) from other functions that are intended to recover all or a significant portion of their costs through user fees and charges (business-type activities). The governmental activities of the Town include most of the Town’s basic services such as police, fire, solid waste and recycling, facilities and operations maintenance, planning, engineering, building inspections, parks, recreation and cultural programs as well as the administrative support functions. The business-type activity of the Town primarily consists of water and sewer utility services.

In accordance with the Governmental Accounting Standards Board criteria for inclusion in the reporting entity, the Town of Cary has no component units that are included in this report.

The entity-wide financial statements are Exhibits A and B of this report.

Fund Financial Statements

The fund financial statements provide more detailed information about the Town’s major funds. Funds are the accounting tools used to track specific sources of funding such as those required by law or for specific purposes. The Town of Cary, like all other governmental entities in North Carolina, uses fund accounting to ensure and demonstrate compliance with finance-related legal requirements, such as the North Carolina General Statutes, the Town’s budget ordinance or revenue bond covenants. All of the funds of the Town can be divided into three categories: governmental funds, proprietary funds, and fiduciary funds.

Governmental Funds: Most of the Town’s basic services are included in governmental funds which are essentially the same functions reported as governmental activities in the entity-wide financial statements. However, unlike the entity-wide financial statements, governmental fund financial statements focus on how cash and other assets are and can be used for near-term spending as well as on balances of resources available for spending at the end of the fiscal year. This information may be useful in evaluating the Town’s resources for near-term financial requirements.

Because the focus of governmental funds is more narrow than that of the entity-wide financial statements, it is useful to compare the information presented for governmental funds with similar information presented for governmental activities in the entity-wide financial statements. By doing so, readers may better understand the long-term impact of the Town’s near-term financing decisions. Exhibit F describes the differences in the statement of revenues, expenditures, and changes in fund balances of governmental funds to the entity-wide statement of activities.

The Town of Cary maintains six individual governmental funds. Information is presented separately in the governmental fund balance sheet and in the governmental fund statement of revenues, expenditures, and changes in fund balances for each of these funds. The General Fund and the Capital Project Fund are considered to be major funds. Although the Amphitheatre Special Revenue Fund, the Transit Special Revenue Fund, the 911 Special Revenue Fund, and the CDBG Special Revenue Fund are not considered to be major funds, they are being presented separately as major funds in the fund financial statements to provide clear reporting.

The Town of Cary adopts an annual appropriated budget for its General Fund. Annual budgets have also been adopted for the Amphitheatre Special Revenue Fund, the Transit Special Revenue Fund, the 911 Special Revenue Fund and the General Capital Reserve Fund (a sub-fund of the Capital Project Fund).

The basic governmental fund financial statements can be found on Exhibits C through J.

Proprietary Funds: The Town’s business type activities are reported in proprietary funds. The Town of Cary maintains two different types of proprietary funds. An enterprise fund is used to report the same function presented as business-type activities in the entity-wide financial statements which for the Town is the water and sewer utility service. Internal service funds are used to accumulate and allocate costs internally among the Town’s various functions. The Town uses internal service funds to account for its fleet maintenance services and its employee health insurance. Because both of these services predominantly benefit the governmental rather than business-type functions, they have been included within governmental activities in the entity-wide financial statements.

Proprietary funds provide the same type of information as the entity-wide financial statements, only in more detail. The utility systems enterprise fund is considered to be a major fund of the Town of Cary. Because the internal service funds are not major funds, both internal service funds are combined in the proprietary fund financial statements. Individual fund data for the internal service funds is provided in combining statements in the supplementary information section of this comprehensive annual financial report.

The basic proprietary fund financial statements can be found on Exhibits K through M of this report.

Fiduciary Funds: Fiduciary funds are used to account for resources held for the benefit of parties outside the Town. The Town has a fiduciary fund to account for the Pension Trust Fund for the Law Enforcement Separation Allowance. Fiduciary funds are not reflected in the entity-wide financial statements because the resources of those funds are not available to support the Town’s own programs. Accounting for fiduciary funds is much like that used for proprietary funds.

The basic fiduciary fund financial statements can be found on Exhibits N and O of this report.

Notes to the Financial Statements: The notes provide additional information that is essential to a full understanding of the information provided in the entity-wide and fund financial statements.

Other Information: In addition to the basic financial statements and accompanying notes, this report also presents certain required supplementary information concerning the Town’s progress toward funding its obligation to provide pension benefits to its law enforcement officers.

The combining statements are presented immediately following the required supplementary information on pensions.

Entity-Wide Financial Analysis

As noted earlier, net assets may serve over time as a useful indicator of a Town’s financial position. In the case of the Town, assets exceeded liabilities by $954.1 million as of June 30, 2006.

By far, the largest portion of the Town’s net assets ($726.9 million or 76%) reflects the Town’s investment in capital assets (e.g. land, buildings, machinery, and equipment), less any related debt still outstanding that was issued to acquire those assets. The Town of Cary uses these capital assets to provide services to citizens and customers; consequently, these assets are not available for future spending. Although the Town of Cary’s investment in its capital assets is reported net of related debt, it should be noted that the resources needed to repay this debt must be provided from other sources, since the capital assets themselves cannot be reasonably used to liquidate these liabilities.

An additional portion of the Town’s net assets ($19.4 million or 2%) are resources that are subject to external restrictions on how they may be used. The remaining balance of unrestricted net assets ($207.8 million or 22%) may be used to meet the Town’s ongoing obligations to citizens and creditors.

At the end of the current fiscal year, the Town reports positive balances in all three categories of net assets, both for the government as a whole, as well as for its separate governmental and business-type activities. The same situation held true for the past four prior fiscal years since these net assets were first computed for the entity-wide statements.

The Town’s net assets increased by $105.6 million for the fiscal year ended June 30, 2006. The increase in net assets is primarily the result of the General Fund and the Utility Systems Enterprise Fund revenues exceeding expenses and the increase in capital assets, both from Town constructed assets and the donation of infrastructure from developers. Assets donated by developers during the year are valued at $36.5 million for streets, land, and other general infrastructure and $11.3 million for utility infrastructure. Of the $76.1 million increase in business-type net assets, $39.4 million resulted from a merger of the Town of Cary’s water and sewer utility system with the Town of Morrisville water and sewer utility system. On April 1, 2006, Cary assumed responsibility for providing water and sewer service for all Morrisville customers. The transfer of responsibility included the transfer of assets and some of the liabilities of the Morrisville utility.

Town of Cary Changes in Net Assets

Governmental Activities: Governmental activities increased the Town’s net assets by $29.4 million, thereby accounting for 28% of the total growth in the net assets of the Town of Cary. Key elements of this increase are as follows.

· Property taxes, the largest revenue source, increased by $2 million (4%). The tax rate remained the same; therefore, the increase is due to an increase in tax base which primarily resulted from growth.

· Charges for services increased $6.1 million (39%) primarily resulting from an increase in permits and fee revenues due to an 87% increase in new construction building permits this fiscal year.

· Capital Grants and Contributions increased $12.6 million (58%) primarily as a result of a significant increase in developer donated streets which is also a result of the increase in new construction.

· Other taxes increased $2.6 million (13%) due to higher than expected sales tax revenue.

· Investment earnings increased $1.3 million (38%) This increase is primarily attributed to an increase in average portfolio yield from 2.43% in the prior year to 3.44% in fiscal 2006.

Increases in operational expenses closely paralleled inflation and growth in the demand for services.

Business-type Activities: A merger of the Town of Morrisville utility system into the Town of Cary’s system accounted for a $39.4 million increase in net assets for business-type activities. On April 1, 2006, the Town of Cary accepted responsibility for approximately 5,000 customers and took ownership of the Morrisville water and sewer utility capital assets such as pump stations, distribution systems and operational equipment. In addition Morrisville transferred financial assets in customer receivables and cash balances. Cary also assumed some of the liabilities of the Morrisville system including customer deposits, prepaid development fees and an obligation to transfer funds to Morrisville to provide for the repayment of Morrisville’s utility related general obligation debt.

Not including the special item, business-type operational activities increased the Town of Cary’s net assets by $36.7 million, accounting for 34.8% of the total growth in the Town’s net assets. Key elements of this increase are as follows.

· Charges for services increased $16.4 million (42%) for several reasons. Cary retail sewer rates were increased by 17% to cover increased fixed costs. Cary retail consumption increased 10%. Consumption increased 13% overall including three months of retail service to Morrisville customers. Also, Morrisville customers paid retail rates approximately 30% higher than Cary retail customers. Water and sewer development fees for new construction increased $9.1 million as a result of increased growth and development in Cary.

· Grants and contributions increased $8.0 million primarily due to increases in developer donated infrastructure.

· Investment earnings increased $1.2 million (43%). This increase is primarily attributed to an increase in average portfolio yield from 2.43% in the prior year to 3.44% in fiscal 2006.

· Most expense areas had increases closely paralleling inflation and growth in the demand for services; however, water reclamation facilities expenses increased about $1.5 million compared to the prior year because of an increase in the amount paid for waste water treatment services to a neighboring municipality.

Financial Analysis of the Town’s Funds

As noted earlier, the Town of Cary uses fund accounting to ensure and demonstrate compliance with finance-related legal requirements.

Governmental Funds: The focus of the Town of Cary’s governmental funds is to provide information on near-term inflows, outflows, and balances of spendable resources. Such information is useful in assessing the Town’s financing requirements. In particular, unreserved fund balance may serve as a useful measure of the Town’s net resources available for spending at the end of the fiscal year.

As of the end of the current fiscal year, the Town’s governmental funds reported combined ending fund balances of $128.1 million, a decrease of $20.1 million compared to the prior year. Approximately $60.1 million of this amount (46.9%) constitutes unreserved, undesignated fund balance, which is available for spending at the Cary Town Council’s discretion. The remainder of fund balance is reserved or designated to indicate that it is not available for new spending because it has already been reserved for 1) street spending of Powell Bill funds ($15.1 million), 2) compliance with North Carolina state statutes ($9.9 million), 3) miscellaneous other purposes including spending already encumbered at June 30 ($2.9 million), or committed to 1) capital projects ($33.2 million), 2) subsequent year’s expenditures ($4.3 million) or 3) other small miscellaneous purposes ($2.6 million).

The General Fund is the chief operating fund of the Town of Cary. At the end of the current fiscal year, unreserved and undesignated fund balance of the General Fund was $53.1 million, while total fund balance reached $68.6 million. As a measure of the General Fund’s liquidity, it may be useful to compare both unreserved, undesignated fund balance and total fund balance to total fund expenditures. Unreserved, undesignated fund balance represents 61.8% of total General Fund expenditures, while total fund balance represents 80% of that same amount.

The fund balance of the Town’s general fund increased by $3 million during the current fiscal year. Key factors in this growth are as follows:

· Property taxes, the largest revenue source, increased by $1.9 million (3.8%). The tax rate remained the same and the increase is due to an increase in tax base primarily resulting from growth.

· Other taxes increased $2.6 million (12.7%) as a result of a 10% increase in sales tax revenue and business license revenue that doubled resulting from increased business license rates and maximum tax limits.

· Permits and fees increased $2.9 million (81%) primarily related to an 87% increase in new construction building permits this year.

· Expenses closely paralleled inflation and growth in the demand for services.

The Capital Projects Fund includes street, parks and recreation, fire, and general government capital projects. At the end of the current fiscal year, total fund balance was $58 million, a decrease of $23.1 million from the prior year. The fund balance decreased as planned spending for street and park projects occurred as intended. Some of the most notable of the capital project spending, $5.9 million, occurred for the Davis Drive Widening project, another $5.9 million was spent on the Tryon Road and Piney Plains project, and $7.0 million was spent on the USA Baseball Project at Brooks Park.

Proprietary Funds: The Town’s proprietary funds provide the same type information found in the entity-wide financial statements, but in more detail.

Unrestricted net assets of the Utility Systems Enterprise Fund at the end of the year amounted to $123.5 million, a $12.3 (11%) increase from the prior year. Refer to the discussion of the Town’s business-type activities for the primary factors that created the positive results.

General Fund Budgetary Highlights

During the year, there was a $6.8 million increase in appropriations between the original and final amended budget. The primary components of the increase were $1.0 million for the affordable housing program, $2.6 million for replacement of solid waste and recycling vehicles, and $1.1 million for construction of a new fire station. The Town was able to appropriate fund balance for these increased budgeted expenditures. The Town maintains fund balance in excess of minimal requirements as a fiscal tool to support Town goals in several ways. Timely financial flexibility is afforded by the balances as evidenced in fiscal year 2006. The original adopted budget for fiscal year 2006 anticipated an appropriation from fund balance of $4.8 million. Budget adjustments, discussed above, throughout the year authorized $6.8 million additional spending for an anticipated revised reduction in fund balance of $11.6 million. Net favorable variances in revenues and expenditures actually resulted in an increase of fund balance of $3 million.

Capital Asset and Debt Administration

Capital assets: The Town of Cary’s investment in capital assets for its governmental and business–type activities as of June 30, 2006, totals $909.1 million (net of accumulated depreciation). This investment in capital assets includes land, buildings, roads, bridges, machinery and equipment, vehicles, park facilities, utility plants, water distribution systems and wastewater collection systems. The total increase in the Town’s investment in capital assets for the current fiscal year was 12.8%, which was comprised of an 8.5% increase for governmental activities and a 20.1% increase for business-type activities. The 20.1% increase for business type activities includes $39.4 utility infrastructure added as a result of the Morrisville utility system merger.

Major capital asset additions during the year include the following:

• Land for governmental activities of $5.9 million, including developer donated land and annexed right of ways;
• Buildings and improvements for governmental activities of $15.4, primarily related to prior year construction-in-progress being completed, including two buildings on town hall campus;
• Construction-in-progress for governmental activities increased $2.6 million;
• General infrastructure assets of $19.2 million such as streets;
• Construction-in-progress for the regional water reclamation facility, thermal biosolids dryer, and a major sewer pump station upgrade; and
• Utility infrastructure assets of $11.3 million such as water lines and sewer collection lines.

Town of Cary Capital Assets

(net of depreciation)

Additional information on the Town’s capital assets can be found in Note 5 of the Basic Financial Statements.

Long-term Debt: As of June 30, 2006, the Town of Cary had total debt outstanding of $205.9 million. Of this, $109.5 million is debt backed by the full faith and credit of the Town in the form of general obligation bonds. $54.1 million of the general obligation debt is born by the Utility system revenues although the Town’s taxing authority is the true security to the bond holders. $42.4 million in debt is in the form of asset backed debt and is secured by the town hall campus and other property. The $41.9 million of revenue bonds are secured solely by the utility system revenues. The State Revolving Loans include two loans from the State of North Carolina that represent both federal and state funding for waste water utility projects. The total approved amount of the loans is $16.1 million. As of June 30, 2006, the draws on this loan total $12.1 million.

Town of Cary’s Outstanding Debt

General Obligation Bonds, Installment Purchases, and Revenue Bonds

The Town of Cary’s total debt decreased by $10.2 million (5%) during the current fiscal year. No additional bonds were issued during the year. The town received $2.4 million in proceeds from the State Revolving Loan for the year’s construction expenses on the biosolids dryer and the regional plant design. The Town repaid $12.7 million of bond principal during the year.

The Town of Cary maintained “AAA” ratings from Standard & Poors, Moody’s Investors Service, and Fitch Ratings. The Town’s revenue bonds are rated “AAA” by Standard & Poors and Fitch Ratings, and “Aa2” by Moody’s Investors Service. These bond ratings are a clear indication of the sound financial condition of the Town of Cary. The Town of Cary is one of few municipalities in the country that maintains the highest general obligation bond rating from all of the major rating agencies. This achievement is a primary factor in keeping interest costs low on the Town’s outstanding debt.

North Carolina general statutes limit the amount of general obligation debt that a unit of government can issue to 8 percent of the total assessed value of taxable property located within that Town’s boundaries. The legal debt margin for Town of Cary is $575.4 million. Practically, these statutory limits exceed the Town’s realistic debt capacity. The Town has $143.7 million in street bonds, $30.1 million in parks and recreation bonds, $7.4 million in water bonds, $110 million in wastewater bonds, and $10 million in open space bonds authorized from 1999, 2003, and 2005 referenda that remain unissued at June 30, 2006. Of the $301.2 million total in general obligation debt authorized but unissued at June 30, 2006, $78.8 million has been appropriated to capital projects. The Town issued $47.3 million in variable rate general obligation debt for streets ($45.3 million) and parks ($2.0 million) on July 12, 2006, leaving $31.5 million of debt that has been appropriated but unissued as of this report date.

Additional information regarding the Town of Cary’s long-term debt can be found in the Notes to the basic financial statements.

Economic Factors and Next Year’s Budgets and Rates

The unemployment rate for the Town is currently 2.9%, which is a decrease of .8% from a year ago. Cary’s rate compares favorably to the state’s average unemployment rate of 4.8%. The Town’s estimated population at June 30, 2006, was 115,854, an increase of 4,815 during the year. New construction permits increased 87% from the prior year. These factors were considered in preparing the Town’s budget for 2007.

The General Fund 2007 budget maintained a tax rate of $.42 per hundred dollars valuation of taxable property, which has been the rate since 2002. In addition, the solid waste fee held steady at $11.75 per month for residential service.

Other key items to note in the 2007 budget include:

· an appropriation of $2.2 million from fund balance;

· a service level increase to provide an additional route within the fixed route transit bus service;

· staffing growth to facilitate 1) a reorganization and growth in demand for services in Police, 2) new facility needs in Parks, Recreation and Cultural Resources, 3) growth in demand for services in Permits and Inspections related to the growth in permitted construction activity, 4) new security measures in Technology Services and a 5) a new program to provide townwide proactive review of internal controls and contractual commitments;

· funding for an enhanced economic development function, including permanent dedicated staffing in partnership with the Cary Chamber of Commerce; and

· interest expense for the Town’s first issue of variable rate general obligation bonds totaling $47.3 million for streets and parks issued in July 2006.

In the Utility Systems Enterprise Fund, for Cary customers, water and sewer base charges were increased to continue to match these revenues with actual administrative costs and the sewer volume charge was increased 10% to cover expected increased costs of providing this service. For a typical 7,000 gallon per month residential customer in Cary, these rate changes will increase a monthly utility bill by 6.3%. Morrisville customer water rates were increased 1% and sewer rates were held steady in accordance with the merger contract. The utility budgets reflect net additional revenues for full year of retail service for customers in Morrisville following the April 1, 2006, utility system merger. Wholesale service revenues were decreased as a result of the merger and utility operating expenses increased to serve the Morrisville customers.

The capital budget for 2007 includes $83.7 million in funding for the following purposes in addition to the current $314.2 million ongoing capital project authorizations:

• $26.8 million for transportation projects;
• $15.1 million for parks, recreation and cultural projects including spending up to $10 million on open space funded with general obligation bonds authorized by voters in 2005;
• $15.5 for general government and fire projects;
• $7.8 million for water projects; and
• $18.5 million for sewer projects.

Subsequent to the formal budget adoption in a Town Council worksession in July 2006 Council appropriated an additional $1.8 million to fully fund downtown streetscape design, a project included in the capital improvements plan for future years of approximately $20 million for downtown improvements. The Town Council has also indicated serious interest in funding an aquatics facility in 2007.

The Town’s capital improvement plan for ten years beyond 2007 totals $732.5 million.

Requests for Information

This report is designed to provide a general overview of the Town’s finances for those with an interest in the Town of Cary’s finances. Questions concerning any of the information found in this report or requests for additional financial information should be directed to the Director of Finance, Town of Cary, Post Office Box 8005, Cary, North Carolina 27512-8005; (919) 469-4110 or karen.mills@townofcary.org .