This section of the Toll Road Enterprise Fund of Harris County (the “Authority”) financial statements presents management’s discussion and analysis (“MD&A”) of the financial performance of the Authority during the fiscal year ended February 29, 2004.

The Authority is an enterprise fund of Harris County, Texas (the “County”) and is included in the County’s financial statements. This analysis presents information about the Authority and the operations and activities of Authority only and is not intended to provide information about the entire County.

Financial Highlights

· At the end of the current fiscal year, the total net asset of the Authority was $47,667,183, which represents an increase of $10.7 million from the prior year. The increase was a result of toll rate increase on November 1, 2003.

· The $13.5 million loan to General Fund and $15 million loan to Fort Bend County were repaid to the Authority during the current fiscal year.

· During fiscal year 2004, the Authority issued $321,500,000 in refunding tax bonds. Debt service for such bonds is financed through the proceeds from bonds, including the interest earned thereon and through toll revenue. Note 8 to the financial statements provide further details on the new debt issuances.

· On December 17, 2002, Harris County Commissioners Court approved a cooperative agreement between Harris County, the Texas Department of Transportation and the Federal Highway Administration that allows for four managed lanes to be designed, built, operated, monitored, and maintained within the limits of Interstate Highway 10 from west of State Highway 6 to Interstate Highway 610. The total distance is approximately 12 miles and usage will be known as value pricing/congestion pricing or peak period pricing, which will entail fees or tolls for usage in the four managed lanes. Harris County’s financial commitment of $237,500,000 will span nine payments over a five-year period. The first installment payment of $37,500,000 was paid to the Texas Department of Transportation (“TxDOT”) in May 2003. The next installment of $25,000,000 is due September 1, 2005.

· As of February 29, 2004 the life-to-date capitalized cost related to the Westpark Tollway is $259,123,460. Westpark Tollway construction is in two phases. Phase I extends from IH-610 West to SH6 for a distance of approximately 12 miles and Phase II extends approximately 3 miles from SH6 to FM 1464. Phase 1 construction began in fiscal year 2001 and Phase II construction began in the fall of 2003.

Overview of the Financial Statements

This discussion and analysis are intended to serve as an introduction to the Authority’s basic financial statements. The Authority’s basic financial statements are comprised of 1) Financial statements: Statement of Net Assets, Statement of Revenues, Expenses, and Changes in Net Assets, and Statement of Cash Flows and 2) Notes to the basic financial statements.

Financial Statements for the Authority include the Statement of Net Assets, the Statement of Revenues, Expenses and Changes in Net Assets, and the Statement of Cash Flows. Since the Authority is an enterprise fund, the financial statements of the Authority are presented on the flow of economic resources measurement focus and use the accrual basis of accounting. Funds are a self-balancing set of accounts used to maintain control over resources that have been segregated for specific activities or objectives. Fund accounting is used to ensure and demonstrate finance-related legal compliance. The Authority is used to account for the acquisition, operation and maintenance of toll roads within Harris County.

Notes to the Basic Financial Statements provide additional information that is essential to a full understanding of the data provided in the financial statements. The notes can be found on pages 14 through 30 of this report.

Government-Wide Financial Analysis

This is the second year the Authority has applied Governmental Accounting Standard Board (“GASB”) Statement No. 34. Net assets may serve over time as useful indicator of a government’s financial position. In the case of the Authority, assets exceeded liabilities by $47,667,183 as of the fiscal year ended February 29, 2004 and $36,965,294 as of the fiscal year ended February 28, 2003.

The largest portion of the Authority’s net assets for fiscal year 2004 represent restricted net assets, which are subject to external restrictions on how they may be used. The Authority’s restricted net assets are for capital projects, debt service and other purposes. The restricted net assets for other purposes may be used as follows: (1) payment or provision for payment of senior indebtedness payable as a first charge on revenues; (2) to pay project expenses; (3) to establish and maintain an operating reserve equal to two months’ project expenses; (4) to pay any senior indebtedness not a first charge on the revenues; (5) to make transfer to the debt service fund as required by the tax indenture; and (6) the balance, if any, shall be transferred to the surplus fund.

Another portion of the Authority’s net assets for fiscal year 2004 reflects its investments in capital assets (e.g. land, improvements, buildings, equipment, infrastructure), net of accumulated depreciation less any outstanding related debt used to construct or acquire those assets. The main use of these capital assets is to provide services to citizens; consequently, these assets are not available for future spending. The net assets invested in capital assets deficit balances indicate that the net capital assets are less than the outstanding related debt. Although the Authority’s investment in its capital assets is reported net of related debt, it should be noted that resources needed to repay this debt must be provided from other sources, since the capital assets themselves cannot be used to liquidate these liabilities.

The following table indicates changes in net assets for the Authority:

Revenues and Contribution

Total revenues and contributions for fiscal year 2004 were $292,193,930, an increase of $26,922,681 (or 10%) in revenues and contribution from fiscal year 2003 of $265,271,249.

The largest revenue source is toll revenue of $265,913,082 or 91% of total revenues and contributions. Although it only shows a 1% increase in total revenues and contributions, toll revenues increased by $21,742,337 (or 9%) from fiscal year 2003. This is due to a toll rate increase.

Contributions and other revenues totaled $15,904,096 or 5% of total revenues and contributions. Contributions of $15,189,452 for fiscal year 2004 increased by 201% over fiscal year 2003 contributions of $5,048,100. This is due to a larger portion of Federal and State shares recognized on toll road projects based on the projects’ percentages of completion. Other revenues of $714,644 for fiscal year 2004 increased by $590,481 over fiscal year 2003 of $124,163. Other revenues are receipts for building rent and miscellaneous fines and fees other than toll payments.

Interest revenue for fiscal year 2004 totaled $10,376,752 or 4% of total revenues. This is a decrease of $5,551,489 from fiscal year 2003 of $15,928,241. The decrease is attributable to lower interest rates and less money in interest bearing accounts.

Expenses

For fiscal year ended February 29, 2004, expenses totaled $213,992,041, an increase of $33,164,510 (or 18.3%) in expenses from fiscal year 2003 of $180,827,531.

Interest expense of $101,075,728 is the Authority’s largest expense category at 47% of total expenses. Interest expense reflects the interest and fees on outstanding debt charged in the year.

Other expense of $21,380,709 or 10% of total expenses consists of materials and supplies, bad debt expense, loss on disposal of capital assets, utilities, and transportation and travel. This expense category increased by $13,383,116 from fiscal year 2003 of $7,997,593. The largest amount of the increase, $6,860,045, was in materials and supplies. The increase is due to several purchases of items that did not meet the criteria to be classified as capital assets. Bad debt expense increased by $5,786,647 due to an increase in the allowance for bad debts. The remaining $736,427 increase of the other expense category consists of increases in loss on disposal of capital assets, utilities, and transportation and travel expenses.

The remaining 43% of expenses consisted of salaries (11%), service fees (11%), depreciation (20%) and amortization expense (1%). All of these expense categories were reasonable in comparison to the prior year.

Transfers Out

On April 18, 2001, the Commissioners Court approved a $20 million annual allocation distributed in the amount of $5 million per precinct, for the funding of non-toll County roads that connect or enhance the traffic flow to toll facilities. In fiscal year 2004, the amount per precinct for such purposes was increased to $15 million and an additional $7.5 million was allocated to the Public Infrastructure Department for other toll road project purposes, aggregating a total of $67.5 million. The funding increase was approved by the Commissioners Court on September 9, 2003.

Capital Assets and Debt Administration

Capital Assets

The Authority’s capital assets, net of accumulated depreciation as of February 29, 2004 and February 28, 2003, amounted to $1,328,146,799 and $1,181,674,001, respectively. These capital assets include land, buildings, equipment, and infrastructure. The Authority’s capital assets increased $146,472,798 or 12.4% over fiscal year 2003.

Major capital asset events during fiscal years 2004 and 2003 included the following:

· The Authority capitalized $97,663,937 and $114,009,727 costs for fiscal year 2004 and 2003, respectively, for the construction of the Westpark Tollway. Westpark Tollway Phase I was completed in May 2004 and Phase II is expected to be completed in the second quarter of 2005.

· The Authority began several construction projects, including the Barker Cypress, Fort Bend Westpark, IH10 Toll, Hardy Downtown Extension, Fort Bend Parkway Extension, construction of additional lane capacity for Sam Houston Tollway, Riley Fuzzel Road, Sam Houston Tollway South Mainline Toll Plaza and Administration Office parking lots, Hardy Toll Road pavement repair and/or additions from Greens Road to FM 1960, Hardy Screen Wall, and the Dairy Ashford Center renovation. Costs capitalized in 2004 and 2003 for these projects were $21,958,542 and $16,828,967, respectively.

· The Authority recognized construction costs in the amount of $2,943,288 during 2004 and $1,598,823 during 2003 related to the direct connector between Eastbound Beltway 8 and Northbound Hardy Toll Road, and $11,640,086 during 2004 and $7,516,667 during 2003 related to SH 249 Direct Connectors partnered with the Texas Department of Transportation.

For further information regarding capital assets and construction in progress, see Notes 6 and 7 to the financial statements.

Long-term debt

At the end of the fiscal year, the Authority had total outstanding debt (bonds, net of deferred amount on refunding) of $1,843,564,702. This represents a $61,532,012 increase from last fiscal year. During 2004, the Authority issued $321,500,000 Toll Road Unlimited Tax and Subordinate Lien Revenue Refunding Bonds, Series 2003 to refund all of the County’s outstanding Toll Road Unlimited Tax and Subordinate Lien Revenue Adjustable/Fixed Rate Bonds, Series 1994 B-H, at a redemption price equal to 100% of the principal amount and to pay certain costs incurred in connection with the issuance of the bonds. Refer to Note 8 to the financial statements for further detail on the Authority’s long-term debt.

Economic Factors

· Additional non-toll highways, roads and streets, or improvements and expansions to existing free highways, roads and streets that may be constructed by the County, TxDOT, the City of Houston or other public entities may adversely affect the usage of the toll road. TxDOT continues to improve and expand IH-45 and US 59. In particular, IH-45 offers free highway competition to the Hardy Toll Road. Improvements over the past few years to IH-45 from its interchange with Sam Houston Tollway-West/North Section/Sam Houston Parkway to FM 1960 have enhanced mobility along that segment of the highway.

· Metro, a regional transit authority, currently operates an extensive bus fleet serving Harris County and all of the City of Houston. Metro offers “park-and-ride” services, which include free automobile parking at suburban Metro lots and bus service to and from Houston’s central business district in competition with the Hardy Toll Road. Metro’s “park-and-ride” service from its most distant lot near the intersection of IH-45 and FM 1960 to downtown Houston, utilizing IH-45’s free “authorized vehicle lane”, competes for a portion of the traffic that could otherwise be expected to utilize the Hardy Toll Road.

· Westpark Tollway Phase I was opened for business on May 16, 2004. This tollway is a four-lane, entirely automated toll road.

Request for Information

This financial report is designed to provide a general overview of the Authority’s finances for all those with an interest in the Authority’s finances. Questions concerning any of the information provided in this report or requests for additional financial information should be addressed to the County Auditor’s Office, 1001 Preston, Suite 800, Houston, Texas 77002, telephone (713)755-4832, or visit the County’s website at www.co.harris.tx.us.