SunnyvaleRTC

SUBJECT: FY 2004/2005 Mid-Year Review and Long-Term Financial Plan Update and Budget Modification No. 23

This report presents to the City Council an update of the City of Sunnyvale Long Term Financial Plan as of January 2005. The analysis includes a discussion of current economic conditions at the national, state, and local levels. Overall, the economy is experiencing measured growth, although the Bay Area region is trailing the state and the nation. The report also provides information on the Governor's Proposed FY 2005/2006 State Budget, which is substantially the same as anticipated last year. A review of revenues and expenditures and fiscal strategies in the General Fund shows that it is on forecast for the near term in most areas, but adjustments will be needed in the longer term. Further there are a number of issues that could have an impact on the City's financial picture now or in the future.

This report also includes Budget Modification No. 23, which reduces $1,296,994 that had been appropriated for salary increases for miscellaneous employees in the current fiscal year from the respective funds. Budget Modification No. 23 places these funds in a reserve in the Employee Benefits Fund to be used for stabilization of future employee retirement costs.

Each year the City Council holds a Fiscal Issues Workshop at mid-year to review the City's current year fiscal status and set a context for consideration of the next year's Long-Term Financial Plan. This report has been prepared to provide needed background information for Council's discussions in this workshop. Topics included are: current economic conditions and outlook; update on the Governor's Proposed FY 2005/2006 State Budget; analysis and update of the General Fund Long-Term Financial Plan; analysis and update of other major funds; and potential issues with significant budgetary impact.

Goal 7.1B of the City's Fiscal Sub-Element states: Maintain sound financial practices which meet all applicable standards and direct the City's financial resources toward meeting the City's long term goals.

The steep economic downturn that has so severely impacted the City's fiscal condition over the last several years appears to have given way to a moderate recovery. According to a recent report by the State Legislative Analyst's Office, "Over the past year, both the nation and California have experienced solid economic growth, led by continued gains in consumer spending, large increases in business investments, and expanding exports." [1] While economic growth is projected to continue into next year, the growth may slow somewhat. Further, there are a number of downside risks that could pose serious threats to the economy and its recovery.

The economic recovery in the Bay Area lagged significantly behind the state and nation, and employment in our region has not recovered. The California recession beginning in 2000 was concentrated in the Bay Area, which lost almost half a million jobs. However, the pace of job loss here appears to have slowed and there are indications that employment may be leveling out. Sales in the Bay Area also began to rise in the third quarter of 2003; prior to that time, our region suffered nine consecutive quarters of year-over-year declines.

In November of each year the State Legislative Analyst's Office (LAO) prepares economic projections for the coming budget year and five years beyond.[2] According to the LAO projections issued in November 2004, "The national economy has experienced broad-based economic growth over the past year" and information suggests that solid economic growth was continuing in the final quarter of 2004.[3] Gross domestic product (GDP), the measure of total goods and services production in the country, expanded at a 4% annual rate in the July – September quarter.[4]

The LAO projections cited above assume that the

U.S.

economy will expand at a solid though moderating pace in 2005, with economic growth as measured by the GDP slowing to approximately 3% in 2005 and accelerating modestly in 2006. The LAO forecast assumes that business investment will continue to increase but the growth in consumer spending will slow. The forecast also cautions that the

U.S.

economy faces two key challenges that may be impediments to future economic growth: volatility of oil prices and limited job growth.[5]

Other economic data supports the general conclusions reached by the LAO. Since the collapse from the euphoric “dot.com” era, consumer spending and residential investment have been the predominant drivers of the nation’s economy. Consumer spending, which has fueled about two-thirds of

U.S.

economic activity since the downturn, has been buoyed by a number of fiscal and monetary policies. Since the beginning of the economic downturn in 2001, the Federal Reserve has adopted an accommodative monetary policy and reduced interest rates to stimulate investment and increasing spending. Consumers took advantage of historically low mortgage rates to either enter the real estate market or to refinance existing loans and use the funds for discretionary spending. To complement the Federal Reserve’s policy, the Federal Government adopted a number of tax reductions to provide additional discretionary income.

However, the benefits reaped from both of these monetary policies may have been maximized. Recent figures show personal savings rates have declined to less than 1% while the consumers’ debt burden has increased to historically high levels.[6] These two factors, when combined with further increases in interest rates and increases in energy prices, will have a dampening effect on consumer spending.

Another important element of the current recovery is business investment. According to the Governor's proposed FY 2005/2006 Budget, the continued rebound in business investment played a big role in the strong expansion of the national economy in 2004, with business investment nearly 14% higher in the first three quarters than in the corresponding quarters of 2003.[7] In order to sustain future growth, business investment will have to increase to offset the potential decreases in consumer spending. However, just as there are impediments to sustained consumer spending, there are a variety of different factors that may hinder future growth in business investment for 2005. First, the federal partial expensing provision, which provides an incentive to invest in new capital goods, expired on December 31, 2004. Economists remain divided as to the future impact the expiration of this provision will have on business spending but the consensus opinion is that business spending will be slightly lower in the early part of 2005. Second, due to higher energy costs and rising employee benefit costs, businesses are hesitant to make new commitments.

Finally, macro-economic issues such as geo-political uncertainties, the Nation’s increasing trade deficit, and the growing federal budget deficit all represent risks to future economic growth over the later years of the planning period.

The California economy also strengthened in 2004. According to the LAO, "factors boosting economic growth over the past year have included:

· The strong national rebound in business investment, particularly in high-tech goods, computers, networks, and software systems produced and supported by California firms;

· The state's booming housing market, which has boosted income in the state's construction, finance, and various retail trade industries; and

· A sharp increase in international exports, which has boosted activities in the manufacturing and agriculture sectors."[8]

The LAO projects that California's economic growth will continue in 2005, although at a more moderate pace than in 2004. On the positive side, the LAO cites "the national outlook for continued strong business investment will boost many industries in this state."[9] However, the same negative forces that will have a dampening impact on the national economy, such as high energy costs and rising interest rates, will effect consumer spending and housing activity in the state.

While both the national and state economies appear to have stabilized in 2004, economic growth in the Bay Area continues to be sluggish, particularly in the Silicon Valley. Evidence in the form of our own Sales Tax and Transient Occupancy Tax receipts seems to indicate that our area reached the bottom and began a slow recovery in the third quarter of 2004. However, employment and the commercial real estate market still remain extremely problematic.

Recent newspaper articles and economic forecasts contain references to an employment recovery in the Silicon Valley and the Bay Area. From November 2003 to November 2004 the unemployment rate decreased from 7.3% to 5%. The UCLA Anderson School Forecast issued in December 2004 predicted that our region would increase its workforce by up to 2% in 2005 and made this statement: “While the Bay Area has certainly suffered dramatically since the tech bust began, what may be more impressive is how well it is recovering.”[10]

However, these very positive projections must be taken in context of the overall massive job loss that Santa Clara County has experienced since the Tech downturn. Since December 2001 the County has suffered a 20% job loss. According to information from the Association of Bay Area Governments (ABAG), over 200,000 jobs were actually lost between 2001 and 2004.[11]

This continued trend in the reduction in local jobs contradicts recent revenue and sales gain by businesses in 2004. Businesses in the local economy for the most part had a healthy year in 2004. “During the first three quarters of 2004, the combined profits of the 150 largest companies in the valley grew 515 percent to $22.2 billion, from $3.6 billion during the same period in 2003.”[12] However, these increases did not translate into employment growth as the region’s employers continue to achieve gains through increased efficiencies and utilization of excess capacity.

Local consumers are currently feeling the effects of this jobless recovery in a lessening of consumer confidence. A recent article in the Mercury News highlights the fact that Bay Area consumers, who are traditionally optimistic, continued to be concerned about limited job growth, the state budget deficit, inflation, and rising interest rates. At some point, this lower consumer confidence may translate into lower consumer spending and thus less Sales Tax revenue for the City.

The Silicon Valley continues to be plagued by extremely high vacancy rates in commercial and industrial properties. Recent estimates are that there is over 50 million square feet of office and research and development available for lease in the Silicon Valley.[13] With an abundance of vacant space, businesses have sought to both upgrade their office locations and take advantage of reduced lease rates. The net result of these moves is to increase the vacancy in the "less desirable" office space.

The annual conference on the area's economy called by the Bay Area Council, held this year on January 14, 2005, provided a useful summary of the fiscal state of our region. The participants agreed that the Bay Area economy will grow, but big problems remain for the region and the state:

"Time heals even economic wounds," said Joe Hurd, senior economist for the UCLA Anderson Forecast. "On the whole, 2005 is going to see improvement everywhere, and the Bay Area in particular." But the future is not all bright, as both the country and the state slip deeper into debt while education, health care and California's infrastructure continue to crumble, said Steve Levy, director of the Center for Continuing Study of the California Economy. "We're building up a set of imbalances," Levy said. "We're in a harder world, a newer, more competitive economy. I think we need to tend a bit more to some of the warnings, even though this year will feel good."[14]

The Governor's Proposed FY 2005/2006 Budget contains program savings in the amount of $7.4 billion and the use of $1.7 billion in remaining deficit reduction bonds to close a projected budget gap of $8.6 billion and fund a reserve of $500 million. The major program savings occur in the areas of Proposition 98 Education (K-12 and community college education), Transportation, Health and Social Services, Employee compensation, and Mandated costs.

Proposition 98 Education: The Budget proposes an increase in funds for K-12 schools and community colleges of $2.9 billion, or 6.1% over the current year. This assumes that the suspension of the Proposition 98 minimum guarantee which is currently in place for FY 2004/2005 will also be in place for FY 2005/2006. Given the assumed General Fund revenue growth included in the Proposed Budget, this Proposition 98 suspension will save $1.1 billion in FY 2004/2005 and an additional $1.2 billion in FY 2005/2006. The proposal fully funds growth in student attendance, Cost of Living increases of 3.93%, and some program expansion. The administration is also proposing that the annual base contribution costs for the State Teachers' Retirement System (STRS) be borne by the school districts or school employees rather than by the state. Currently the state General Fund contributes 2% of teacher payroll to STRS annually. This shift would result in FY 2005/2006 General Fund savings of $469 million.

Transportation: The Budget proposes to suspend Proposition 42 and not transfer $1.3 billion in gasoline Sales Tax revenue from the General Fund to transportation. This amount would be repaid over 15 years beginning in FY 2007/2008. The Governor also proposes to amend Proposition 42 to prohibit any suspension after FY 2006/2007.

Health and Social Services: Expenditures in this area are proposed to increase by 4.6% or $1.2 billion from the current FY 2004/2005 Budget. This increase consists of caseload increases of about 8.9% offset by major policy changes that result in savings of about $1.1 billion. The largest policy changes are in the areas of medi-cal reforms, CalWORKS grants, and Supplemental Security Income (SSI) payments. Specifically, the budget proposed a 6.5% decrease in CalWORKS grants, the elimination of cost-of-living adjustments for CalWORKS grants, and suspension of cost-of-living adjustments for SSI grants.

State Employee Compensation: The Budget proposes to save $408 million in state employee compensation costs. Savings of $296 million are anticipated from an increase in the share of annual retirement contributions that state employees pay. An additional $112 million savings is anticipated from several other employee compensation reforms to be included in new contracts such as a five-day unpaid furlough, elimination of two holidays, a change in how overtime is calculated, and a change in health benefit contributions. These changes would need to be negotiated through the collective bargaining process. The Budget does include funding of $198 million for existing MOU obligations.

Mandates: The Budget would suspend most mandates on local programs for FY 2005/2006, for a savings of $250 million. It is proposed that the suspended mandates would be repaid over a 15 year period, rather than the five year period that was contemplated in last year's budget agreement.

The Governor's Proposed FY 2005/2006 Budget reflects last year's budget agreement that resulted in the passage of Proposition 1A. Local governments will again contribute shifts in Property Tax to the Educational Revenue Augmentation Fund (ERAF) in the amounts previously agreed upon. This results in Sunnyvale losing $2.05 million in General Fund Property Tax and $264,000 in Redevelopment Tax Increment again in FY 2005/2006. These amounts have already been anticipated in our Long Term Financial Plans.

Other elements of the Proposed Budget that have an impact on Sunnyvale include the anticipated elimination of the booking fee reimbursement, which has a net cost to us of $90,000. Supplemental Law Enforcement funding is maintained in the Proposed Budget at the existing level, which for Sunnyvale is about $193,000.

While the Governor's Proposed FY 2005/2006 Budget is balanced for FY 2005/2006, the State will continue to experience a structural budget imbalance in future years absent ongoing corrective actions. The Budget therefore contemplates a number of reforms to the State's budgeting process, pensions, transportation funding, and Proposition 98 funding. The Governor has called a special session for the Legislature to consider these major reform proposals and has indicated that he would take constitutional amendments to the voters in the absence of legislative action. It is currently unclear how solid and viable some of these potential reforms might be. The LAO Overview of the Governor's Budget summarizes the proposals as follows: "While the 2005-06 proposal has several positive attributes, it falls well short of fully addressing the state's ongoing projected fiscal imbalances. Moreover, its budget reform proposals would put more future state spending on 'cruise control' and hamper the ability of future policy makers to establish budget priorities."[15] In the weeks and months to come staff will be closely reviewing the proposed reforms as the details on them unfold.

In preparing the FY 2004/2005 Budget and Long Term Financial Plan, staff made certain assumptions about the rate of growth of revenues and expenditures in the General Fund. In addition, several fiscal strategies were anticipated, including operating budget reductions and selected new revenues. Staff has reviewed these major assumptions as of mid-year and offers the following update on the status of the General Fund both in the current year and over the 20-year planning horizon.

Six key sources generate almost 90% of the City's General Fund revenues. They are: Sales Tax, Property Tax, Transient Occupancy Tax, Motor Vehicle License Fees (VLF), Utility Users Tax/Franchise Fees, and construction-related taxes and fees. In general, the adopted Budget projected that revenue from these major sources would recover from the major decline that began with the dot.com bust of the early 2000's and begin to experience moderate and steady growth. Currently, it does appear that a rebound has begun to occur and that we are seeing more economic strength in our major revenue sources. Below are discussions of these major revenue sources, including a projection for the current year and any potential adjustments that might need to be made to the projections that were included in the FY 2004/2005 Long Term Financial Plan. It should be noted that comparisons for forecasts for some specific revenue sources are difficult to make because of the reshuffling of Vehicle License Fees, Property Taxes, and Sales Taxes due to the State budget deal and the effects of the State's Triple Flip.

Since the peak in FY 2000/2001, when the City collected $36.3 million, our Sales Tax revenue has fallen at a dramatic rate. Sales Tax revenues began to stabilize during the first half of FY 2003/2004 and began to show signs of moderate growth during the second half of the fiscal year. Sales Tax revenues in FY 2003/2004 were $23.45 million, or 4.8% higher than the $22.7 million received in FY 2002/2003. However, approximately $500,000 of the FY 2003/2004 revenue was attributable to one-time Use Tax that does not constitute part of the base for forecasting purposes. The table below illustrates actual Sales Tax receipts for FY 2000/2001 through FY 2003/2004 as well as budget for FY 2004/2005.

FY 2000/2001 Actual	FY 2001/2002 Actual	FY 2002/2003 Actual	FY 2003/2004 Actual	FY 2004/2005 Budget
$36,302,796	$25,787,528	$22,766,997	$23,451,665	$22,740,513
			$22,951,665 (adj)

As shown above, Sales Tax revenue for FY 2004/2005 was budgeted to be $22.7 million. To date, because of lags in Sales Tax remittance and reporting schedules, the City has only received actual sales information for one quarter (Third Quarter 2004, representing sales for July - September 2004.) Actual sales for Third Quarter 2004 are up a modest 1.8% from the same period last year. Based on this limited information, staff believes that actual receipts for FY 2004/2005 will closely track our original projections or slightly exceed forecast.

As you will recall our long-term forecast for Sales Tax revenue was derived by segmenting total revenue into distinct economic sectors (Business and Industry, General Consumer Goods, Autos and Transportation, and Other). In projecting our Sales Tax revenues staff developed individual projections for each sector and then assimilated the numbers into a single weighted aggregate forecast. This forecast was then indexed to an eight-year economic cycle to account for historical volatility. Review of the components of the Third Quarter 2004 Sales Tax shows that the Business and Industry sector grew by about 1% while staff had projected a 10% growth. Fortunately, the auto and transportation sector, which is our second highest Sales Tax component, grew at a much higher 10% rate. Several other smaller sectors also exceeded planned growth, while the general consumer goods category remained flat.

Council is aware of several new retail establishments that are coming or are proposing to come to Sunnyvale in the near future (e.g. Circuit City, Good Guys, etc.) These additions will help to maintain, and possibly expand, our Sales Tax base. However, we have recently lost a major business-to-business Sales Tax producer which will result in a $400,000 annual loss. As we refine our forecast for FY 2005/2006 and long-term we will be factoring in the new additions and identifiable losses.

Information from the HdL Companies, our Sales Tax consultants, indicates that the Bay Area is lagging significantly behind the statewide trend. Statewide growth in Sales Tax for the Third Quarter 2004 was 4.4%, compared to the Bay Area region growth of 1.1% and Sunnyvale's growth of 1.8%. (See Attachment A).

Staff has compiled a number of economic forecasts for Sales Tax growth in the region and in the state, including the Governor's Budget, the LAO, ABAG, and the UCLA Anderson School. In the coming month we will be reviewing these forecasts as we refine our long-term forecasts. Preliminarily, it appears that our growth assumption for FY 2005/2006 may need to be adjusted downward by approximately 1%. At this time we are not certain how this will impact the eight-year business cycle that formed the basis of our long-term projections.

Adding uncertainty to our forecast of Sales Tax revenue is the fact that Sales Tax receipts are now being handled differently by the State. Beginning July 1, 2004, the State implemented a mechanism commonly referred to as the “Triple Flip” as part of the issuance of Deficit Recovery Bonds. In the Triple Flip, 25% of the local portion of Sales Tax is swapped with Property Tax dollar for dollar based upon actual sales collected for the period that the Deficit Recovery Bonds are in place. There are two major negative effects of this funding mechanism. The first effect relates to the timing of when the revenues are remitted to the City. Sales Tax is remitted on a monthly basis while Property Tax is remitted twice a year. This change in timing lowers our cash flow and our corresponding interest earnings. The second effect relates to the dollar for dollar exchange of revenues. In order to accurately account for the swap, the County will estimate the amount of in-lieu Property Tax based upon the prior year’s receipts. The County will then reconcile their remittances with the amount of Sales Tax withheld by the State and make-up any differential in January of the following year. This mechanism makes it very difficult for us to accurately portray our actual Sales Tax revenues at any given time.

Final information on the FY 2004/2005 Property Tax roll for the City of Sunnyvale reflects a 2.64% decrease in net taxable value. Overall, this contains a 4.83% increase in the residential sector and reductions in other sectors as follows:

CATEGORY	CHANGE IN NET TAXABLE VALUE	% Change
Residential	$449,306,936	4.83%
Commercial	($91,904,274)	-5.17%
Industrial	($366,427,585)	-8.45%
Institutional	($10,308,208)	-9.73%
Miscellaneous	($5,576,119)	-5.01%
Vacant Land	($7,148,261)	-5.83%
Unsecured	($553,208,799)	-21.06%

This pattern is reflected statewide, with residential real estate values constituting the largest share of taxable valuation growth. In our area, increases in residential value have partially offset the substantial decreases in commercial and industrial property values which we have experienced in the last few years. In his latest Annual Report, Assessor Larry Stone reports that “In just three years, the net assessed value of business property in Santa Clara County has declined almost 25%, from $31 billion to $24 billion.[16] For the second straight year the Santa Clara County Assessor’s Office has reduced assessed valuations Countywide on commercial and industrial property to account for the historically high vacancy rates.

Property Tax is received in two large installments, in mid December and mid April. Our cumulative forecast for Property Tax, net of funding swaps by the State, called for an increase of 2.86% in FY 2004/2005. Because the City's net taxable valuation showed a 2.64% decrease, we will not realize the full revenue projected. Most notably, receipts received for unsecured property are down 14%, or $291,982, compared to last year. This decline in Unsecured Property Tax reflects the continued hesitancy of businesses to expand operations and purchase or replace capital equipment and the continued high vacancy rates in commercial and industrial properties.

In developing our long-term projections we created a model similar to that used for Sales Tax forecasts. For Secured Property Tax we isolated the assessed valuations for both Residential and Commercial/Industrial, as each segment is currently in difference stages of the economic cycle. Our projections call for sustained growth related to residential property valuations and flat to moderate growth in commercial/industrial valuations. The average forecast for the remainder of the 10-year projection calls for an annual increase of 4.36%. Due to the probability of higher than average vacancy rates in the commercial and industrial sectors for the near future, additional downward adjustments to our projections may be necessary.

As part of the state budget agreement reached last year, cities will no longer receive the constitutionally guaranteed revenue from the Vehicle License Fee or "VLF backfill." Instead, starting FY 2004/2005 the state will be transferring an amount equal to the VLF offset to the City from the County's Educational Revenue Augmentation Fund Property Tax. Although the transfer will be based on actual VLF receipts this year, in the future these payments will constitute a permanent increase to our base property tax and will increase or decrease in accordance with future assessed valuations. This transfer of revenues has been incorporated into our long-term projections.

Since FY 2000/2001 TOT revenues have declined by 55.7% or approximately $6 million. Through the first half of FY 2003/2004 TOT revenues continued to decline as compared to the prior year. However, beginning in February 2004 TOT revenues began to exceed receipts from the prior year.

Through the first five months of FY 2004/2005 TOT revenues were $134,557 higher, or 7%, as compared to the same time period last fiscal year. Based upon year to date receipts we anticipate year-end revenues to meet the current year’s projection of $5 million. Our forecast for FY 2004/2005 called for an increase of 10%. Assuming the current growth trend of 7% continues for the remainder of the fiscal year, TOT revenues will meet estimates because FY 2003/2004 TOT revenues exceeded May estimates by 3.6%.

The City does not have access to information on the average room rates or occupancy for our hotel and motel properties, so it is difficult to identify the source of the 7% growth this year. However, staff has reviewed regional data from various hospitality industry sources and had conversations with local hoteliers and offers the following comments. The increase in TOT appears to be primarily due to increases in occupancy rates rather than room rates. The occupancy, however, is still lower than desirable because of the glut of hotel rooms built during the dot.com boom. This over-supply also allows consumers to select newer and nicer properties at affordable prices, which has a negative effect on the older properties with less amenities. Business travel is continuing to be lighter than previously experienced because of tighter security requirements, and the desire of business to contain costs.

The bulk of our TOT revenues stems from weekday business travel, as evidenced by an extremely high level of correlation between TOT revenues and Sales Tax revenue from the Business and Industry sector. Based upon this relationship, future year projections mirror the business cycle seen in the Business and Industry Sales Tax sector and average approximately 6% over the remainder of the planning period. Assuming no changes in the status quo, staff believes that long term projections will be met.

There are a number of circumstances that could negatively effect future growth in the City's TOT revenues. These are a decrease in the number of rooms available (either through hotel conversion or demolition), increased price competition via discount Internet travel sites, and continued advancement of videoconferencing technologies. Proposals to convert or reduce several of our hotel sites have either come to Council or are expected to do so in the near future. Reduction in the number of hotel rooms will not necessarily result in a loss of TOT; in some cases, the occupancy will simply shift to another available property and decrease vacancy rates. As mentioned earlier, the current trend is for travelers to choose a higher quality property because prices have softened. To the extent that our properties cannot compete with newer, more desirable properties in neighboring cities we will lose occupancy and therefore revenue. Any proposed hotel conversion will need to be reviewed carefully as to the impact on our revenues and our Long Term Financial Plan.

As mentioned earlier, the state permanently reduced the VLF rate from 2% to .65%, which is the current effective rate to the consumer. For FY 2004/2005 the VLF that the City would have gotten at the 2% rate will be calculated and this amount will be added to our Property Tax base through transfers from the Educational Revenue Augmentation Fund (ERAF). In preparing our projections for FY 2004/2005 staff reduced the revenue by the amount that the VLF rate was reduced (i.e. 67.5%). Subsequently it was clarified that most of the existing .65% will be utilized for County realignment programs and very little VLF will actually come to cities. Our VLF projections for future years are overstated due to the reallocation methodology, and our Property Tax projections are correspondingly understated. Staff will make these adjustments in the Proposed Budget for FY 2005/2006. However, in FY 2004/2005 some residual VLF revenue from last fiscal year will be reflected in current receipts because of timing issues and we expect to realize the entire amount budgeted.

The City’s UUT revenues are based upon receipts from intrastate telephone, gas, and electric usage. Approximately 63% or $3.6 million of UUT revenue is derived from the sale of electricity, 26% or $1.4 million is related to intra-state telephone usage, and 11% or $600,000 is derived from the sale of gas by PG&E to Sunnyvale citizens and businesses.

The City receives a one-time franchise payment from PG&E in early February. This payment represents approximately 41%, or $2.2 million of all Franchise revenue. The City’s other main franchise agreements are with Comcast Cable and Specialty Garbage. The combination of these three agreements accounts for 85% of all franchise related revenue. The City’s franchise agreements with each of these entities is based upon actual usage of each of the services and does not necessarily correlate with increases in service/subscription rates.

Our forecast for FY 2004/2005 called for a 3% aggregate increase in UUT and Franchise revenues. Based upon year to date receipts UUT revenues are tracking with this forecast.

A number of factors could significantly impact future UUT revenues. The major issues are potential revision of federal and state telecommunications law and the advancements in technology related to Voice Over Internet Protocol (VoIP). These factors could have a significant negative effect on the City's UUT revenues from telephone usage. This issue is discussed in more detail later in this report. However, absent any change in these areas we expect that our long-term projections will be met.

This category includes Construction Tax as well as receipts from the issuance of building, electrical, and other permits. Revenues related to building activity continue to show signs of solid growth. Our forecast for FY 2004/2005 called for 5.8% aggregate growth as the City’s Building Officer had noted a large number of new construction projects to be completed in the coming year. Current revenues are tracking 15% higher than projected or approximately $500,000. Staff anticipates revenues may exceed original estimates by approximately $500,000 at year end based upon the current level of building activity. Future forecasts were based upon a historic eight-year economic cycle and call for continued growth through FY 2005/2006 with revenues beginning to moderate in FY 2006/2007. We currently do not anticipate any change in our projections for the remainder of the Long-Term Financial Plan.

The FY 2004/2005 Adopted Budget included assumptions for salary increases in the future as shown on the following table:

Labor Unit	FY 2004/05	FY 2005/06	FY 2006/07 – FY 2013/14	FY 2014/15 – FY 2023/24
SEA/Confidential	2.10%	3.00%	3.00%	4.00%
PSOA	3.40%	4.10%	3.00%	4.00%
COA	3.40%	4.10%	3.00%	4.00%
SEIU	8.12%	3.00%	3.00%	4.00%
Management	2.10%	3.00%	3.00%	4.00%

*Increase for SEIU in FY 2004/05 represents an average increase for all classifications.

During this fiscal year, the Public Safety Officers Association (PSOA) compensation survey resulted in a salary increase of 3.58% for Public Safety Officers and 3.44% for Public Safety Lieutenants effective July 1, 2004. Last year Council took action to roll over the Communication Officers Association (COA) Memorandum of Understanding (MOU) through December 2004. Since COA salaries are adjusted in relationship to PSOA under their MOU, the COA received 3.58% increases in November 2004 as well. These increases required a modest budget modification but were substantially within original budgeted amounts.

The Sunnyvale Employees Association (SEA) MOU expired on June 30, 2004. On January 6, 2005 SEA ratified a four-year agreement, effective July 1, 2004 through June 30, 2008. On January 11, 2005 Council adopted the SEA MOU. The approved MOU called for no salary increases for FY 2004/2005 based on a revised compensation formula and provided increased medical benefits beginning January 1, 2005. The agreement also called for an enhanced retirement benefit to take effect July 1, 2007 if approved by the CalPERS membership.

The January 11, 2005 Report to Council on the SEA MOU (RTC 05-018) discussed the fiscal effects of the new agreement over the 20-year Long Term Financial Plan using current PERS and budgetary assumptions. On a year-to- year basis, savings will occur in FY 2004/2005 and FY 2005/2006 and then be drawn down when the enhanced retirement benefit takes effect. In order to appropriately capture the upfront savings in salaries and benefits, staff is recommending Budget Modification No. 23 to reduce the budgeted 2.1% salary increase for SEA, Management and SEIU positions tied to SEA. These funds would be transferred to a reserve in the Employee Benefits Fund to be utilized when the enhanced retirement benefit takes effect in FY 2007/2008.

The City contributes to two California Public Employees Retirement System (CalPERS) plans for and on behalf of its employees: Safety (3% @ 50 Plan) and Miscellaneous (2% @ 55 Plan). The employer contribution rate is adjusted annually by CalPERS through an actuarial analysis based on the fiscal year which ended two years ago. For example, in November 2004, CalPERS provided the revised employer rate for FY 2005/2006 based on the year ended FY 2002/2003. For the last several years CalPERS staff has also provided a projected employer contribute rate for a second fiscal year. The contribution rate is applied against employee salaries (PERSable earnings) in order to calculate the dollar amounts the City must contribute.

The following table shows the current employer contribution rate and the rates provided by CalPERS in November for both Safety and Miscellaneous employees for FY 2005/2006. The table also includes the projected rate for these same groups that was provided last year when the FY 2004/2005 rate was calculated.