NOTE 1 – PRESENTATION OF INTERIM INFORMATION
The February 28, 2015 consolidated balance sheet, the consolidated statements of operations for the three and six months ended February 28, 2015 and 2014, respectively, the consolidated statement of shareholders’ equity and comprehensive loss for the six months ended February 28, 2015, and the consolidated statements of cash flows for the six months ended February 28, 2015 and 2014, respectively, have been prepared by Pure Cycle Corporation (the “Company”) and have not been audited. The unaudited consolidated financial statements include all adjustments that are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows at February 28, 2015, and for all periods presented.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. It is suggested that these consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company's 2014 Annual Report on Form 10-K (the “2014 Annual Report”) filed with the Securities and Exchange Commission (the “SEC”) on November 14, 2014, as amended on November 17, 2014. The results of operations for interim periods presented are not necessarily indicative of the operating results for the full fiscal year. The August 31, 2014 balance sheet was taken from the Company’s audited financial statements.
Use of Estimates
The preparation of consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid debt instruments with original maturities of three months or less. The Company’s cash equivalents are comprised entirely of money market funds maintained at a high quality financial institution. At various times during the six months ended February 28, 2015, the Company’s main operating account exceeded federally insured limits.
Financial Instruments – Concentration of Credit Risk and Fair Value
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company places its cash equivalents with high quality financial institutions. The Company has historically invested its idle cash primarily in certificates of deposit, money market instruments, commercial paper obligations, corporate bonds and U.S. government treasury obligations. To date, the Company has not experienced significant losses on any of these investments.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.
Cash and Cash Equivalents – The Company’s cash and cash equivalents are reported using the values as reported by the financial institution where the funds are held. These securities primarily include balances in the Company’s operating and savings accounts. The carrying amount of cash and cash equivalents approximate fair value.
Trade Accounts Receivable – The Company records accounts receivable net of allowances for uncollectible accounts.
Accounts Payable – The carrying amounts of accounts payable approximate fair value due to the relatively short period to maturity for these instruments.
Long-Term Financial Liabilities – The Comprehensive Amendment Agreement No. 1 (the “CAA”) is comprised of a recorded balance and an off-balance sheet or “contingent” obligation associated with the Company’s acquisition of its “Rangeview Water Supply” (defined in Note 4 below). The amount payable is a fixed amount but is repayable only upon the sale of “Export Water” (defined in Note 4 below). Because of the uncertainty of the sale of Export Water, the Company has determined that the contingent portion of the CAA does not have a determinable fair value. The CAA is described further in Note 4 – Long-Term Obligations and Operating Lease – Participating Interests in Export Water Supply.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
The recorded balance of the “Tap Participation Fee” liability (described below) as of August 31, 2014, is its estimated fair value determined by projecting new home development in the Company’s targeted service area over an estimated development period.
Notes Receivable – Related Party – The market value of the note receivable – related party: Rangeview Metropolitan District (the “District”) is not practical to estimate due to the related party nature of the underlying transaction.
Receivable from HP A&M – In conjunction with High Plains A&M, LLC (“HP A&M”) defaulting on certain promissory notes in fiscal year 2012, the Company had the right to collect from HP A&M any amounts the Company spent to cure the defaulted notes. Accordingly, through the date of the settlement the Company had recorded the entire amount of the HP A&M notes at default as well as expenses incurred to cure the defaults as a receivable from HP A&M less proceeds received from the sale of shares pledged by HP A&M as security. As described further in Note 9 – Litigation Loss Contingencies, the Company has settled all claims with HP A&M relating to the defaults on these promissory notes, resulting in the forgiveness of these receivables.
Promissory Notes Payable – During fiscal year 2013, the Company began acquiring the defaulted and non-defaulted promissory notes that are payable by HP A&M. The majority of the notes issued by the Company to acquire the HP A&M notes have a five-year term, bear interest at an annual rate of five percent and require semi-annual payments with a straight-line amortization schedule. The carrying value of the notes payable approximate the fair value as the rates are comparable to market rates.
During October 2014, the Company borrowed $4,450,000 from the First National Bank of Las Animas. The note has a 20-year term, requires semi-annual payments, and carries a 5.27% per annum rate for the first five years. After the first five years, the interest rate on the note is subject to change (no more often than annually) based on the changes in the First National Bank of Las Animas Ag/Commercial Real Estate Rate. The Company may pay the note in full at any time without penalty. The carrying value of this note approximates the fair value as the rate is comparable to market rates.
As described further in Note 4, in December 2014, the District entered into an agreement to finance approximately $1.4 million of the purchase of certain WISE infrastructure. The $1.4 million is repayable in equal annual installments over the next three years and accrues interest at the rate of 3%. The carrying value of this obligation approximates the fair value as the rate is comparable to market rates.
Off-Balance Sheet Instruments – The Company’s off-balance sheet instruments consist entirely of the contingent portion of the CAA. Because repayment of this portion of the CAA is contingent on the sale of Export Water, which is not reasonably estimable, the Company has determined that the contingent portion of the CAA does not have a determinable fair value. See further discussion in Note 4 – Long-Term Obligations and Operating Lease – Participating Interests in Export Water Supply.
Tap Participation Fee
This note should be read in conjunction with Note 4 – Long-Term Obligations and Operating Lease and Note 9 – Litigation Loss Contingencies below.
Pursuant to the Asset Purchase Agreement dated May 10, 2006 (the “Arkansas River Agreement”), the Company was obligated to pay HP A&M a defined percentage of a defined number of water tap fees the Company receives after the date of the Arkansas River Agreement. A Tap Participation Fee (“TPF”) was due and payable once the Company had sold a water tap and received the consideration due for such water tap. The Company did not sell any water taps during the three or six months ended February 28, 2015 or 2014. As further discussed in Note 9 – Litigation Loss Contingencies, the Company has settled all claims with HP A&M relating to the defaults, and the parties have eliminated the TPF.
Prior to the settlement, the Company imputed interest expense on the unpaid TPF using the effective interest method over an estimated period which is utilized in the valuation of the liability. The Company did not impute interest during the three months ended February 28, 2015. The Company imputed interest of $403,000 during the three months ended February 28, 2014. The Company imputed interest of $23,800 and $1,060,200 during the six months ended February 28, 2015 and 2014, respectively.
Due to the Company’s settlement with HP A&M, no water taps remain subject to the TPF as of February 28, 2015. As of August 31, 2014, there were 2,184 water taps subject to the TPF.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
Revenue Recognition
Wholesale Water and Wastewater Fees – Monthly wholesale water usage charges are assessed to the Company’s customers based on actual metered usage each month plus a base monthly service fee. The Company recognizes wholesale water usage revenues upon delivering water to its customers or its governmental customer’s end-use customers, as applicable. The water revenues recognized by the Company are shown net of royalties to the State of Colorado Board of Land Commissioners (the “Land Board”) and, when applicable, amounts retained by the District. The Company recognized $328,400 and $392,800 of metered water usage revenues during the three months ended February 28, 2015 and 2014, respectively. The Company recognized $820,300 and $714,400 of metered water usage revenues during the six months ended February 28, 2015 and 2014, respectively.
The Company recognizes wastewater treatment fees monthly based on usage. The monthly wastewater treatment fees are shown net of amounts retained by the District. The Company recognized $13,200 and $12,300 of wastewater treatment fees during the three months ended February 28, 2015 and 2014, respectively. The Company recognized $24,900 and $22,100 of wastewater treatment fees during the six months ended February 28, 2015 and 2014, respectively. Costs of delivering water and providing wastewater services to customers are recognized as incurred.
Tap and Construction Fees – The Company has various water and wastewater service agreements, a component of which may include tap and construction fees. The Company recognizes water tap fees as revenue ratably over the estimated service period upon completion of the “Wholesale Facilities” (defined in Part I, Item 1 of the 2014 Annual Report) constructed to provide service to Arapahoe County, Colorado (the “County”). The Company recognized $3,600 of water tap fee revenues during each of the three months ended February 28, 2015 and 2014, respectively. The Company recognized $7,200 of water tap fee revenues during each of the six months ended February 28, 2015 and 2014, respectively. The water tap fees to be recognized over this period are net of the royalty payments to the Land Board and amounts paid to third parties pursuant to the CAA as further described in Note 4 – Long-Term Obligations and Operating Lease below.
The Company recognized $10,400 of “Special Facilities” (defined in Part I, Item 1 of the 2014 Annual Report) funding as revenue during each of the three months ended February 28, 2015 and 2014, respectively. The Company recognized $20,800 of Special Facilities funding as revenue during each of the six months ended February 28, 2015 and 2014, respectively. This is the ratable portion of the Special Facilities funding proceeds received from water agreements as more fully described in Note 2 – Summary of Significant Accounting Policies to the 2014 Annual Report.
As of February 28, 2015, and August 31, 2014, the Company has deferred recognition of approximately $1,199,500 and $1,232,200, respectively, of water tap and construction fee revenue from the County, which will be recognized as revenue ratably over the estimated useful accounting life of the assets constructed with the construction proceeds as described above.
Agriculture Farming Operations – The Company leases its Arkansas River water and land to area farmers who actively farm the properties. The Company records farm lease income ratably each month based on estimated annual lease income the Company anticipates collecting from its land and water leases. The Company records these amounts as receivables, less an estimated allowance for uncollectible accounts. The allowance as of February 28, 2015 and August 31, 2014, was determined by the Company’s specific review of all past due accounts. The Company has recorded allowances for doubtful accounts totaling $26,300 as of February 28, 2015 and August 31, 2014. As of February 28, 2015, the Company has recorded deferred revenue of $90,500 on its farm income related to billings for future periods. As of August 31, 2014, the Company has accrued a receivable of $79,000 of farm income related to future billings. The Company manages the farm lease business as a separate line of business from the wholesale water and wastewater business.
Royalty and Other Obligations
Revenues from the sale of Export Water are shown net of royalties payable to the Land Board. Revenues from the sale of water on the “Lowry Range” (described in Note 4 – Water and Land Assets in Part II, Item 8 of the 2014 Annual Report) are shown net of the royalties to the Land Board and the amounts retained by the District.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
Oil and Gas Lease Payments
As further described in Note 2 – Summary of Significant Accounting Policies in Part II, Item 8 of the 2014 Annual Report, on March 10, 2011, the Company entered into a Paid-Up Oil and Gas Lease (the “O&G Lease”) and a Surface Use and Damage Agreement (the “Surface Use Agreement”) with Anadarko E&P Company, L.P. (“Anadarko”), a wholly owned subsidiary of Anadarko Petroleum Company. In December of 2012, the O&G Lease was purchased by a wholly owned subsidiary of ConocoPhillips Company. Pursuant to the O&G Lease, during the year ended August 31, 2011, the Company received an up-front payment of $1,243,400 for the purpose of exploring for, developing, producing and marketing oil and gas on approximately 634 acres of mineral estate owned by the Company at its “Sky Ranch” property (described in Note 4 – Water and Land Assets to the 2014 Annual Report). The Company began recognizing the up-front payments as income on a straight-line basis over three years (the initial term of the O&G Lease) on March 10, 2011. The Company received an additional payment of $1,243,400 during February 2014 to extend the O&G Lease an additional two years through February 2016, which will be recognized as income on a straight-line basis over two years (the extension term of the O&G Lease). During the fiscal year ended August 31, 2014, the Company received an up-front payment of $72,000 for the purpose of exploring for, developing, producing, and marketing oil and gas on 40 acres of mineral estate the Company owns adjacent to the Lowry Range (the “Rangeview Lease”). During the three months ended February 28, 2015 and 2014, the Company recognized $161,400 and $106,800, respectively, of lease income related to the up-front payments received pursuant to the O&G Lease and the Rangeview Lease. During the six months ended February 28, 2015 and 2014, the Company recognized $322,900 and $213,500, respectively, of lease income related to the up-front payments received pursuant to the O&G Lease and the Rangeview Lease.
As of February 28, 2015 and August 31, 2014, the Company has deferred recognition of $702,600 and $1,025,500, respectively, of income related to the O&G Lease and the Rangeview Lease, which will be recognized into income ratably through February 2016 and July 2017, respectively.
Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the eventual use of the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Based on the Company’s procedures, the Company determined that land and water shares “held for sale” related to the Arkansas River Assets were impaired as of August 31, 2014. See further discussion in Note 3 –Water and Land Assets below under “Land and Water Shares Held for Sale.”
Capitalized Costs of Water and Wastewater Systems and Depletion and Depreciation of Water Assets
Costs to construct water and wastewater systems that meet the Company’s capitalization criteria are capitalized as incurred, including interest, and depreciated on a straight-line basis over their estimated useful lives of up to 30 years. The Company capitalizes design and construction costs related to construction activities, and it capitalizes certain legal, engineering and permitting costs relating to the adjudication and improvement of its water assets. The Company depletes its groundwater assets that are being utilized on the basis of units produced (i.e., thousands of gallons sold) divided by the total volume of water adjudicated in the water decrees.
Share-Based Compensation
The Company maintains a stock option plan for the benefit of its employees and non-employee directors. The Company records share-based compensation costs as expense over the applicable vesting period of the stock award using the straight-line method. The compensation costs to be expensed are measured at the grant date based on the fair value of the award. The Company has adopted the alternative transition method for calculating the tax effects of share-based compensation, which allows for a simplified method of calculating the tax effects of employee share-based compensation. Because the Company has a full valuation allowance on its deferred tax assets, the granting and exercise of stock options has no impact on the income tax provisions. The Company recognized $63,800 and $59,500 of share-based compensation expense during the three months ended February 28, 2015 and 2014, respectively. The Company recognized $132,600 and $114,300 of share-based compensation expense during the six months ended February 28, 2015 and 2014, respectively.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
Income Taxes
The Company uses a "more-likely-than-not" threshold for the recognition and de-recognition of tax positions, including any potential interest and penalties relating to tax positions taken by the Company. The Company did not have any significant unrecognized tax benefits as of February 28, 2015.
The Company files income tax returns with the Internal Revenue Service and the State of Colorado. The tax years that remain subject to examination are fiscal year 2012 through fiscal year 2014. The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months.
The Company's policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. At February 28, 2015, the Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the three or six months ended February 28, 2015 or 2014.
Income (Loss) per Common Share
Income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares outstanding during each period. Common stock options and warrants aggregating 341,100 and 380,100 common share equivalents were outstanding as of February 28, 2015 and 2014, respectively, and have been included in the calculation of net income per common share but excluded from the calculation of loss per common share as their effect is anti-dilutive.
Recently Issued Accounting Pronouncements
The Company continually assesses any new accounting pronouncements to determine their applicability. When it is determined that a new accounting pronouncement affects the Company’s financial reporting, the Company undertakes a study to determine the consequence of the change to its consolidated financial statements and assures that there are proper controls in place to ascertain that the Company’s consolidated financial statements properly reflect the change. During the current period, there were no new accounting pronouncements issued that will significantly impact the Company’s financial reporting.
NOTE 2 – FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the principal or most advantageous market. The Company uses a fair value hierarchy that has three levels of inputs, both observable and unobservable, with use of the lowest possible level of input to determine fair value.
Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the NASDAQ. The Company had one of these instruments as of February 28, 2015 and August 31, 2014.
Level 2 — Valuations for assets and liabilities obtained from readily available pricing sources via independent providers for market transactions involving similar assets or liabilities. The Company had no Level 2 assets or liabilities as of February 28, 2015 or August 31, 2014.
Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. The Company had one Level 3 liability as of August 31, 2014, the TPF liability, which is described in greater detail in Note 4 – Long-Term Obligations and Operating Lease below. The Company had no Level 3 assets or liabilities as of February 28, 2015.
The Company maintains policies and procedures to value instruments using what management believes to be the best and most relevant data available.
The Company’s non-financial assets measured at fair value on a non-recurring basis consist entirely of its investments in water and water systems and other long-lived assets. See Note 3 –Water and Land Assets below.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
Level 3 Liability – Tap Participation Fee. Prior to the Company’s settlement with HP A&M eliminating the TPF, the Company’s TPF liability was the Company’s only financial liability measured on a non-recurring basis. As further described in Note 4 – Long-Term Obligations and Operating Lease, the TPF liability was valued by projecting new home development in the Company’s targeted service area over an estimated development period.
Although not required, the Company deems the following table, which presents the changes in the TPF for the six months ended February 28, 2015, to be helpful to the users of its consolidated financial statements:
| |
|
Fair Value Measurement using Significant
Unobservable Inputs (Level 3)
|
|
| |
|
Gross Estimated
Tap Participation
Fee Liability
|
|
|
Tap
Participation
Fee Reported
Liability
|
|
|
Discount - to be imputed as interest expense in future periods
|
|
|
Balance at August 31, 2014
|
|
$ |
12,038,300 |
|
|
$ |
7,935,300 |
|
|
$ |
4,103,000 |
|
|
Total gains and losses (realized and unrealized):
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Imputed interest recorded as "Other Expense"
|
|
|
- |
|
|
|
23,800 |
|
|
|
(23,800 |
) |
|
Purchases, sales, issuances, payments, reductions resulting from foreclosures, and HP A&M settlement
|
|
|
(12,038,300 |
) |
|
|
(7,959,100 |
) |
|
|
(4,079,200 |
) |
|
Transfers in and/or out of Level 3
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Balance at February 28, 2015
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
NOTE 3 – WATER AND LAND ASSETS
The Company’s water rights and current water and wastewater service agreements are more fully described in Note 4 – Water and Land Assets in Part II, Item 8 of the 2014 Annual Report. There have been no significant changes to the Company’s water rights or water and wastewater service agreements during the six months ended February 28, 2015.
The Company’s water and water systems consists of the following costs and accumulated depreciation and depletion at February 28, 2015 and August 31, 2014:
| |
|
February 28, 2015
|
|
|
August 31, 2014
|
|
| |
|
Costs
|
|
|
Accumulated Depreciation and Depletion
|
|
|
Costs
|
|
|
Accumulated Depreciation and Depletion
|
|
|
Arkansas River Valley assets
|
|
$ |
68,820,800 |
|
|
$ |
(1,488,600 |
) |
|
$ |
67,746,400 |
|
|
$ |
(1,488,600 |
) |
|
Rangeview water supply
|
|
|
14,444,600 |
|
|
|
(8,600 |
) |
|
|
14,444,600 |
|
|
|
(8,400 |
) |
|
Sky Ranch water rights and other costs
|
|
|
6,533,900 |
|
|
|
(145,200 |
) |
|
|
6,004,000 |
|
|
|
(93,000 |
) |
|
Fairgrounds water and water system
|
|
|
2,899,900 |
|
|
|
(754,700 |
) |
|
|
2,899,900 |
|
|
|
(710,600 |
) |
|
Rangeview water system
|
|
|
1,253,100 |
|
|
|
(89,600 |
) |
|
|
1,148,200 |
|
|
|
(77,900 |
) |
|
Water supply – other
|
|
|
3,679,500 |
|
|
|
(143,500 |
) |
|
|
1,050,200 |
|
|
|
(90,900 |
) |
|
Totals
|
|
|
97,631,800 |
|
|
|
(2,630,200 |
) |
|
|
93,293,300 |
|
|
|
(2,469,400 |
) |
|
Net investments in water and water systems
|
|
$ |
95,001,600 |
|
|
|
|
|
|
$ |
90,823,900 |
|
|
|
|
|
Capitalized terms in this section not defined herein are defined in Note 4 – Water and Land Assets to the 2014 Annual Report.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
Depletion and Depreciation. The Company recorded depletion charges of $3,700 and $100 during the three month periods ended February 28, 2015 and 2014, respectively. The Company recorded depletion charges of $6,200 and $200 during the six months ended February 28, 2015 and 2014, respectively. During the three and six months ended February 28, 2015, this related to the Rangeview and Sky Ranch Water supplies (defined below), and during the three and six months ended February 28, 2014, this related entirely to the Rangeview Water Supply. No depletion is taken against the Arkansas River (defined below) because the water located at this location was not being utilized for municipal purpose as of February 28, 2015.
The Company recorded $89,600 and $45,000 of depreciation expense during the three months ended February 28, 2015 and 2014, respectively. The Company recorded $165,900 and $93,400 of depreciation expense during the six months ended February 28, 2015 and 2014, respectively.
Land and Water Shares Held for Sale. During fiscal year end 2012, management decided to sell certain farms in order to have liquidity sufficient to acquire the notes defaulted upon by HP A&M and to meet the future obligations on the promissory notes the Company intended to issue as consideration to purchase the notes owed by HP A&M. Management planned to sell approximately 1,603 acres of land along with 3,397 Fort Lyon Canal Company (“FLCC”) shares associated with this land.
Through August 31, 2014, the Company completed sales of approximately 1,886 acres of land and 2,982 FLCC shares associated with the land; and, in November 2014, completed sales of approximately 299 acres of land along with 239 FLCC shares associated with the land. Management believes that the November 2014 sale completed the sales cycle related to the land held for sale as of August 31, 2012.
In addition, management identified as of August 2014 an additional 640 acres of land and 512 FLCC shares associated with the land as held for sale in order to have sufficient liquidity to continue to meet future obligations on the promissory notes the Company issued to purchase the defaulted notes owed by HP A&M and to continue to fund water system expansions. The net book value of the assets identified as held for sale was $1.9 million prior to designation as held for sale. The anticipated sales price for these assets is $1.5 million based on recent sales transactions, which required the Company to record an impairment of approximately $400,000 in fiscal year 2014.
NOTE 4 – LONG-TERM OBLIGATIONS AND OPERATING LEASE
The Participating Interests in Export Water Supply and the TPF payable to HP A&M (prior to settlement) are obligations of the Company that have no scheduled maturity dates. Therefore, these liabilities are not disclosed in tabular format, but they are described below.
Participating Interests in Export Water Supply
The Company acquired its Rangeview Water Supply through various amended agreements entered into in the early 1990s. The acquisition was consummated with the signing of the CAA in 1996. Upon entering into the CAA, the Company recorded an initial liability of $11.1 million, which represented the cash the Company received from the participating interest holders that was used to purchase the Company’s Export Water (described in greater detail in Note 4 – Water and Land Assets to the 2014 Annual Report). The Company agreed to remit a total of $31.8 million of proceeds received from the sale of Export Water to the participating interest holders in return for their initial $11.1 million investment. The obligation for the $11.1 million was recorded as debt, and the remaining $20.7 million contingent liability was not reflected on the Company’s balance sheet because the obligation to pay this is contingent on the sale of Export Water, the amounts and timing of which are not reasonably determinable.
The CAA obligation is non-interest bearing, and if the Export Water is not sold, the parties to the CAA have no recourse against the Company. If the Company does not sell the Export Water, the holders of the Series B Preferred Stock are also not entitled to payment of any dividend and have no contractual recourse against the Company.
As the proceeds from the sale of Export Water are received and the amounts are remitted to the external CAA holders, the Company allocates a ratable percentage of this payment to the principal portion (the Participating Interests in Export Water Supply liability account) with the balance of the payment being charged to the contingent obligation portion. Because the original recorded liability, which was $11.1 million, was 35% of the original total liability of $31.8 million, approximately 35% of each payment remitted to the CAA holders is allocated to the recorded liability account. The remaining portion of each payment, or approximately 65%, is allocated to the contingent obligation, which is recorded on a net revenue basis.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
From time to time the Company repurchased various portions of the CAA obligations in priority. In July 2014, the Land Board relinquished its approximately $2.4 million of CAA interests was the Company as part of the settlement of the 2011 lawsuit filed by the Company and the District against the Land Board. As a result, during the fourth quarter of the fiscal year ended August 31, 2014, the Company recorded a gain on the extinguishment of participating interests of the CAA of approximately $832,100. The Company did not make any CAA acquisitions during the six months ended February 28, 2015 or 2014.
As a result of the acquisitions, the relinquishment by the Land Board, and the sale of Export Water, as detailed in the table below, the remaining potential third party obligation at February 28, 2015, is approximately $1 million, and the Company has the right to approximately $29.9 million:
| |
|
Export Water
Proceeds
Received
|
|
|
Initial Export
Water Proceeds to Pure Cycle
|
|
|
Total Potential
Third Party
Obligation
|
|
|
Paticipating
Interests
Liability
|
|
|
Contingency
|
|
|
Original balances
|
|
$ |
– |
|
|
$ |
218,500 |
|
|
$ |
31,807,700 |
|
|
$ |
11,090,600 |
|
|
$ |
20,717,100 |
|
|
Activity from inception until August 31, 2014:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisitions
|
|
|
– |
|
|
|
28,077,500 |
|
|
|
(28,077,500 |
) |
|
|
(9,790,000 |
) |
|
|
(18,287,500 |
) |
|
Relinquishment
|
|
|
|
|
|
|
2,386,400 |
|
|
|
(2,386,400 |
) |
|
|
(832,100 |
) |
|
|
(1,554,300 |
) |
|
Option payments - Sky Ranch
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and The Hills at Sky Ranch
|
|
|
110,400 |
|
|
|
(42,300 |
) |
|
|
(68,100 |
) |
|
|
(23,800 |
) |
|
|
(44,300 |
) |
|
Arapahoe County tap fees *
|
|
|
533,000 |
|
|
|
(373,100 |
) |
|
|
(159,900 |
) |
|
|
(55,800 |
) |
|
|
(104,100 |
) |
|
Export Water sale payments
|
|
|
360,900 |
|
|
|
(262,200 |
) |
|
|
(98,700 |
) |
|
|
(34,300 |
) |
|
|
(64,400 |
) |
|
Balance at August 31, 2014
|
|
|
1,004,300 |
|
|
|
30,004,800 |
|
|
|
1,017,100 |
|
|
|
354,600 |
|
|
|
662,500 |
|
|
Fiscal 2015 activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Export Water sale payments
|
|
|
172,000 |
|
|
|
(151,500 |
) |
|
|
(20,500 |
) |
|
|
(7,100 |
) |
|
|
(13,400 |
) |
|
Balance at February 28, 2015
|
|
$ |
1,176,300 |
|
|
$ |
29,853,300 |
|
|
$ |
996,600 |
|
|
$ |
347,500 |
|
|
$ |
649,100 |
|
* The Arapahoe County tap fees are net of $34,522 in royalties paid to the Land Board.
The CAA includes contractually established priorities which call for payments to CAA holders in order of their priority. This means the first payees receive their full payment before the next priority level receives any payment and so on until full repayment. The Company will receive approximately $6 million of the first priority payout (the remaining entire first priority payout totals approximately $6.8 million as of February 28, 2015).
Arkansas River Agreement Obligations
As discussed in Note 9 – Litigation Loss Contingencies, as a result of the settlement of litigation with HP A&M, the TPF liability has been eliminated as of February 28, 2015.
Initially the obligation was to pay 10% of the Company’s gross proceeds, or the equivalent thereof, from the sale of 40,000 water taps sold after the date of the Arkansas River Agreement. The 40,000 water taps were reduced to 383 water taps as a result of (i) sales of Arkansas River Valley land in 2006 and 2009; (ii) the sale of unutilized water rights owned by the Company in the Arkansas River Valley in 2007; (iii) the election made by HP A&M, effective September 1, 2011, pursuant to the Arkansas River Agreement, to increase the TPF percentage from 10% to 20%, and to take a corresponding 50% reduction in the number of taps subject to the TPF; (iv) the allocation of 26.9% of the Net Revenues (defined as all lease and related income received from the farms less employee expenses, direct expenses for managing the leases and a reasonable overhead allocation) received by HP A&M from management of the farm leasing operations from September 1, 2011 to August 3, 2012 prior to termination of the Property Management Agreement; and (v) the reduction of 19,044 taps as the result of foreclosures on certain farms pursuant to the remedies outlined in the Arkansas River Agreement (2,233 in fiscal year 2013, 15,010 in fiscal year 2014, and 1,801 in fiscal year 2015).
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
The fair value of the TPF liability through the date of the settlement was an estimate prepared by management of the Company. The fair value of the liability was based on discounted estimated cash flows subject to the TPF calculated by projecting future annual water tap sales for the number of taps subject to the TPF at the date of valuation. Future cash flows from water tap sales were estimated by utilizing the following historical information, where available:
|
|
·
|
New homes constructed in the area known as the 11-county “Front Range” of Colorado from the 1980s through the valuation date. The Company utilized data for this length of time to provide development information over many economic cycles because the Company anticipates development in its targeted service area to encompass many economic cycles over the development period.
|
|
|
·
|
New home construction patterns for large master planned housing developments along the Front Range. The Company utilized this information because these developments are deemed comparable to projects anticipated to be constructed in the Company’s targeted service area (i.e., these master planned communities were located in predominately undeveloped areas on the outskirts of the Front Range).
|
|
|
·
|
Population growth rates for Colorado and the Front Range. Population growth rates were utilized to predict anticipated growth along the Front Range, which was used to predict an estimated number of new homes necessary to house the increased population.
|
|
|
·
|
The Consumer Price Index since the 1980s, which was utilized to project estimated future water tap fees.
|
Utilizing this historical information, the Company projected an estimated new home development pattern in its targeted service area sufficient to cover the sale of the water taps subject to the TPF at the date of the revaluation, August 31, 2014. The Company revalued the TPF payable as of August 31, 2014 due to the reduction of taps subject to the TPF as a result of the exercise of remedies under the Arkansas River Agreement. The estimated proceeds generated from the sale of those water taps resulted in estimated payments to HP A&M over the life of the projected development period of $2 million, which is a decrease of $100.7 million from the previous valuation completed at August 31, 2013 ($102.7 million). The estimated payments to HP A&M are then discounted to the current valuation date, and the difference between the amount reflected on the Company’s balance sheet at the valuation date and the total estimated payments is imputed as interest expense over the estimated development time using the effective interest method. The implied interest rate for the most recent valuation was 3.4%.
Actual new home development in the Company’s service area and actual future tap fees inevitably will vary significantly from the Company’s estimates, which prior to the settlement could have had a material impact on the Company’s consolidated financial statements. An important component in the Company’s estimate of the value of the TPF, which is based on historical trends, is that the Company reasonably expects water tap fees to continue to increase in the coming years. Tap fees are market based and the continued increase in tap fees reflects, among other things, the increasing costs to acquire and develop new water supplies. Tap fees thus are partially indicative of the increasing value of the Company’s water assets. Prior to the settlement, the Company continually assessed the value of the TPF liability and updated its valuation analysis whenever events or circumstances indicated that the assumptions used to estimate the value of the liability had changed materially. The difference between the net present value and the estimated realizable value was imputed as interest expense using the effective interest method over the estimated development period utilized in the valuation of the TPF. Through February 28, 2015, $27.5 million of interest has been imputed since the acquisition date, recorded using the effective interest method.
Prior to the settlement with HP A&M eliminating the TPF, the Company’s agreement with HP A&M provided for a reduction of the number of water taps subject to the TPF payable to HP A&M in the event the farms or water rights are subject to foreclosure proceedings or other risks of loss. During fiscal year 2013, four of the farms and one FLLC certificate representing water rights only, collectively including 1,216 FLCC shares, were foreclosed resulting in a reduction of the number of taps subject to the TPF by 2,233 taps (approximately $11.7 million of the TPF). During fiscal year 2014, an additional 31 farms and two FLCC certificates representing water rights only, collectively including 8,174 FLCC shares, were foreclosed resulting in a reduction of the number of taps subject to the TPF by an additional 15,010 taps (approximately $53.3 million of the TPF), leaving 2,184 taps (approximately $7.9 million of the TPF), subject to the TPF.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
HP A&M relinquished all rights to the TPF pursuant to the settlement agreement the Company reached during January 2015. As a result, the TPF has been eliminated as of February 28, 2015. The Company recorded the decreases in the TPF payable as an equity transaction due to the related party nature of the original transaction of approximately $6.2 million in the three months ended November 30, 2015 and the remaining approximately $1.7 million upon final settlement, see note 9.
Promissory Notes Payable – Approximately 60 of the 80 properties the Company originally acquired from HP A&M were subject to outstanding promissory notes payable to third parties that were secured by deeds of trust on the Company’s properties and water rights, as well as mineral interests. HP A&M defaulted on all of the promissory notes. HP A&M owed approximately $9.6 million of principal and accrued interest as of September 1, 2012. These promissory notes were secured by approximately 14,000 acres of land and 16,882 FLCC shares representing water rights owned by the Company.
On July 2, 2012, the Company formally notified HP A&M that its failure to pay the promissory notes constituted an Event of Default under the Seller Pledge Agreement (as defined below) and a default of a material covenant under the Arkansas River Agreement. The Company informed HP A&M that unless such defaults were cured within 30 days, the Property Management Agreement would be terminated and the Company would proceed to exercise certain rights and remedies under the Arkansas River Agreement, the Seller Pledge Agreement, and the Property Management Agreement to protect its assets. The Company’s remedies at law and under the Arkansas River Agreement and related agreements included, but were not limited to, the right to (i) foreclose on 1,500,000 shares of Pure Cycle common stock issued to HP A&M and the proceeds therefrom (the “Pledged Shares”) which were pledged by HP A&M pursuant to a pledge agreement (the “Seller Pledge Agreement”) to secure the payment and performance by HP A&M of the promissory notes described above; (ii) reduce the Tap Participation Fee; (iii) terminate the Property Management Agreement; and (iv) recover damages caused by the defaults, including certain costs and expenses, including attorneys’ fees.
On August 3, 2012, the Company formally terminated the Property Management Agreement. On September 27, 2012, the Pledged Shares were sold at public auction in a foreclosure sale for $2.35 per share, yielding approximately $3.42 million of proceeds to the Company (net of fees of $110,000).
To protect its land and water interests, during the fiscal years ended August 31, 2014 and 2013, the Company purchased approximately $9.4 million of the $9.6 million notes payable by HP A&M.
During October 2014, the Company borrowed $4,450,000 from the First National Bank of Las Animas. Proceeds from the loan were used to consolidate mortgage debt and for working capital. The note has a 20-year term commencing October 27, 2014, requires semi-annual payments, and carries a 5.27% per annum rate for the first five years. The note is secured by a total of 3,596.8 acres, 3,282 FLCC shares, and an assignment of two HP A&M notes and deeds of trust with balances due of approximately $843,400, which are secured by 1,087.4 FLCC shares. After the first five years, the interest rate on the note is subject to change (no more often than annually) based on the changes in the First National Bank of Las Animas Ag/Real Estate Rate. The Company may pay the note in full at any time without penalty.
The amount owed on the Company’s notes is approximately $5.9 million, including accrued interest of $105,300, and approximately $5 million, including accrued interest of $80,800, at February 28, 2015 and August 31, 2014, respectively.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
Future Maturities
|
Mortgage notes payable, mainly bear interest at 5%, 5-year term; one note in amount of $4.45 million has 20-year term
|
|
$ |
5,910,800 |
|
|
Less: current portion
|
|
|
(848,300 |
) |
|
Total long-term mortgage payable
|
|
$ |
5,062,500 |
|
| |
|
|
|
|
|
Future long-term maturities
|
|
|
|
|
|
2016
|
|
|
578,600 |
|
|
2017
|
|
|
576,000 |
|
|
2018
|
|
|
164,500 |
|
|
2019
|
|
|
157,100 |
|
|
2020
|
|
|
169,800 |
|
|
Post 2020
|
|
|
3,416,500 |
|
|
Total
|
|
$ |
5,062,500 |
|
WISE Partnership
During December 2014, the Company, through the District, consented to the waiver of all contingencies set forth in the Amended and Restated WISE Partnership – Water Delivery Agreement, dated December 31, 2013 (the “WISE Partnership Agreement”), among the City and County of Denver acting through its Board of Water Commissioners (“Denver Water”), the City of Aurora acting by and through its Utility Enterprise (“Aurora Water”), and the South Metro WISE Authority (“SMWA”). The SMWA was formed by the District and nine other governmental or quasi-governmental water providers pursuant to the South Metro WISE Authority Formation and Organizational Intergovernmental Agreement, dated December 31, 2013 (the “SM IGA”), to enable the members of SMWA to participate in the regional water supply project known as WISE created by the WISE Partnership Agreement. The SM IGA specifies each member’s pro rata share of WISE and the members’ rights and obligations with respect to WISE. The WISE Partnership Agreement provides for the purchase of certain infrastructure (i.e., pipelines, water storage facilities, water treatment facilities, and other appurtenant facilities) to deliver water to and among the 10 members of the SMWA, Denver Water and Aurora Water. Certain infrastructure has been constructed and other infrastructure will be constructed over the next several years.
By consenting to the waiver of the contingencies set forth in the WISE Partnership Agreement, pursuant to the terms of the Rangeview/Pure Cycle WISE Project Financing Agreement (the “WISE Financing Agreement”) between the Company and the District, the Company has an agreement to fund the District’s participation in WISE effective as of December 22, 2014. The Company’s cost of funding the District’s purchase of its share of existing infrastructure and future infrastructure for WISE is projected to be approximately $7 million over the next five years, which includes funding of approximately $1.2 million annually over the next five years and funding of the District’s obligations to repay approximately $1.4 million borrowed by the District from certain SMWA members to finance the purchase of infrastructure for WISE pursuant to an agreement dated November 19, 2014 (the “Rangeview Funding Agreement”). The $1.4 million is repayable in equal annual installments over the next three years and accrues interest at the rate of 3% and is recorded in WISE funding obligation and in investments in water and water systems in the Company’s balance sheet.
Operating Lease
Effective January 2015, the Company entered into an operating lease for approximately 2,500 square feet of office and warehouse space. The lease has a one-year term with payments of $3,000 per month.
NOTE 5 – SHAREHOLDERS’ EQUITY
The Company maintains the 2014 Incentive Plan (the “2014 Incentive Plan”), which was approved by shareholders in January 2014 and became effective April 12, 2014. Executives, eligible employees, consultants and non-employee directors are eligible to receive options and stock grants pursuant to the 2014 Incentive Plan. Pursuant to the 2014 Incentive Plan, options to purchase shares of stock and restricted stock awards can be granted with exercise prices, vesting conditions and other performance criteria determined by the Compensation Committee of the board of directors (the “Board”). The Company has reserved 1.6 million shares of common stock for issuance under the 2014 Incentive Plan. The Company began awarding options under the 2014 Incentive Plan during January 2015. Prior to the effective date of the 2014 Incentive Plan, the Company granted stock awards to eligible participants under its 2004 Incentive Plan (the “2004 Equity Plan”), which expired April 11, 2014. No additional awards may be granted pursuant to the 2004 Equity Plan; however, awards outstanding as of April 11, 2014, will continue to vest and expire and may be exercised in accordance with the terms of the 2004 Equity Plan.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
The following table summarizes the combined stock option activity for the 2004 Equity Plan and 2014 Incentive Plan for the six months ended February 28, 2015:
| |
|
Number of Options
|
|
|
Weighted-Average Exercise Price
|
|
|
Weighted-Average Remaining Contractual Term
|
|
|
Approximate Aggregate Instrinsic Value
|
|
|
Oustanding at beginning of period
|
|
|
315,000 |
|
|
$ |
5.76 |
|
|
|
|
|
|
|
|
Granted
|
|
|
26,000 |
|
|
$ |
4.17 |
|
|
|
|
|
|
|
|
Exercised
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
Forfeited or expired
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
Outstanding at February 28, 2015
|
|
|
341,000 |
|
|
$ |
5.07 |
|
|
|
6.43 |
|
|
|
- |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at February 28, 2015
|
|
|
248,333 |
|
|
$ |
4.95 |
|
|
|
5.52 |
|
|
|
- |
|
The following table summarizes the combined activity and value of non-vested options under the 2004 Equity Plan and 2014 Incentive Plan as of and for the six months ended February 28, 2015:
| |
|
Number of Options
|
|
|
Weighted-Average Grant Date Fair Value
|
|
| |
|
|
99,167 |
|
|
$ |
4.85 |
|
|
Granted
|
|
|
26,000 |
|
|
|
2.78 |
|
|
Vested
|
|
|
(32,500 |
) |
|
|
4.19 |
|
|
Forfeited
|
|
|
- |
|
|
|
- |
|
| |
|
|
92,667 |
|
|
$ |
3.90 |
|
The Company calculated the fair value of the options at approximately $72,000, using the Black Scholes Model with the following variables: weighted average exercise price of $4.17 (which was the closing sale price of common stock on the date grant); estimated option lives of 10 years; weighted average risk free interest rate of 1.77%; weighted average stock price volatility of 57.45%; and an estimated forfeiture rate of 0%.
All non-vested options are expected to vest. The total fair value of options vested during the three and six months ended February 28, 2015 and February 28, 2014 was $136,300 and $76,800, respectively.
Stock-based compensation expense was $63,800 and $59,500 for the three months ended February 28, 2015 and 2014, respectively. Stock-based compensation expense was $132,600 and $114,300 for the six months ended February 28, 2015 and 2014, respectively.
At February 28, 2015, the Company had unrecognized expenses relating to non-vested options that are expected to vest totaling $262,700, which have a weighted average life of less than three years. The Company has not recorded any excess tax benefits to additional paid-in capital.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
NOTE 6 – RELATED PARTY TRANSACTIONS
On December 16, 2009, the Company entered into a Participation Agreement with the District, whereby the Company agreed to provide funding to the District in connection with the District’s membership in the South Metro Water Supply Authority (“SMWSA”). The Company did not provide any funding to the District pursuant to the Participation Agreement during the three months ended February 28, 2015. The Company provided $59,500 of funding to the District pursuant to the Participation Agreement during the three months ended February 28, 2014. The Company provided $600 and $114,300 of funding to the District pursuant to the Participation Agreement during the six months ended February 28, 2015 and 2014, respectively. These amounts were expensed as general and administrative expenses at the time of funding. On November 10, 2014, the Company entered into a WISE Financing Agreement with the District, whereby the Company agreed to fund the District’s cost of participating in a regional water supply project known as the WISE partnership (“WISE”). Pursuant to the WISE Financing Agreement, the Company made payments of $1,156,800 during the six months ended February 28, 2015, to purchase certain rights to use existing water transmission and related infrastructure acquired by WISE and is recorded as investment in water and water systems in the Company's Balance Sheet. The Company estimates that it will be required to invest approximately $1.2 million per year over the next five years for additional payments for the water transmission line and additional facilities, water and related assets for WISE.
In 1995, the Company extended a loan to the District, a related party. The loan provided for borrowings of up to $250,000, is unsecured, bears interest based on the prevailing prime rate plus 2% (5.25% at February 28, 2015) and matured on December 31, 2013. The Company extended the maturity date of the loan to December 31, 2015. Beginning in January 2014, the District and the Company entered into a funding agreement which allows the Company to continue to provide funding to the District for day-to-day operations and accrue the funding into a note which bears interest at a rate of 8% and shall remain in full force and effect for so long as the 2014 Amended and Restated Lease Agreement remains in effect. The $656,700 balance of the note receivable at February 28, 2015, includes borrowings of $311,300 and accrued interest of $345,400.
NOTE 7 – SIGNIFICANT CUSTOMERS
The Company sells wholesale water and wastewater services to the District pursuant to the Rangeview Water Agreements (defined in Note 4 – Water and Land Assets to the 2014 Annual Report). Sales to the District accounted for 12% and 9% of the Company’s total water and wastewater revenues for the three months ended February 28, 2015 and 2014, respectively. Sales to the District accounted for 10% of the Company’s total water and wastewater revenues for each of the six months ended February 28, 2015 and 2014, respectively. The District has one significant customer. Pursuant to the Rangeview Water Agreements, the Company is providing water and wastewater services to this customer on behalf of the District. The District’s significant customer accounted for 11% and 8% of the Company’s total water and wastewater revenues for the three months ended February 28, 2015 and 2014, respectively. The District’s significant customer accounted for 9% and 8% of the Company’s total water and wastewater revenues for the six months ended February 28, 2015 and 2014, respectively.
Revenues related to the provision of water for the oil and gas industry to one customer accounted for 85% and 86% of the Company’s water and wastewater revenues for the three months ended February 28, 2015 and 2014, respectively. Revenues related to the provision of water for the oil and gas industry to one customer accounted for 87% of the Company’s water and wastewater revenues for each of the six months ended February 28, 2015 and 2014.
The Company had accounts receivable from the District which accounted for 6% and 5% of the Company’s trade receivables balances at February 28, 2015 and August 31, 2014, respectively. Accounts receivable from the District’s largest customer accounted for 6% and 4% of the Company’s trade receivables as of February 28, 2015 and August 31, 2014, respectively. Accounts receivable from industrial water sales accounted for 26% and 75% of the Company’s trade receivable balances at February 28, 2015 and August 31, 2014, respectively.
NOTE 8 – ACCRUED LIABILITIES
At February 28, 2015, the Company had accrued liabilities of $97,300, of which $23,600 was for estimated property taxes, $2,000 was for farm lease prepayments, and $71,700 was for operating payables.
At August 31, 2014, the Company had accrued liabilities of $257,900, of which $99,700 was for estimated property taxes, $59,500 was for professional fees, $22,400 was for farm lease prepayments, and the remaining $76,300 was for operating payables.
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
NOTE 9 – LITIGATION LOSS CONTINGENCIES
The Company has historically been involved in various claims, litigation and other legal proceedings that arise in the ordinary course of its business. The Company records an accrual for a loss contingency when its occurrence is probable and damages can be reasonably estimated based on the anticipated most likely outcome or the minimum amount within a range of possible outcomes. The Company makes such estimates based on information known about the claims and experience in contesting, litigating and settling similar claims. Disclosures are also provided for reasonably possible losses that could have a material effect on the Company's financial position, results of operations or cash flows.
On September 29, 2014, the Company entered into a Settlement Agreement and Release with HP A&M (“Settlement Agreement”). The Settlement Agreement settles the lawsuit filed by HP A&M against the Company in the District Court, City and County of Denver, Colorado on February 27, 2012, alleging breaches of representations and warranties made in connection with the Arkansas River Agreement. Pursuant to the Settlement Agreement and a joint stipulated motion to dismiss filed with the court following execution of the Settlement Agreement, HP A&M released all claims asserted against the Company in its 2012 lawsuit, and the lawsuit was dismissed with prejudice.
On January 29, 2015, the Company and its wholly-owned subsidiary, PCY Holdings, LLC (“PCY Holdings”), entered into a settlement agreement with HP A&M settling all remaining lawsuits among the parties. The agreement settles four lawsuits, including a lawsuit filed against HP A&M in the District Court, City and County of Denver, State of Colorado on April 4, 2014, alleging HP A&M breached the Arkansas River Agreement, Seller Pledge Agreement and Property Management Agreement, among other ways, by failing to (i) pay, perform and discharge its obligations when due or otherwise pursuant to the Excluded Indebtedness, (ii) cure defaults under the Notes and Deeds of Trust applicable to the Excluded Indebtedness, and (iii) use Net Revenue, pursuant to the Property Management Agreement, to pay Excluded Indebtedness. The agreement also settles a lawsuit pending before the Colorado Court of Appeals that HP A&M filed against PCY Holdings and the Public Trustee for the County of Bent, Colorado, seeking (i) a declaratory judgment that it is entitled to redeem the four properties from foreclosure sales by paying the amount of the outstanding debt, plus fees, which is the amount PCY Holdings bid in the sales, and (ii) preliminary and permanent injunctions against the Public Trustee preventing the Public Trustee from issuing confirmation deeds for the foreclosure sales to PCY Holdings or anyone other than HP A&M, and a related lawsuit in which PCY Holdings was seeking to remove lis pendens from the four properties.
In exchange for settling all lawsuits, the settlement agreement provides for (i) the relinquishment of the TPF, (ii) the sale of 300,000 shares of the Company’s common stock owned by HP A&M, with the proceeds to be delivered to the Company, (iii) the assignment of HP A&M’s (75%) mineral interests to the Company, (iv) the dismissal of all claims by HP A&M, and (v) the forgiveness of the HP A&M receivable.
The settlement has been executed and is reflected in the financial statements for the period ended February 28, 2015 as follows: (1) the value of the common shares to be sold on behalf of the Company pursuant to the settlement of $1,407,000 is recorded as collateral stock, a contra-equity balance, on the balance sheet, (2) the mineral interests estimated to be $1,068,400 were recorded on the balance sheet as part of the Arkansas River Valley asset, (3) the TPF of $1,731,800 and the HP A&M receivable of $7,133,300 outstanding as of the date of settlement were reduced to nil and (4) the balance of $2,926,100 was recorded as an equity transaction resulting in an decrease to equity.
NOTE 10 – SEGMENT INFORMATION
The Company operates primarily in two lines of business: (i) the wholesale water and wastewater business; and (ii) the agricultural farming business. The Company provides wholesale water and wastewater services to customers using water rights owned by the Company and develops infrastructure to divert, treat and distribute that water and collect, treat and reuse wastewater. The Company’s agricultural business consists of the Company leasing its Arkansas River Valley land and water to area farmers under cash leases or in certain cases crop share leases. The following tables show information by operating segment for the three and six months ended February 28, 2015 and 2014:
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
|
Three Months Ended February 28, 2015
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Business segments
|
|
|
|
|
|
|
|
| |
|
Wholesale
|
|
|
|
|
|
|
|
|
|
|
| |
|
water and
|
|
|
|
|
|
|
|
|
|
|
| |
|
wastewater
|
|
|
Agricultural
|
|
|
All Other
|
|
|
Total
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$ |
341,700 |
|
|
$ |
284,500 |
|
|
$ |
30,300 |
|
|
$ |
656,500 |
|
|
Gross profit
|
|
|
197,300 |
|
|
|
264,100 |
|
|
|
19,400 |
|
|
|
480,800 |
|
|
Depletion and depreciation
|
|
|
93,300 |
|
|
|
- |
|
|
|
- |
|
|
|
93,300 |
|
|
Other significant noncash items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
- |
|
|
|
- |
|
|
|
63,800 |
|
|
|
63,800 |
|
|
TPF interest expense
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Segment assets
|
|
|
92,093,000 |
|
|
|
8,479,900 |
|
|
|
2,392,000 |
|
|
|
102,964,900 |
|
|
Expenditures for segment assets
|
|
|
719,600 |
|
|
|
- |
|
|
|
- |
|
|
|
719,600 |
|
|
Three Months Ended February 28, 2014
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Business segments
|
|
|
|
|
|
|
|
| |
|
Wholesale
|
|
|
|
|
|
|
|
|
|
|
| |
|
water and
|
|
|
|
|
|
|
|
|
|
|
| |
|
wastewater
|
|
|
Agricultural
|
|
|
All Other
|
|
|
Total
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$ |
415,300 |
|
|
$ |
306,600 |
|
|
$ |
14,000 |
|
|
$ |
735,900 |
|
|
Gross profit
|
|
|
251,600 |
|
|
|
285,900 |
|
|
|
14,000 |
|
|
|
551,500 |
|
|
Depletion and depreciation
|
|
|
45,100 |
|
|
|
- |
|
|
|
- |
|
|
|
45,100 |
|
|
Other significant noncash items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
- |
|
|
|
- |
|
|
|
59,500 |
|
|
|
59,500 |
|
|
TPF interest expense
|
|
|
403,000 |
|
|
|
- |
|
|
|
- |
|
|
|
403,000 |
|
|
Segment assets
|
|
|
93,806,200 |
|
|
|
6,808,900 |
|
|
|
7,290,600 |
|
|
|
107,905,700 |
|
|
Expenditures for segment assets
|
|
|
121,800 |
|
|
|
- |
|
|
|
- |
|
|
|
121,800 |
|
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
|
Six Months Ended February 28, 2015
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Business segments
|
|
|
|
|
|
|
|
| |
|
Wholesale
|
|
|
|
|
|
|
|
|
|
|
| |
|
water and
|
|
|
|
|
|
|
|
|
|
|
| |
|
wastewater
|
|
|
Agricultural
|
|
|
All Other
|
|
|
Total
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$ |
845,200 |
|
|
$ |
548,300 |
|
|
$ |
96,800 |
|
|
$ |
1,490,300 |
|
|
Gross profit
|
|
|
514,200 |
|
|
|
501,400 |
|
|
|
75,800 |
|
|
|
1,091,400 |
|
|
Depletion and depreciation
|
|
|
172,100 |
|
|
|
- |
|
|
|
- |
|
|
|
172,100 |
|
|
Other significant noncash items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
- |
|
|
|
- |
|
|
|
132,600 |
|
|
|
132,600 |
|
|
TPF interest expense
|
|
|
23,800 |
|
|
|
- |
|
|
|
- |
|
|
|
23,800 |
|
|
Segment assets
|
|
|
92,093,000 |
|
|
|
8,479,900 |
|
|
|
2,392,000 |
|
|
|
102,964,900 |
|
|
Expenditures for segment assets
|
|
|
1,871,000 |
|
|
|
2,900 |
|
|
|
- |
|
|
|
1,873,900 |
|
|
Six Months ended February 28, 2014
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Business segments
|
|
|
|
|
|
|
|
| |
|
Wholesale
|
|
|
|
|
|
|
|
|
|
|
| |
|
water and
|
|
|
|
|
|
|
|
|
|
|
| |
|
wastewater
|
|
|
Agricultural
|
|
|
All Other
|
|
|
Total
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$ |
759,500 |
|
|
$ |
526,900 |
|
|
$ |
28,000 |
|
|
$ |
1,314,400 |
|
|
Gross profit
|
|
|
436,100 |
|
|
|
485,500 |
|
|
|
28,000 |
|
|
|
949,600 |
|
|
Depletion and depreciation
|
|
|
93,600 |
|
|
|
- |
|
|
|
- |
|
|
|
93,600 |
|
|
Other significant noncash items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
- |
|
|
|
- |
|
|
|
114,300 |
|
|
|
114,300 |
|
|
TPF interest expense
|
|
|
1,060,200 |
|
|
|
- |
|
|
|
- |
|
|
|
1,060,200 |
|
|
Segment assets
|
|
|
93,806,200 |
|
|
|
6,808,900 |
|
|
|
7,290,600 |
|
|
|
107,905,700 |
|
|
Expenditures for segment assets
|
|
|
521,400 |
|
|
|
- |
|
|
|
- |
|
|
|
521,400 |
|
PURE CYCLE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 2015
NOTE 11 – SUBSEQUENT EVENT
On March 11, 2015, the Company and Arkansas River Farms, LLC, a newly formed Colorado limited liability company (“Arkansas River Farms”), an affiliate of C&A Companies, Inc., a Colorado corporation, and Resource Land Holdings, L.L.C., a Colorado limited liability company, entered into a Purchase and Sale Agreement (the “Purchase and Sale Agreement”). The Purchase and Sale Agreement provides that, upon the terms and subject to the conditions set forth in the Purchase and Sale Agreement, the Company will sell approximately 14,641 acres of real property located in Bent, Otero and Prowers Counties, Colorado, together with certain rights, easements, and benefits appurtenant to the land, including all improvements, all sand and gravel, 25% of the Company’s mineral rights, water rights (including 18,448.44 shares of stock in the FLCC and 45 shares of stock in the Lower Arkansas Water Management Association), and all water taps and rights to acquire water taps associated with the land and the wells located on the land, to Arkansas River Farms for approximately $53 million in cash, subject to certain adjustments. The Purchase and Sale Agreement has been approved by the Board and is subject to shareholder approval.
The Company will continue to operate the assets as held for use and will continue to lease the farms to area farmers until the sale has been completed. The assets will remain in Investments in Water and Water Systems until shareholder approval and the completion of due diligence at which time the assets will be transferred to Land and Water Held for Sale. The assets being sold have a book value of approximately $69 million, or 68% of Pure Cycle’s total assets as of February 28, 2015. Upon shareholder approval and completion of the sale the Company will record a loss of approximately $16 million.
See the Company’s Current Report on Form 8-K filed with the SEC on March 17, 2015, and, when filed with the SEC, the Company's Definitive Proxy Statement on Schedule 14A for additional information.
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
OVERVIEW
The discussion and analysis below includes certain forward-looking statements that are subject to risks, uncertainties and other factors, as described in “Risk Factors” in our Annual Report on Form 10-K, that could cause our actual growth, results of operations, performance, financial position and business prospects and opportunities for this fiscal year and periods that follow to differ materially from those expressed in or implied by those forward-looking statements. Readers are cautioned that forward-looking statements contained in this Form 10-Q should be read in conjunction with our disclosure under the heading “Disclosure Regarding Forward-Looking Statements” below.
The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand our results of operations and financial condition and should be read in conjunction with the accompanying consolidated financial statements and the notes thereto and the financial statements and the notes thereto contained in our 2014 Annual Report on Form 10-K (the “2014 Annual Report”).
The following section focuses on the key indicators reviewed by management in evaluating our financial condition and operating performance, including the following:
|
|
·
|
Revenue generated from our water and wastewater services and farming operations;
|
|
|
·
|
Expenses associated with developing our water and land assets; and
|
|
|
·
|
Cash available to continue development of our water rights and service agreements.
|
Our MD&A section includes the following items:
Our Business – a general description of our business, our services and our business strategy.
Results of Operations – an analysis of our results of operations for the periods presented in our consolidated financial statements.
Liquidity, Capital Resources and Financial Position – an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements.
Critical Accounting Policies and Estimates – a discussion of our critical accounting policies that require critical judgments, assumptions and estimates.
Forward-Looking Statements – an identification of forward-looking statements and a description of risks that could cause actual results to differ materially from those discussed in forward-looking statements.
Our Business
Pure Cycle Corporation (“we”, “us” or “our”) is a Colorado corporation that (i) provides wholesale water and wastewater services to end-use customers of governmental entities and to commercial and industrial customers and (ii) manages land and water assets for farming.
Wholesale Water and Wastewater
These services include water production, storage, treatment, bulk transmission to retail distribution systems, wastewater collection and treatment, irrigation water treatment and transmission, construction management, billing and collection and emergency response.
We are a vertically integrated wholesale water and wastewater provider, which means we own or control substantially all assets necessary to provide wholesale water and wastewater services to our customers. This includes owning (i) water rights which we use to provide domestic, irrigation, and industrial water to our wholesale customers (we own surface water, groundwater, reclaimed water rights and storage rights); (ii) infrastructure (such as wells, diversion structures, pipelines, reservoirs and treatment facilities) required to withdraw, treat, store and deliver water; (iii) infrastructure required to collect, treat, store and reuse wastewater; and (iv) infrastructure required to treat and deliver reclaimed water for irrigation use.
We currently provide wholesale water and wastewater service predominately to two local governmental entity customers. Our largest wholesale domestic customer is the Rangeview Metropolitan District (the “District”). We provide service to the District and its end-use customers pursuant to the Rangeview Water Agreements (defined in Part I, Item 1 – Business Summary – Our Water and Land Assets in the 2014 Annual Report) between us and the District for the provision of wholesale water service to the District for use in the District’s service area. Through the District, we serve 258 Single Family Equivalent (“SFE”) (as defined below) water connections and 157 SFE wastewater connections located in southeastern metropolitan Denver. One SFE is a customer – whether residential, commercial or industrial – that imparts a demand on our water or wastewater systems similar to the demand of a family of four persons living in a single family house on a standard sized lot. One SFE is assumed to have a water demand of approximately 0.4 acre feet per year and to contribute wastewater flows of approximately 300 gallons per day. In the past two years, we have been providing an increasing amount of water to industrial customers in our service area and adjacent to our service areas in the oil and gas industry for the purpose of hydraulic fracturing. Oil and gas operators have leased more than 135,000 acres within and adjacent to our service areas for the purpose of exploring oil and gas interests in the Niobrara and other formations, and this activity has led to increased water demands.
We plan to utilize our significant water assets along with our adjudicated reservoir sites to provide wholesale water and wastewater services to local governmental entities, which in turn will provide residential/commercial water and wastewater services to communities along the eastern slope of Colorado in the area generally referred to as the Front Range. Principally we target the I-70 corridor, which is located east of downtown Denver and south of the Denver International Airport. This area is predominately undeveloped and is expected to experience substantial growth over the next 30 years. We also plan to continue to provide water service to commercial and industrial customers.
Agricultural Operations and Leasing
Based on total acreage, approximately 85% of our farm operations are managed through cash lease arrangements with local area farmers, whereby we charge a fixed fee to lease our land and the water for agricultural purposes to tenant farmers. Based on total acreage, approximately 15% of our farm operations are managed through crop share leases, pursuant to which we and the tenant farmer jointly share in the gross revenues generated from the crops grown under a 75% farmer, 25% landlord participation. The majority of crops grown on our farms are alfalfa, with a number of acres also planted in corn, sorghum, and wheat. On March 11, 2015, we entered into an agreement to sell our remaining 14,641 acres of farm land and water in the Arkansas Valley. The sale is subject to customary diligence and shareholder approval and is scheduled to close in June 2015.
We also own 931 acres of land along the I-70 corridor east of Denver, Colorado. We are currently leasing this land to an area farmer until such time as the property can be developed.
These land interests are described in the Arkansas River Assets and Sky Ranch sections of Note 4 - Water and Land Assets in Part II, Item 8 of the 2014 Annual Report.
Results of Operations
Executive Summary
The results of our operations for the three and six months ended February 28, 2015 and 2014 are as follows:
|
Summary Table 1a
|
|
| |
|
Three months ended February 28,
|
|
|
|
|
| |
|
2015
|
|
|
2014
|
|
|
Change
|
|
|
% Change
|
|
|
Millions of gallons of water delivered
|
|
|
29.8 |
|
|
|
34.6 |
|
|
|
(4.8 |
) |
|
|
-14 |
% |
|
Metered water usage revenues
|
|
$ |
328,400 |
|
|
$ |
392,800 |
|
|
$ |
(64,400 |
) |
|
|
-16 |
% |
|
Operating costs to deliver water
|
|
$ |
92,600 |
|
|
$ |
111,000 |
|
|
$ |
(18,400 |
) |
|
|
-17 |
% |
|
(excluding depreciation and depletion)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Water delivery gross margin %
|
|
|
72 |
% |
|
|
72 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wastewater treatment revenues
|
|
$ |
13,200 |
|
|
$ |
12,300 |
|
|
$ |
900 |
|
|
|
7 |
% |
|
Operating costs to treat wastewater
|
|
$ |
6,500 |
|
|
$ |
7,800 |
|
|
$ |
(1,300 |
) |
|
|
-17 |
% |
|
Wastewater treatment gross margin %
|
|
|
51 |
% |
|
|
37 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tap and specialty facility revenues
|
|
$ |
13,900 |
|
|
$ |
13,900 |
|
|
$ |
- |
|
|
|
0 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Farm operations revenues
|
|
$ |
284,500 |
|
|
$ |
306,600 |
|
|
$ |
(22,100 |
) |
|
|
-7 |
% |
|
Farm operating costs
|
|
$ |
20,400 |
|
|
$ |
20,700 |
|
|
$ |
(300 |
) |
|
|
-1 |
% |
|
Farm operations gross margin %
|
|
|
93 |
% |
|
|
93 |
% |
|
|
|
|
|
|
|
|
|
General and administrative expenses
|
|
$ |
612,900 |
|
|
$ |
685,000 |
|
|
$ |
(72,100 |
) |
|
|
-11 |
% |
|
Net loss
|
|
$ |
86,000 |
|
|
$ |
456,000 |
|
|
$ |
(370,000 |
) |
|
|
81 |
% |
|
Summary Table 1b
|
|
| |
|
Six months ended February 28,
|
|
|
|
|
| |
|
2015
|
|
|
2014
|
|
|
Change
|
|
|
% Change
|
|
|
Millions of gallons of water delivered
|
|
|
76.3 |
|
|
|
71.4 |
|
|
|
4.9 |
|
|
|
7 |
% |
|
Metered water usage revenues
|
|
$ |
820,300 |
|
|
$ |
714,400 |
|
|
$ |
105,900 |
|
|
|
15 |
% |
|
Operating costs to deliver water
|
|
$ |
229,400 |
|
|
$ |
213,500 |
|
|
$ |
15,900 |
|
|
|
7 |
% |
|
(excluding depreciation and depletion)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Water delivery gross margin %
|
|
|
72 |
% |
|
|
70 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Wastewater treatment revenues
|
|
$ |
24,900 |
|
|
$ |
22,100 |
|
|
$ |
2,800 |
|
|
|
13 |
% |
|
Operating costs to treat wastewater
|
|
$ |
12,800 |
|
|
$ |
18,200 |
|
|
$ |
(5,400 |
) |
|
|
-30 |
% |
|
Wastewater treatment gross margin %
|
|
|
49 |
% |
|
|
18 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tap and specialty facility revenues
|
|
$ |
27,900 |
|
|
$ |
27,900 |
|
|
$ |
- |
|
|
|
0 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Farm operations revenues
|
|
$ |
548,300 |
|
|
$ |
526,900 |
|
|
$ |
21,400 |
|
|
|
4 |
% |
|
Farm operating costs
|
|
$ |
46,900 |
|
|
$ |
41,400 |
|
|
$ |
5,500 |
|
|
|
13 |
% |
|
Farm operations gross margin %
|
|
|
91 |
% |
|
|
92 |
% |
|
|
|
|
|
|
|
|
|
General and administrative expenses
|
|
$ |
1,260,400 |
|
|
$ |
1,304,900 |
|
|
$ |
(44,500 |
) |
|
|
-3 |
% |
|
Net loss
|
|
$ |
75,700 |
|
|
$ |
1,302,500 |
|
|
$ |
(1,226,800 |
) |
|
|
94 |
% |