Auditor: Edmonds Public Facilities District could be at risk

City continues to subsidize Edmonds Center for the Arts; new bank loan could help pay off debt
By Brian Soergel | Sep 13, 2018
Photo by: Brian Soergel The Edmonds Center for the Arts.

In its most recent audit of the City of Edmonds’ Public Facilities District, which operates the nonprofit Edmonds Center for the Arts, the State Auditor’s Office reported that the district has received recommendations on its financial sustainability in eight of its past nine audits.

The most recent, in July and accounting for 2017, found that the PFD board has taken steps to increase its operating revenues, but its operating margin continues a steep declining trend, from $4.4 million in 2014 to $2.9 million in 2017.

At the same time, PFD’s net assets – accumulated by the ECA through community support and which are not subject to use restrictions – have continued to climb, from $686,000 in 2013 to over $1 million in 2017.

That means, the auditor reports, that the length of time the district has had a negative balance limits its ability to deal monetarily with emergencies and unanticipated needs.

Indeed, in 2008, the district did not receive sufficient sales tax revenue from the state to meet its debt obligations – due to dwindling sales tax revenue – and began borrowing from the City for its sales tax obligations and for refunding bonds.

This borrowing trend has continued through 2017, and to date the PFD owes the City about $1.2 million, according to Councilmember and Finance Committee member Diane Buckshnis.

More woes: In 2009, the state auditor’s office reported concerns with the public facility district’s financial condition, including its inability to make debt payments on the center’s renovation. And in 2014, the state auditor found that the district, once again, did not have the proper internal controls to separate its public and private money.

The current audit reported that the district’s cash flow constraints are expected to continue in the near future.

“Because expenditures are consistently exceeding revenues, the district is at increased risk of not being able to sustain the operation or continue to provide the same level of service,” the report states, noting that the district’s cash flow problems are expected to continue in the near future.

The audit came to the same conclusion in its report last year.

Indeed, there have been consistent internal control issues, including three years of financial data being lost due to data not being backed up.

Background

In April 2001, the Edmonds City Council passed an ordinance to form the Edmonds Public Facilities District. The district was created to finance, design, construct, operate and maintain a public facility, the Edmonds Center for the Arts.

A five-member board of directors governs the district, and is formally appointed and confirmed to four-year terms by the Edmonds City Council. The ECA also has a board of directors that manages nonprofit and philanthropy aspects.

As is true of all performing arts centers, a large portion of the district’s annual operating revenue is through the support of private individuals, foundations and corporations.

But in 2011, the auditor reported that the district wasn’t generating sufficient funds to meet its financial obligations. The district continued to borrow money from the City, which is obligated, under a contingent loan agreement, to provide funds to the district for debt service payments.

The City guarantees the PFD’s two bonds and has an agreement with the PFD to cover any shortfall from state sales tax revenue not sufficient for bond payments. To date, the PFD owes the City about $1.2 million.

The PFD has had to borrow from the City to cover shortfalls for at least the past six annual audits.

Paying off bonds

A new deal to help pay off one of the PFD’s bonds is in the works. It could be approved by City Council next week after a discussion this week by the council’s Finance Committee.

In 2008, the PFD issued $4 million in sales tax obligation and refunding bonds, which the City guaranteed with the agreement. The bonds’ proceeds were used to pay off a line of credit the PFD opened to finance a portion of the construction of ECA.

To date, the PFD has paid $1.345 million in principal payments toward that total, leaving an outstanding principal balance of $2.655 million, due over the next seven years.

“Current interest rate conditions no longer warrant bond refinancing, which is the reason for the new proposal – the PFD pays off the bonds and takes out a bank loan using a City’s certificate of deposit collateral,” Buckshnis said.

The average coupon rate for the bonds is 4.24 percent. According to City documents, the PFD will pay off the outstanding bonds with a loan from First Financial Bank, which would be collateralized with a City of Edmonds certificate of deposit purchased from First Financial for the same dollar amount.

The bank’s loan rate for the PFD’s loan would be fixed at 3 percent for its duration, which would also be extended for 10 years (current bonds have seven-year maturity).

The CD rate would be 2.1 percent annual percentage yield, guaranteed for 10 years so the City will make some money from the transaction.

“The primary goal is to work on stabilizing the PFD’s financial condition and paying off the bonds with a loan saves money Buckshnis said. “This transaction will remove the bond’s annual payments from the state tax revenue requirement.

“This new arrangement should lessen the likelihood that the PFD will need to borrow additional funds in 2019 and, moving forward, and provide them with money to help start repayment of the $1.2 million owed the City,” she said.

Council concerns

At a recent City Council meeting, Councilmember Thomas Mesaros made funding of the Edmonds Public Facilities District one of his 2019 budget priorities. Mesaros is the council’s liaison to the PFD.

The motion to continue funding was approved on a 4-3 vote, with Councilmembers Mesaros, Mike Nelson, Neil Tibbott and Adrienne Fraley-Monillas voting yes. Councilmembers Buckshnis and Dave Teitzel – both members of the council’s finance committee, voted no, as did Kristiana Johnson.

Buckshnis expressed concerns and wanted to take a closer look at the PFD’s financial management and operations before considering allocating money to fund its operations.

She pointed to the recent audit report and management letter continuing to show financial deterioration, as well as continued comments regarding internal control problems.

“The City is working on a method to help ease the PFD bond debt expenses, as we all want the Edmonds Center for the Arts to succeed,” Buckshnis said.

“This new business arrangement will free up and redistribute expense streams. So, as a council, we should allow the PFD and ECA boards to see how these changes will affect the overall financial health of the PFD.”

She added that current 2018 preliminary revenue streams and state tax revenue estimates are both improving.

“So rather than guess at a number to give them for operating,” she said, “let’s take time to figure out the need and see what policies and practices have been put in place to remedy the continued concerns noted by auditors.

“But citizens need to realize that ECA is managed by two separate entities, with two separate boards.”

Steps to improvement

The district has taken steps to improve its bottom line.

Throughout its history, the ECA has brought in quality entertainment to the city, but it faces competition from acts that come through Seattle clubs and concert venues, as well as from deep-pocketed casinos.

And although some of the better-known performers can draw healthy crowds, lesser-known acts often play to sparse houses.

The auditor’s report noted that ECA increased fees on tickets sold at the box office, introduced new programs and updated rental contracts to bring in more revenue. It also has worked on reducing the amounts borrowed through its contingent loan agreement with Edmonds.

“We recommend,” the auditor reported, “the district continue to monitor and take steps to improve its financial condition. In addition, we recommend the district strive to operate as a self-sustaining organization.”

In August 2017, the district hired its first operations director, Matt Keller, a new position supported in part by a multiyear grant from a private foundation.

Keller’s role is to provide direct oversight of the accounting, human resources, information technology, facilities, rental/production and patron services departments, allowing Executive Director Joseph McIalwain to focus efforts on the district’s business development.

Other problems

The audit went on to list other problems, centered on the PFD’s board of directors and management, who are responsible for expenditures of public funds.

Most seriously, it found that the district’s updated policy continues to allow ECA employees to frontload compensated leave at the beginning of the year, which is then immediately available for use. This is not allowed in the state’s Constitution.

McIalwain said that due to the seasonal nature of the district’s operation as a performing arts center, the crediting of paid leave at the beginning of each fiscal year had been a district policy and practice designed to assist the district’s employees as well as help the district’s operation, and was modeled after similar policies in place in some local school districts.

The concept, McIalwain said, was to allow employees to take leave when it would work best in their schedules, according to specific business cycles, rather than requiring employees to wait for leave to fully accrue and then be forced to take it at a more challenging time in the business cycle.

“The district ultimately came to an agreement with the State Auditor’s Office and will make adjustments to its policy as required,” McIalwain said.

“Management is currently in the process of modifying its employment policy handbook to explicitly prohibit upfront crediting of paid leave in order to be in compliance.”

The district’s board of directors is expected to approve the modification at its regular meeting in November.

In addition, the audit report found that the district’s policy did not prohibit cash advances, provide guidance on pay and overtime, and had not been updated to show the leave-accrual rate for McIalwain himself.

The district has already inserted a draft section in the Employment Policy Handbook that addresses and prohibits cash advances, McIalwain said.

In practice, the district has not issued a cash advance to any employee since the 2016 fiscal year, he added. This updated policy also will be approved by the board in November.

Regarding overtime pay, McIalwain said the district is improving and clarifying the policy for its employment handbook.

“The auditor’s recommendation regarding the accrual of paid leave for the executive director is to more clearly define how the director’s unused accrued vacation may carry forward from one year to the next,” McIalwain said.

“The district board believes the language used in the director’s contract is reflective of its current leave policy for all employees. The auditor’s office expressed concern that the language used in the employment contract as it is written may be interpreted differently, and therefore should be clarified.

"The district will clarify the language in the director’s employment contract and will make certain that it more clearly reflects the language in its employment policy handbook. The district will formalize this adjustment prior to the end of the current fiscal year.”

As far as disbursements go, the audit found continuing problems with safeguarding public funds.

The auditor’s office, in testing 30 credit card transactions totaling $6,984 and four employee reimbursements totaling $359, identified times that did not get “promotional hosting forms” – used for the hosting of individuals or groups of individuals at meetings, meals, events, tours, or other gatherings or ensure travel expenses had prior written approval.

“Management is working with staff to ensure that promotional hosting forms are completed and submitted to management consistently,” McIalwain said.

“Management will regularly counsel and train staff on this policy and related procedures, and will closely monitor the execution of these procedures to ensure compliance.”

The audit, too, found that the district’s internal travel policy states that alcohol is not reimbursable, but that conflicts with its promotional hosting policy, which states that alcohol may be considered allowable for hosting purposes.

McIalwain said that when the travel policy was updated in 2017, alcoholic beverages were inadvertently listed as a non-reimbursable expense.

“Once this discrepancy was identified by the Auditor’s Office, district management corrected its travel policy to match its promotional hosting policy,” McIalwain said. “This policy has been updated, and will be formally approved by the District’s board of directors at its regular meeting in October.”

The roof

In July 2017, the district began the process of construction on the replacement of its leaking roof over its 1939 gymnasium. It was completed with an official ceremony in May.

The district received two grants in 2015 for replacing the gymnasium roof: $225,000 from Snohomish County and $250,000 from the State of Washington, for a total of $475,000 for the project.

The audit reported that its review of the district’s steps in replacing the roof showed that it did not comply with its policies and state law regarding the procurement of services.

Specifically, the district did not provide advance notice of the need for professional services, and the only evaluation criteria the district used to select an architectural and engineering consultant was that it had used this consultant before.

In addition, the report found the following procurement issues related to competitive bidding:

 

  • (The auditor) could not confirm if bidders provided all required documentation or if the lowest responsible bidder was awarded, as the district did not have all supporting documentation;
  • Bids were not opened and read publicly at a fixed time and place;
  • Contractor registration was not confirmed at the time of bid submittal; and
  • Confirmation was not performed to ensure the contractor awarded was not disqualified from bidding on a public works project.

McIalwain said that the PFD hired a consulting firm to manage the procurement process for the roof project.

“The district released an RFP (request for proposal) as required by law to attract bidders for this construction project,” he said.

“The district did accept the lowest qualified bid for the project. The construction company paid prevailing wage to its workers as required by state law. The project itself went extremely smoothly, and came in significantly under budget.

“However, it is also true that the district did not ensure that our consulting partner followed all of the district’s own internal procurement policies and procedures, and some state laws governing procurement of this type. These errors were made mistakenly.”

McIalwain said that the Auditor’s Office made the review of procurement policies and procedures and adherence to those procedures one of its top review priorities statewide for 2017.

Tens, if not hundreds, of public agencies across the state were given management letters or findings in this area as a result, he said.

“When our district is found to be out of compliance in any case, we take immediate action to correct the issue and improve our organizational systems,” McIalwain said. “We have done that in this case.”

In addition to the roof replacement, the PFD will also be conducting several interior upgrades and improvements.

“We will be repairing and upgrading the lighting inside the gymnasium, repairing and painting interior walls, and replacing the scoreboard,” McIalwain said.

“These changes will help improve the functionality of the gymnasium and will help increase use of this important community asset. The lighting improvements will also help lower electricity usage and cost.”

Long-term stability

The most recent audit report concluded that the board of directors and PFD management are confident that the financial condition of the district is stable, and that the strategies outlined in the management’s discussion and analysis section of the report will lead to long-term financial stability.

Further, the recently adopted extension of the Public Facilities District legislation by the state of Washington will conservatively provide an estimated $15 million in new projected revenue.

This new law extends the current legislation establishing and governing Public Facilities Districts, including the related sales tax rebate, by a period of 15 years beyond its original sunset date of 2026 to the year 2041.

The extension of this funding source will provide the district with several options for refunding or refinancing long-term debt for capital maintenance, replacement or improvements.

“With just over a decade in operation, our district is still in the early stages of formulating its policies, procedures and systems,” McIalwain said.

“We strive to improve every day, and to steward public resources with absolute care. We believe we have done that in this case, even in light of the state auditor’s report regarding our procurement process.”

McIalwain said that it’s important to note that auditor’s office was “extremely pleased with the district’s financial statement preparation, the efficiency of the audit process, the reduced timeline for audit site work, and the progress the district made during and immediately following the audit to address items identified by the audit team.”

In addition, McIalwain said that the district had made such positive progress over the last several years in its management and operations that the auditor’s office has decided to shift the district to an every-other-year accountability audit schedule, effective immediately.

The next accountability audit will not take place until 2020 for fiscal year 2019. The auditor’s office will conduct only an audit of financial statements for 2018.

“This is an important stamp of approval from the auditor’s office,” McIalwain said, “and a significant cost savings for the district in fiscal year 2019.”

The new audit schedule will also allow the district sufficient time to make necessary updates to policies and procedures recommended by the Auditor’s Office, and to put those changes into practice.

The district, McIalwain, is committed to addressing the recommendations made by the Auditor’s Office prior to the end of the district’s current fiscal year, which is Dec. 31.

 

 

 

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