NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
NOTE 1:
ORGANIZATION
Pure Cycle Corporation (the Company) was incorporated in Delaware in 1976 and reincorporated in Colorado in 2008. The
Company owns water assets in the Denver, Colorado metropolitan area, in the Arkansas River Valley in southern Colorado, and on the western slope of Colorado. The Company is currently using its water assets located in the Denver metropolitan area to
provide wholesale water and wastewater services to customers located in the Denver metropolitan area.
The Company provides a full line of
water and wastewater services which includes designing and constructing water and wastewater systems as well as operating and maintaining such systems. The Companys business focus is to provide wholesale water and wastewater services,
predominately to local governmental entities, which provide services to their end-use customers throughout the Denver metropolitan area as well as along the Colorado Front Range.
The Company believes it has sufficient working capital and financing sources to fund its operations for at least the next fiscal year, because at August 31, 2012, the Company had $2.7 million of
cash, cash equivalents and marketable securities, and $1.4 million of working capital. Subsequent to fiscal year end 2012, the Company sold the 1.5 million shares of Pure Cycle common stock issued to High Plains A&M, LLC (HP
A&M), which were pledged as security for certain debt obligations, in a foreclosure sale for $3.5 million or $2.35 per share.
The
Companys ability to generate working capital from its water and wastewater projects is dependent on its ability to successfully market its water, or in the event it is unsuccessful, to sell the underlying water assets. In the event increased
sales are not achieved or the Company is unable to sell its water assets at a sufficient level, the Company may have to issue additional short or long-term debt or seek to sell additional shares of the Companys common or preferred stock to
generate sufficient working capital. There can be no assurance that the Company will be successful in marketing its water on terms that are acceptable to the Company.
NOTE 2:
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The
preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (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 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 Companys cash equivalents are comprised entirely of money market funds maintained at a high quality financial institution in an
account which as of August 31, 2012, did not exceed federally insured limits. At various times during the year ended August 31, 2012, the Companys 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 equivalents and marketable securities. The Company places its cash equivalents and
investments with high quality financial institutions. At various times throughout the year ended August 31, 2012, cash deposits have exceeded federally insured limits. The Company invests its idle cash primarily in certificates of deposit,
money market instruments, commercial paper obligations, corporate bonds and US 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.
F-6
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Current Assets and Liabilities
The amounts reported on the balance sheets for cash and cash equivalents, trade receivables and trade payables approximate their fair values because of the relatively short maturity of these instruments.
The amount reported on the balance sheets for marketable securities represents the fair value of the underlying instruments as reported by
the financial institutions where the funds are held as of August 31, 2012 and 2011. The Company has recorded net unrealized losses on its marketable securities of $1,100 and $2,900 at August 31, 2012 and August 31, 2011, respectively.
The Company did not realize any gains or losses on its marketable securities during each of the three years ended August 31, 2012, 2011 and 2010.
Notes Receivable and Construction Proceeds Receivable
The amounts reported on the balance
sheet for the Companys notes receivable and construction proceeds receivable approximate their fair values as they bear interest at rates which are comparable to current market rates.
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 Companys 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 5
Participating Interests in Export Water
.
The recorded
balance of the Tap Participation Fee liability (as described below) is its estimated fair value determined by projecting new home development in the Companys targeted service area over an estimated development period.
Notes Payables and Related Party Accounts Receivable
In conjunction with HP A&M defaulting on certain promissory notes, the Company has the right to collect from HP A&M any amounts the Company spends to cure the defaulted notes. Accordingly the
Company has recorded the entire amount of the HP A&M notes as a receivable from HP A&M. The total receivable from HP A&M is $9.6 million with $4.6 million as current and $5.0 million as long term. The short term portion of the receivable
represents the amount of the defaulted promissory notes payable by HP A&M which were purchased by the Company and with respect to which the Company will pursue remedies under the asset purchase agreement (the Arkansas River Agreement
described in more detail in Note 4) over the next 12 months.
Subsequent to fiscal 2012, 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 have a five-year term, bear interest at an annual rate of five percent (5%) and require semi-annual payments with a straight-line
amortization schedule.
Cash Flows
The Company did not pay any interest or income taxes during the fiscal years ended August 31, 2012, 2011 and 2010, respectively.
Marketable Securities
At August 31, 2012, the Companys marketable securities
are comprised entirely of certificates of deposit maintained at various financial institutions, each of which have invested balances below federally insured limits and pay interest at stated rates through maturity. The certificates mature at various
dates through May 2013; however, these securities represent temporary investments and it is managements intent to hold these securities available for current operations and not hold them until maturity, therefore they are classified as
available-for-sale securities and are recorded at fair value. The Company has no investments in equity instruments.
F-7
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
The Companys marketable securities are recorded as available-for-sale and therefore any
unrecognized changes in the fair value of these marketable securities is included as a component of accumulated comprehensive income (loss).
Accounts Receivable
The Company records
accounts receivable net of allowances for uncollectible accounts. The Company recorded $20,400 and $0 as of August 31, 2012 and 2011 respectively for allowances for uncollectible accounts. The allowance for uncollectible accounts was determined
based on specific review of all past due accounts. The August 31, 2012 allowance for uncollectible accounts is entirely due to the assumed farm accounts receivable (see Note 7) from HP A&M.
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 Companys procedures, the Company believes there are impairments to its
Paradise Water Supply asset (defined in Note 4 below) and land and water rights held for sale related to the Arkansas River Assets. There was no impairment in the carrying amounts of the remaining long-lived assets at August 31, 2012 and
2011. See further discussion in Note 4 below under sections Paradise Water Supply and Arkansas River Assets.
Capitalized Costs of Water and Wastewater Systems and Depreciation and Depletion Charges
Costs to construct water and wastewater systems that meet the Companys capitalization criteria are capitalized as incurred, including interest, and depreciated on a straight-line basis over their
estimated useful lives of up to thirty 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 water 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.
Tap Participation Fee Liability and Imputed Interest Expense
The Tap Participation Fee liability, as described in Note 7
Long Term Debt and Operating Lease
, represents the
discounted fair value of the amounts the Company estimates it will pay HP A&M pursuant to the Arkansas River Agreement. The Company imputes interest expense on the unpaid Tap Participation Fee using the effective interest method over the
estimated development period utilized in the valuation of the liability. The Company imputed interest of $3.5 million, $3.8 million and $3.6 million during the years ended August 31, 2012, 2011 and 2010, respectively.
The Tap Participation Fee is due and payable once the Company has sold a water tap and received the consideration due for such water tap. The Company did
not sell any water taps during the years ended August 31, 2012, 2011 or 2010. As of August 31, 2012, 19,427 water taps remain subject to the Tap Participation Fee.
F-8
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Revenue Recognition
The Company generates revenues mainly from (i) one time water and wastewater tap fees, (ii) construction fees, and (iii) monthly wholesale water usage fees and wastewater service fees.
Because these items are separately delivered, the Company accounts for each of the items separately, as described below.
Tap and
Construction Fees
Tap fees, also called system development fees, are received in advance, are non-refundable and are typically used to
fund construction of certain facilities and defray the acquisition costs of obtaining water rights.
Construction fees are fees used by the
Company to construct assets that are typically required to be constructed by developers or home builders.
Proceeds from tap fees and
construction fees are deferred upon receipt and recognized in income either upon completion of construction of infrastructure or ratably over time, depending on whether the Company owns the infrastructure constructed with the proceeds or a customer
owns the infrastructure constructed with the proceeds.
Tap and construction fees derived from agreements in which the Company will not own
the assets constructed with the fees are recognized as revenue using the percentage-of-completion method. Costs of construction of the assets when the Company will not own the assets are recorded as construction costs.
Tap and construction fees derived from agreements for which the Company will own the infrastructure are recognized as revenues ratably over the estimated
accounting service life of the facilities constructed, starting at completion of construction, which could be in excess of thirty years. Costs of construction of the assets when the Company will own the assets are capitalized and depreciated over
their estimated economic lives.
In August 2005, the Company entered into the Water Service Agreement (the County Agreement) with
Arapahoe County (the County) to provide water service to the Countys fairgrounds (the Fairgrounds). Pursuant to the County Agreement, the Company sold the County 38.5 water taps for consideration of $567,490. In July
2006, upon completion of the construction of the Wholesale Facilities (which were paid for with the water tap fee proceeds), the Company began ratably recognizing $428,000 of water tap fees into income. The $428,000 is the net of the
water tap fees received by the Company of $567,490, decreased by (i) royalties to the Colorado State Board of Land Commissioners (the Land Board which owns the Lowry Range) of $34,522; and (ii) 65% of the total
payments made to external CAA holders or $104,136. In each of the three fiscal years ended August 31, 2012, 2011 and 2010, the Company recognized $14,300 of tap fee revenue. At August 31, 2012, $341,900 of these tap fees are still
deferred.
The Company recognized $41,500 of Special Facilities funding as revenue in each of the three fiscal years ended
August 31, 2012 and 2011 respectively. These construction revenues also relate to the County Agreement entered into in August 2005.
As
of August 31, 2012, the Company has deferred recognition of $1.3 million of tap and construction fee revenue from the County, which will be recognized as revenue ratably through 2036.
In addition to the tap fee revenues and the construction revenues, the Company also records interest income from the County using the effective interest method. Pursuant to the County Agreement, the
County is making payments to the Company totaling $82,200 per year for the construction of the Special Facilities at the Fairgrounds. These payments will continue through 2015 and include interest at 6% per annum. The Company recognized
$19,200, $22,900 and $26,300 of interest income from the County during the fiscal years ended August 31, 2012, 2011 and 2010, respectively.
In August 2012, the Company entered into an agreement with Front Range Pipeline which grants Front Range Pipeline easement rights for a period of three years to construct a pipeline for total
consideration of $28,700. As of August 31, 2012, the Company had $28,500 in deferred revenue from Front Range Pipeline.
F-9
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Monthly Wholesale Usage and Service Fees
Monthly wholesale water usage charges are assessed to the Companys customers based on actual metered usage each month plus a base monthly service fee assessed per single family equivalent
(SFE) unit served. One SFE is a customer, whether residential, commercial or industrial, that imparts a demand on the Companys 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. Water usage pricing uses a tiered pricing structure. The
Company recognizes wholesale water usage revenues upon delivering water to its customers or its governmental customers end-use customers, as applicable. The water revenues recognized by the Company are shown net of royalties to the Land Board
and, when applicable, amounts retained by the Rangeview Metropolitan District (the District).
The Company recognizes wastewater
processing revenues monthly based on usage. The monthly wastewater service fees are shown net of amounts retained by the District.
Amounts
recognized for water and wastewater services during the fiscal years ended August 31, 2012, 2011 and 2010, are presented in the statements of operations.
Costs of delivering water and providing wastewater service to customers are recognized as incurred.
The Company delivered 34.2 million, 34.5 million and 33.1 million gallons of water to customers during the fiscal years ended August 31, 2012, 2011 and 2010, respectively.
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 are shown net of the royalties to the Land Board and the amounts retained by the District. See further description of the Lowry Range in Note 4
Water Assets
under
section Rangeview Water Supply and Water System.
Oil and Gas Lease Payments
As further described in Note 4 below, 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. Pursuant to the O&G Lease on March 10, 2011, the
Company received an up-front payment of $1,243,400 from Anadarko 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. The
Company began recognizing the up-front payment from Anadarko as income on a straight-line basis over three years (the initial term of the O&G Lease) on March 10, 2011. During the years ended August 31, 2012 and 2011, the Company
recognized $423,000 and $199,000 respectively, of income related to the up-front payments received pursuant to the O&G Lease.
As of
August 31, 2012, the Company has deferred recognition of $639,000 of income related to the O&G Lease, which will be recognized into income ratably through February 2014.
Share-based Compensation
The Company maintains a stock option plan for the benefit of its
employees and directors. The Company records share-based compensation costs which are measured at the grant date based on the fair value of the award and are recognized as expense over the applicable vesting period of the stock award using the
straight-line method. 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 during the fiscal years ended August 31, 2012 and 2011 had no impact on the income tax provisions.
F-10
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
The Company recognized $54,600, $94,600 and $87,600 of share-based compensation expenses during the
fiscal years ended August 31, 2012, 2011 and 2010, respectively.
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 does not have any significant unrecognized tax benefits as of August 31, 2012.
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 2009 through fiscal 2011. The Company does not
believe there will be any material changes in its unrecognized tax positions over the next twelve months.
The Companys policy is to
recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. At August 31, 2012, the Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor
was any interest expense recognized during the fiscal years ended August 31, 2012, 2011 or 2010.
Loss per Common Share
Loss per common share is computed by dividing net loss by the weighted average number of shares outstanding during each period. Common
stock options and warrants aggregating 215,100, 280,100 and 262,600 common share equivalents as of August 31, 2012, 2011 and 2010, respectively, have been 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. Where it is determined that a new accounting pronouncement affects the Companys financial
reporting, the Company undertakes a study to determine the consequence of the change to its financial statements and assures that there are proper controls in place to ascertain that the Companys financials properly reflect the change. A
variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, the Company has
not determined whether implementation of such proposed standards would be material to the Companys financial statements. New pronouncements assessed by the Company recently are discussed below:
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05,
Comprehensive Income (Topic 220) Presentation of Comprehensive Income
(ASU 2011-05). ASU 2011-05 requires entities to present net income and other comprehensive income in either a single continuous statement or in two
separate, but consecutive, statements of net income and other comprehensive income. ASU 2011-05 is effective for fiscal years and interim periods beginning after December 15, 2011 (September 1, 2012 for the Company). The Company does not expect
the adoption of ASU 2011-04 to have a material impact on its results of operations, financial condition, or cash flows.
NOTE 3
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.
F-11
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Level 1 Valuations for assets and liabilities traded in active exchange markets, such as the New
York Stock Exchange. The Company had none of these instruments at August 31, 2012 or 2011.
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 one Level 2 asset at August 31, 2012 and 2011, its marketable securities. The
Companys principal markets for these securities are the secondary institutional markets and valuations are based on observable market data in those markets.
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 at August 31, 2012 and 2011,
the Tap Participation Fee liability, which is described in greater detail in Note 2
Summary of Significant Accounting Policies
and Note 7
Long-Term Debt And Operating Lease
.
The Company maintains policies and procedures to value instruments using the best and most relevant data available.
The Companys 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 4 for impairment of water rights and land with the associated water rights held for sale.
Level 2
Asset Marketable Securities Measured on a Recurring Basis.
The Companys marketable securities are the Companys only financial assets measured on a recurring basis. The fair values of the marketable securities are
based on the values reported by the financial institutions where the funds are held. These securities include only federally insured certificates of deposit.
Level 3 Liability Tap Participation Fee.
The Companys Tap Participation Fee liability is the Companys only financial liability measured on a non-recurring basis. The Tap
Participation Fee liability is valued by projecting new home development in the Companys targeted service area over an estimated development period. Due to the long-term nature of the Tap Participation Fee, the valuation of the Tap
Participation Fee is not sensitive to minor changes. See further description of the Tap Participation Fee in Note
7
Long-Term
Debt and Operating Lease
.
The following table provides information on the assets and liabilities measured at fair value as of
August 31, 2012:
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|
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|
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Fair Value Measurement Using:
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Quoted Prices in
Active Markets for
Identical Assets
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Significant Other
Observable Inputs
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Significant
Unobservable
Inputs
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Total
Unrealized
Gains and
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Fair Value
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Cost / Other Value
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(Level 1)
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(Level 2)
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|
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(Level 3)
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|
|
(Losses)
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|
Marketable securities
|
|
$
|
1,101,367
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|
|
$
|
1,101,367
|
|
|
$
|
|
|
|
$
|
1,101,367
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|
|
$
|
|
|
|
$
|
(1,081
|
)
|
Tap Participation Fee
|
|
$
|
68,269,176
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|
|
$
|
68,269,176
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|
|
$
|
|
|
|
$
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|
|
|
$
|
68,269,176
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|
|
$
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|
|
F-12
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Although not required, the Company deems the following table, which presents the changes in the Tap
Participation Fee for the year ended August 31, 2012, to be helpful to the users of its financial statements:
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Fair Value Measurement using Significant Unobservable
Inputs (Level 3)
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Gross Estimated
Tap Participation
Fee Liability
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Tap
Participation
Fee Reported
Liability
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Discount - to
be imputed as
interest
expense in
future periods
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Balance at August 31, 2011
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$
|
113,147,700
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|
|
$
|
64,988,300
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|
|
$
|
48,159,400
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Total gains and losses (realized and unrealized):
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Imputed interest recorded as Other Expense
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3,470,500
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|
|
|
(3,470,500
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)
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Purchases, sales, issuances, payments, and settlements
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|
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(189,700
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)
|
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|
(189,700
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)
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|
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Transfers in and/or out of Level 3
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Balance at August 31, 2012
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$
|
112,958,000
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|
|
$
|
68,269,100
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|
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$
|
44,688,900
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|
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|
The methodologies for estimating the fair value of financial assets and liabilities that are measured at fair value are
discussed above. The methodologies for other financial assets and liabilities are discussed below.
Cash and Cash Equivalents
: The
Companys 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 Companys operating and savings accounts. The carrying
amount of cash and cash equivalents approximate fair value.
Accounts Receivable and Accounts Payable
: The carrying amounts of accounts
receivable and accounts payable approximate fair value due to the relatively short period to maturity for these instruments.
Notes
Receivable and Construction Proceeds Receivable:
The carrying amounts of the Companys notes receivable and construction proceeds receivable approximate fair value as they bear interest at rates which are comparable to current market rates.
Related Party Receivable HP A&M
: In conjunction with HP A&M defaulting on certain promissory notes, the Company has the
right to collect from HP A&M any amounts the Company spends to cure the defaulted notes. Accordingly the Company has recorded the entire amount of the HP A&M notes as a receivable from HP A&M. Due to the fact that HP A&M is a related
party the fair value of the accounts receivable is not practical to determine.
Notes Payable
: Subsequent to fiscal 2012, 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 have a five-year term, bear interest at an annual rate of five percent (5%) 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.
Farm Accounts Receivable and Future Farm Income
: The Company terminated the Property Management Agreement with HP A&M effective August 3, 2012, and all future farm income is now payable
directly to the Company instead of HP A&M. On July 23, 2012, the Company notified all the farm lessees that all lease payments would be billed directly by and paid directly to the Company from the date of the notice forward. All other terms
of the leases remained unchanged. Under the farm lease agreements, the farmers are billed twice a year in November and March. The unpaid balances from prior billings (performed by HP A&M) were recorded on the Companys books as accounts
receivable less an allowance for uncollectible accounts. The allowance was determined by the Companys specific review of all past due accounts.
Off-Balance Sheet Instruments
: The Companys 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 5
Participating Interests In Export
Water
.
F-13
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
NOTE 4:
WATER ASSETS
The Companys water and water systems consist of the following approximate costs and accumulated depreciation and depletion as of
August 31:
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August 31, 2012
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August 31, 2011
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Costs
|
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Accumulated
Depreciation
and Depletion
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Costs
|
|
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Accumulated
Depreciation
and Depletion
|
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Arkansas River Valley assets
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$
|
69,112,300
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|
$
|
(1,315,900
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)
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$
|
81,318,800
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|
|
$
|
(1,144,100
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)
|
Rangeview water supply
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14,376,100
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(7,100
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)
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14,299,700
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(6,600
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)
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Paradise water supply
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5,540,200
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Sky Ranch water rights and other costs
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|
|
3,924,100
|
|
|
|
(50,800
|
)
|
|
|
3,915,200
|
|
|
|
(21,800
|
)
|
Fairgrounds water and water system
|
|
|
2,899,900
|
|
|
|
(534,500
|
)
|
|
|
2,899,900
|
|
|
|
(446,400
|
)
|
Rangeview water system
|
|
|
167,700
|
|
|
|
(67,600
|
)
|
|
|
167,700
|
|
|
|
(62,400
|
)
|
Water supply other
|
|
|
25,600
|
|
|
|
(19,400
|
)
|
|
|
25,600
|
|
|
|
(13,700
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Totals
|
|
|
90,505,700
|
|
|
|
(1,995,300
|
)
|
|
|
108,167,100
|
|
|
|
(1,695,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investments in water and water systems
|
|
$
|
88,510,400
|
|
|
|
|
|
|
$
|
106,472,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depletion and Depreciation
The Company recorded $500 of depletion charges during each of the three fiscal years ended August 31, 2012, 2011 and 2010, respectively. This related entirely to the Rangeview Water Supply (defined
below). No depletion is taken against the Arkansas River water or Sky Ranch Water Supply (all are defined below) because the water located at these locations are not yet being utilized for their intended purpose as of August 31, 2012.
The Company recorded $309,200, $300,800 and $255,100 of depreciation expense in each of the fiscal years ended August 31, 2012, 2011 and
2010, respectively. These figures include depreciation for other equipment not included in the table above.
Arkansas River Assets
Arkansas River Water
The
Company owns 60,000 acre feet of senior water rights in the Arkansas River and its tributaries in Southeastern Colorado. The Company anticipates that of this, 40,000 acre feet may be available for non-agricultural uses along the front range of
Colorado sometime in the future. The Company acquired its Arkansas River assets from HP A&M pursuant to the Arkansas River Agreement entered into on May 10, 2006.
In order to utilize the Arkansas River water in the Companys service areas, the Company will be required to convert this water to municipal and industrial uses. Change of water use must be done
through the Colorado water court and several conditions must be present prior to the water court granting an application for transfer of a water right. A transfer case would be expected to include the following provisions:
(i)
|
a provision of anti-speculation in which the applicant must have contractual obligations to provide water service to customers prior to the water court ruling on the
transfer of a water right,
|
(ii)
|
the applicant can only transfer the consumptive use portion of its water rights (the Company expects to face opposition to any consumptive use calculation
of the historic agricultural uses of its water),
|
(iii)
|
applicants likely would be required to mitigate the loss of tax base in the basin of origin,
|
F-14
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
(iv)
|
applicants would likely have re-vegetation requirements to restore irrigated soils to non-irrigated, and
|
(v)
|
applicants would be required to meet water quality measures which would be included in the cost of transferring the water rights.
|
The value of the assets was recorded based on the determined fair value of the consideration paid at the acquisition date, because the value of the
consideration was deemed a more reliable criterion of value than the value of the acquired assets. The consideration paid was comprised of equity (3.0 million shares of the Companys common stock) and the Tap Participation Fee. Because the
estimated value of the consideration paid was less than the total estimated fair value of the assets acquired by the Company, the relative values assigned to the assets were ratably reduced. For a discussion of promissory notes owed by HP A&M to
third parties which are secured by the Companys Arkansas River water rights, see Arkansas River Land section below, Note 7
Long Term Debt and Operating Lease
, and Note 15
Subsequent
Events
.
Fort Lyon Canal Company (FLCC) Shares
The Arkansas River water rights are represented by over 21,800 shares of the FLCC, which is a non-profit mutual ditch company established in the late
1800s that operates and maintains the 110 mile Fort Lyon Canal between La Junta, Colorado and Lamar, Colorado. The shares in the FLCC represent the amount of water the Company owns in the Fort Lyon Canal.
Pursuant to the Arkansas River Agreement, the Company pledged to HP A&M: (i) one-half of the FLCC shares purchased by the Company, (ii) all
shares of FLCC hereafter issued to the Company by means of any dividend or distribution in respect of the shares pledged hereunder (together with the shares identified in (i), the Companys Pledged Shares), (iii) the
certificates representing the Companys Pledged Shares, (iv) the land associated with the water represented by the Companys Pledged Shares, and (v) all rights to money or property which the Company now has or hereafter acquires
in respect of the Companys Pledged Shares. This pledge agreement will terminate upon payment of the Tap Participation Fee.
Arkansas River Land
The Company owns 16,000 acres of real property which is being used for agricultural purposes and was acquired from HP A&M in 2006 in connection with the water acquisition described above. The land is
located in the counties of Bent, Otero and Prowers in southern Colorado. The Company also owns certain contract rights, tangible personal property, mineral rights, and other water interests related to the Arkansas River water and land.
The land owned by the Company is divided into 80 separate properties, each of which is being leased to area farmers. Most of the operating leases expire
on December 31, 2014, while the remaining leases have a variety of expiration dates. Pursuant to a property management agreement between HP A&M and the Company (the Property Management Agreement), HP A&M had the right to
pursue leasing of the land and Arkansas River water to interested parties and all lease income associated with leasing the land and Arkansas River water, together with all costs associated with these activities, were the sole opportunity and
obligation of HP A&M. The Property Management Agreements initial term expired on August 31, 2011 and beginning September 1, 2011, the Property Management Agreement entered into the Extended Term which could extend the
Property Management Agreement until September 2014 at the latest. During the Extended Term, HP A&M was to continue to manage the leases and receive all lease payments from the lessees as a management fee. Beginning September 1, 2011, until
the Property Management Agreement was terminated the Company allocated 26.9% (calculated pursuant to the Property Management Agreement based on consideration paid to HP A&M since the signing of the Arkansas River Agreement) of the net revenues
paid to HP A&M (which is the lease payments HP A&M retains less expenses for employees, reasonable overhead and actual expenses paid to manage the farm leases) against the Tap Participation Fee liability. Because the Company did not have the
risk of loss associated with the leases (HP A&Ms management fee was equal to all lease income and contractually HP A&M had the risk of loss on the leases), the lease income and management fees are reflected on a net basis throughout
the initial and Extended Terms of the Property Management Agreement until termination on August 3, 2012.
F-15
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
The Property Management Agreement was terminated on August 3, 2012 due to defaults by HP A&M on
certain promissory notes secured by deeds of trust on the Companys land and water. On July 23, 2012, the Company notified all the farm lessees that HP A&M had notified the Company that HP A&M intended to default on its obligations
under the promissory notes issued by HP A&M to purchase farms and water rights in the Fort Lyon Canal system. The lessees were informed that all lease payments would be billed directly by and paid directly to the Company from the date of the
notice forward. All other terms of the leases remained unchanged. Under the farm lease agreements, the farmers are billed twice a year in November and March. During fiscal 2012, the Company received lease income from farm leases of approximately
$71,100. The allocation of 26.9% of the net revenues against the Tap Participation Fee, the termination of the Property Management and the defaults by HP A&M are described in greater detail in Note 7
Long-Term Debt and Operating
Lease
.
On February 10, 2010, the Company sold four acres of its Arkansas River Valley land for $10,000 in cash. The land had an
allocated carrying value of $600, which resulted in a gain of $9,400 being recorded during 2010. The Company maintained all water rights associated with the acreage that was sold.
Land and Water Shares Held for Sale
Prior to fiscal year end 2012, management decided to
sell certain farms in order to have the cash flow sufficient to acquire the notes defaulted upon by HP A&M and to meet the future obligations on the promissory notes the Company intends to issue as consideration to purchase the notes owed by HP
A&M. Management is anticipating selling approximately 1,486 acres of land along with 3,377 FLCC shares associated with this land. The net book value of the assets held for sale is $12.2 million. The negotiated sale price for these assets is $5.7
million resulting in a loss of $6.5 million.
Rangeview Water Supply and Water System
The Rangeview Water Supply consists of 28,350 acre feet and is a combination of tributary surface water and groundwater rights along with
certain storage rights associated with the Lowry Range, a 27,000-acre property owned by the Land Board located 16 miles southeast of Denver, Colorado. The $14.4 million on the Companys balance sheet as of August 31, 2012, represents the
costs of assets acquired or facilities constructed to extend water service to customers located on and off the Lowry Range. The recorded costs of the Rangeview Water Supply include payments to the sellers of the Rangeview Water Supply, design and
construction costs and certain direct costs related to improvements to the asset including legal and engineering fees.
The Company acquired
the Rangeview Water Supply beginning in 1996 when:
(i)
|
The District entered into the Amended and Restated Lease Agreement with the Land Board, which owns the Lowry Range;
|
(ii)
|
The Company entered into the Agreement for Sale of Export Water with the District, a quasi-municipal political subdivision of the State of Colorado;
|
(iii)
|
The Company entered into the Service Agreement with the District for the provision of water service to the Lowry Range; and
|
(iv)
|
In 1997, the Company entered into the Wastewater Service Agreement with the District for the provision of wastewater service to the Districts service area
(collectively these agreements are referred to as the Rangeview Water Agreements).
|
Pursuant to the Rangeview Water
Agreements, the Company has the exclusive right, through 2081, to use 13,400 acre feet of the Rangeview Water Supply specifically on the Lowry Range. The Rangeview Water Agreements also provide for the Company to use surface reservoir storage
capacity in providing water service to customers both on and off the Lowry Range. The Company owns the rights to use the remaining 11,650 acre feet groundwater, which can be exported off the Lowry Range to serve area users (referred to as
Export Water). The Company also has the option with the Land Board to exchange an aggregate gross volume of 165,000 acre feet of groundwater for 1,650 acre feet per year of adjudicated surface water and to use this surface water as
Export Water.
F-16
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Services on the Lowry Range
Pursuant to the Rangeview Water Agreements, the Company designs, finances, constructs, operates and maintains the Districts water and wastewater systems to provide service to the Districts
customers on the Lowry Range. The Company will operate both the water and the wastewater systems during the contract period and the District owns both systems. After 2081, ownership of the water system will revert to the Land Board, with the
District retaining ownership of the wastewater system.
Rates and charges for all water and wastewater services on the Lowry Range, including
tap fees and usage or monthly fees, are governed by the terms of the Rangeview Water Agreements. Rates and charges are required to be less than the average of similar rates and charges of three surrounding municipal water and wastewater service
providers, which are reassessed annually. Pursuant to the Rangeview Water Agreements the Land Board receives a 12% royalty on all gross revenues received from water sales to customers on the Lowry Range. The District retains 5% of the remaining
gross revenues and the Company receives 95% of the remaining gross revenues after the Land Board Royalty. The Land Board does not receive a royalty on wastewater fees. The Company receives 100% of the Districts wastewater tap fees and 90% of
the Districts wastewater usage fees (the District retains the other 10%).
Export Water
The Company owns the Export Water and uses and intends to use it to provide water and wastewater services to customers off the Lowry Range. The Company
will own all facilities required to extend water and wastewater services using its Export Water. The Company anticipates contracting with third parties for the construction of these facilities. If the Company sells Export Water, the Company is
required to pay royalties to the Land Board ranging from 10% of gross revenues to 50% of net revenue after deducting certain costs.
The
County Fairgrounds Water and Water System
The Company owns 321 acre feet of groundwater purchased pursuant to the County Agreement. The
Company plans to use this water in conjunction with its Rangeview Water Rights in providing water to areas outside the Lowry Range. The $2.9 million of capitalized costs includes the costs to construct various Wholesale and Special Facilities,
including a new deep water well, a 500,000 gallon water tank and pipelines to transport water to the Fairgrounds.
Sky Ranch
Effective July 30, 2010, the Company entered into a Loan Sale and Assignment Agreement (the Loan Sale Agreement) with the
Bank of America, N.A. (BofA), to acquire from BofA loan instruments secured by 931 acres of undeveloped land known as Sky Ranch. The Company acquired the promissory note payable by Sky Ranch, LLC (a wholly owned subsidiary of Neumann
Homes, Inc.), and the deed of trust granted by Sky Ranch, LLC, to secure the promissory note from the BofA for cash payments totaling $7.0 million. Concurrent with the signing of the Loan Sale Agreement, during fiscal 2010, the Company made an
escrow payment totaling $700,000 to BofA. The balance of the acquisition price, or $6.3 million, was paid to BofA in connection with the closing, which was on October 18, 2010. The property includes 820 acre feet of water, of which the Company
already owned 89 acre feet purchased pursuant to the agreements entered into with the former developer, which was acquired for $100,000 prior to fiscal 2011. On October 26, 2010, the United States Bankruptcy Court, Northern District of
Illinois, entered an order granting the Companys motion requesting that title to the Sky Ranch property be deeded to the Company free and clear of all bankruptcy claims. Pursuant to the order, the Company owns the Sky Ranch property effective
as of November 2, 2010.
F-17
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Total consideration for the land and water included the $7.0 million purchase price, plus direct costs
and fees of $554,100. The Company allocated the total acquisition cost to the land and water rights based on estimates of each assets respective fair value, as described in the table below. Because the total acquisition cost was less than the
total estimated fair value of the assets acquired by the Company, the relative values assigned to the land and water have been ratably reduced (allocated values are detailed in the table below). The estimated fair value of the land and water rights
were determined by internal analysis of estimated future cash flows from land and water rights sales and supplemented with an external appraisal of the land acquired. See further discussion regarding the exclusivity of the water rights in Note
12
Litigation Loss Contingencies
.
The following table presents the allocation of the acquisition costs (and the relative
fair values of each asset), including professional fees and other costs related to the acquisition, to the land and water based on their relative fair values:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset
|
|
Estimated Fair
Value
|
|
|
% of Total
Fair Value
|
|
|
Allocable
Acquisition Costs
|
|
|
Fair Value
Allocation
|
|
|
Costs Specific
to Land
1
|
|
|
Total Values
Assigned to
Identifiable
Assets
|
|
Land
|
|
$
|
10,637,900
|
|
|
|
48.13
|
%
|
|
$
|
7,187,900
|
|
|
$
|
3,459,800
|
|
|
$
|
279,100
|
|
|
$
|
3,738,900
|
|
Water
2
|
|
|
11,462,700
|
|
|
|
51.87
|
%
|
|
|
7,187,900
|
|
|
|
3,728,100
|
|
|
|
|
|
|
|
3,728,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
22,100,600
|
|
|
|
100
|
%
|
|
|
|
|
|
$
|
7,187,900
|
|
|
$
|
279,100
|
|
|
$
|
7,467,000
|
|
Costs of acquisition
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
87,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total capitalized costs related to Sky Ranch
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
7,554,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Table Notes
1.
|
Includes $71,000 of property taxes.
|
2.
|
The water rights value does not include the $100,000 of costs already capitalized on the Companys balance sheet related to the 89 acre feet of water acquired from
the prior owner of the land and not pursuant to the Loan Sale Agreement.
|
3.
|
The amounts recorded as costs of acquisition consist of professional fees and other related costs.
|
The assets acquired by the Company are being depreciated consistent with the Companys depreciation policies.
The funding for this acquisition was completed in September 2010, when the Company entered into the $5.2 million Convertible Negotiable Promissory Note
(the Convertible Note Related Party) with PAR Investment Partners, L.P. (PAR), a greater than 5% shareholder of the Company, and sold 1.8 million shares of its common stock for $5.5 million. Both financing
transactions are described below, including the conversion of the Convertible Note Related Party on January 11, 2011. Of the combined $10.7 million raised by the Company, $6.3 million was used to complete the Loan Sale Agreement
with BofA and the remaining funds, $4.4 million, are being used for working capital and other general corporate purposes.
Issuance and
Conversion of the Convertible Note
Related Party
The Company issued the $5.2 million Convertible Note
Related Party to PAR on September 28, 2010. The Companys shareholders authorized conversion of the Convertible Note Related Party at the January 11, 2011 annual shareholders meeting. Following the meeting, PAR
surrendered the Convertible Note Related Party for conversion, and the Company issued 1,982,099 unregistered shares of its common stock to PAR. From issuance until conversion, the Convertible Note Related Party accrued
interest at a rate of 10% per annum. During the fiscal year ended August 31, 2011, the Company accrued $151,700 of interest on the Convertible Note Related Party. The number of shares issued was based on the outstanding balance
of $5.35 million (principal and accrued interest) divided by a conversion rate of $2.70. Since the Convertible Note Related Party included a conversion feature that was a standard conversion feature not subject to change, the Company
determined this was not an embedded derivative. Additionally, at the date of issuance, the market price of the Companys common stock was less than the conversion price; therefore, the Company determined that the instrument did not contain a
beneficial conversion feature. In conjunction with the Convertible Note Related Party, the Company granted PAR one demand right and piggyback rights to register the shares of common stock issuable upon conversion of the Convertible
Note Related Party.
F-18
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Sale of common stock pursuant to the shelf registration statement
On September 29, 2010, the Company sold 1,848,931 shares of its common stock for $5.5 million or $3.00 per share. These shares were sold pursuant to
a $10.0 million shelf registration statement (Registration Number 333-168160) filed with the SEC, which became effective on July 28, 2010. The Company may issue up to an additional $4.45 million of its common stock pursuant to this shelf
registration statement. 930,600 shares of common stock sold in this offering were sold at PAR for $2.8 million or $3.00 per share.
O&G
Lease
On March 10, 2011, the Company entered into the O&G Lease and the Surface Use Agreement with Anadarko. Pursuant to the
O&G Lease, the Company received an up-front payment of $1,243,400 from Anadarko for the purpose of exploring for, developing, producing and marketing oil and gas on 634 acres of mineral estate owned by the Company at its Sky Ranch property. The
Company also received $9,000 in surface use and damage payments.
Paradise Water Supply
In 1987, the Company acquired water, water wells, and related assets from Paradise Oil, Water and Land Development, Inc., which constitute the
Paradise Water Supply. The $5.5 million of capitalized costs includes costs to acquire the Paradise Water Supply, as well as certain direct legal and engineering costs relating to improvements to the asset. The Paradise Water Supply
includes 70,000 acre feet of conditionally decreed tributary Colorado River water, a right-of-way permit from the United States Department of the Interior, Bureau of Land Management, for the construction of a 70,000 acre foot dam and reservoir
across federal lands, and four unrelated water wells.
Every six years the Paradise Water Supply is subject to a finding of reasonable
diligence review by the water court and the State Engineer. For a favorable finding, the Company must demonstrate that it is diligently pursuing the development of the water rights. If the Company does not receive a favorable finding of reasonable
diligence, it will lose its right to the Paradise Water Supply. The most recent diligence review was started in our fiscal 2005 and was completed in 2008, but not without objectors and not without the Company having to agree to certain stipulations
to remove the objections. In order to continue to maintain the Paradise water right, by 2014 the Company must (i) select an alternative reservoir site; (ii) file an application in water court to change the place of storage; (iii) identify specific
end users and places of use for the water; and (iv) identify specific source(s) of the water rights for use. Management does not intend to spend the resources needed to find an alternative reservoir site without a specific use for the water. The
Company has been unable to find potential customers for this water and cannot be certain that a customer will commit to use the water within the next two years. Since the Company does not have a customer that will commit to use the water and the
Company will not commit the resources necessary to move the reservoir site in the absence of a customer, the Company expects to lose these conditional water rights. Accordingly during the fourth quarter of fiscal 2012, the Company has determined the
Paradise Water Supply is fully impaired and an impairment charge of $5.5 million was recorded.
NOTE 5:
PARTICIPATING INTERESTS IN EXPORT WATER
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 represents the cash the Company received and used to purchase its Export Water. In return,
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. The obligation for the $11.1 million was recorded as debt, and the remaining $20.7 million contingent
liability was not reflected on the Companys balance sheet because the obligation to pay this is contingent on sales of Export Water, the amounts and timing of which are not reasonably determinable. See further discussion regarding the Export
Water in Note 4
Water Assets
.
F-19
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
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, 35% of each payment remitted to the CAA holders is allocated to the recorded liability account. The remaining portion of each payment, or 65%, is allocated
to the contingent obligation, which is recorded on a net revenue basis.
In fiscal years 2007 and 2008, in order to reduce the long term
impact of the CAA, the Company repurchased various portions of the CAA obligations in priority. The Company did not make any CAA acquisitions during the fiscal years ended August 31, 2012, 2011 and 2010. As a result of the acquisitions, and due
to the sale of Export Water, as detailed in the table below, the remaining potential third party obligation as of August 31, 2012 is $3.5 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
|
|
|
$
|
31,807,732
|
|
|
$
|
11,090,630
|
|
|
$
|
20,717,102
|
|
Activity from inception until August 31, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisitions
|
|
|
|
|
|
|
28,077,500
|
|
|
|
(28,077,500
|
)
|
|
|
(9,789,983
|
)
|
|
|
(18,287,517
|
)
|
Option paymentsSky Ranch and The Hills at Sky Ranch
|
|
|
110,400
|
|
|
|
(42,280
|
)
|
|
|
(68,120
|
)
|
|
|
(23,754
|
)
|
|
|
(44,366
|
)
|
Arapahoe County tap fees *
|
|
|
532,968
|
|
|
|
(373,078
|
)
|
|
|
(159,890
|
)
|
|
|
(55,754
|
)
|
|
|
(104,136
|
)
|
Export Water sale payments
|
|
|
85,123
|
|
|
|
(59,585
|
)
|
|
|
(25,538
|
)
|
|
|
(8,907
|
)
|
|
|
(16,631
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at August 31, 2011
|
|
|
728,491
|
|
|
|
27,821,057
|
|
|
|
3,476,684
|
|
|
|
1,212,232
|
|
|
|
2,264,452
|
|
Fiscal 2012 activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Export Water sale payments
|
|
|
26,163
|
|
|
|
(18,314
|
)
|
|
|
(7,849
|
)
|
|
|
(3,304
|
)
|
|
|
(4,545
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at August 31, 2012
|
|
$
|
754,654
|
|
|
$
|
27,802,743
|
|
|
$
|
3,468,835
|
|
|
$
|
1,208,928
|
|
|
$
|
2,259,907
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
The Arapahoe County tap fees are less $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 three payees receive their full payment before the next
priority level receives any payment and so on until full repayment. The Company will receive $5.1 million of the first priority payout. The remaining entire first priority payout totals $7.3 million as of August 31, 2012.
NOTE 6:
ACCRUED LIABILITIES
At August 31, 2012, the Company had accrued liabilities of $172,600, of which $60,500 was for estimated property taxes on the Sky
Ranch property, $56,800 was for professional fees, $33,500 for prepaid farm lease payments and the remaining $21,800 was related to operating payables.
F-20
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
At August 31, 2011, the Company had accrued liabilities of $118,600, of which $62,400 was for
estimated property taxes on the Sky Ranch property, $49,500 was for professional fees, and the remaining $6,700 was related to operating payables.
NOTE 7:
LONG-TERM DEBT AND OPERATING LEASE
As of August 31, 2012, the Company has no debt with contractual maturity dates.
The Participating Interest in Export Water supply and the Tap Participation Fee payable to HP A&M are obligations of the Company that have no
scheduled maturity dates. Therefore, these liabilities are not disclosed in tabular format. However, the Participating Interest in Export Water supply is described in Note 5
Participating Interest in Export Water
and the Tap
Participation Fee is described below in section Tap Participation Fee Payable to HP A&M.
Tap Participation Fee Payable to
HP A&M
The Companys Tap Participation Fee liability represents the estimated discounted fair value of the Companys
obligation to pay HP A&M twenty percent (20%) of the Companys gross proceeds, or the equivalent thereof, from the sale of the next 19,427 water taps sold by the Company. This was initially an obligation to pay ten percent
(10%) 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 19,427 as a result of (i) sales of Arkansas River 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 terms of the Arkansas River Agreement to increase the Tap Participation Fee
percentage from ten percent (10%) to twenty percent (20%) and take a corresponding fifty percent (50%) reduction in the number of taps subject to the Tap Participation Fee, and (iv) the allocation of 26.9% of net revenues
received by HP A&M from management of the farm leasing operations as described below.
At the acquisition date, the Company valued
the Tap Participation Fee at $45.6 million using a discounted cash flow analysis of the projected future payments to HP A&M. The $68.3 million balance at August 31, 2012, includes $22.7 million of imputed interest, recorded using the effective
interest method. The value of the Tap Participation Fee is estimated by projecting new home development in the Companys targeted service area over an estimated development period. Projecting new home development in the Companys targeted
service area involved the utilization of third party historical and projected housing and population growth data for the Denver, Colorado metropolitan area, which was applied to an estimated development pattern, supported by historical development
patterns of certain master planned communities in the Denver, Colorado metropolitan area. This estimated development pattern was then applied to projected future water tap fees, which were estimated using historical water tap fees. The Company
updated its estimated discounted cash flow analysis as of September 1, 2011. The Company completed an update to its analysis of the fair value of the Tap Participation Fee as of August 31, 2012, at which time it determined that changes in the
projected estimated discounted cash flows did not materially impact the Tap Participation Fee liability as of August 31, 2012, or the amount recorded as imputed interest during the year ended August 31, 2012. Based on a lack of material changes, no
change in valuation was deemed necessary at August 31, 2012.
Actual new home development in the Companys service area and actual future
tap fees inevitably will vary significantly from the Companys estimates, which could have a material impact on the Companys financial statements as well as its results of operations. An important component in the Companys estimate
of the value of the Tap Participation Fee, 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 Companys water assets. The Company continues to assess the value of the Tap
Participation Fee liability and updates its valuation analysis whenever events or circumstances indicate the assumptions used to estimate the value of the liability have changed materially. The difference between the net present value and the
estimated realizable value will be imputed as interest expense using the effective interest method over the estimated development period utilized in the valuation of the Tap Participation Fee.
F-21
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Payment of the Tap Participation Fee may be accelerated in the event of a merger, reorganization, sale
of substantially all assets, or similar transactions and in the event of bankruptcy and insolvency events.
The Tap Participation Fee is due
and payable once the Company has sold a water tap and received the consideration due for such water tap. The Company did not sell any water taps during the fiscal years ended August 31, 2012 or 2011. However, beginning September 1, 2011,
until the Property Management Agreement was terminated on August 3, 2012, the Company allocated 26.9% (calculated pursuant to the Property Management Agreement based on consideration paid to HP A&M since the signing of the Arkansas River
Agreement) of the net revenues paid to HP A&M (which is equal to the lease payments HP A&M retains less expenses for employees, reasonable overhead and actual expenses paid to manage the farm leases) against the Tap Participation Fee
liability. Because the Company did not have the risk of loss associated with the leases (HP A&Ms management fee was equal to all lease income and contractually HP A&M had the risk of loss on the leases), the lease income and management
fees have been reflected on a net revenue basis throughout the initial and Extended Terms of the Property Management Agreement. This allocation is 26.9% of the net revenues against the Tap Participation Fee reduced the taps subject to the Tap
Participation Fee to 19,427 as of August 31, 2012. Because HP A&M defaulted on certain obligations under the Arkansas River Agreement, the Company terminated the Property Management Agreement effective as of August 3, 2012.
Accordingly, the allocation of the 26.9% of the net revenues as a reduction of the Tap Participation Fee will no longer be applicable in fiscal 2013.
Promissory Notes Payable by HP A&M in default
60 of the 80 properties the Company
acquired from HP A&M are subject to outstanding promissory notes payable to third parties with principal and accrued interest totaling $9.6 million and $10.0 million at August 31, 2012 and 2011, respectively. These promissory notes are
secured by deeds of trust on the Companys properties and water rights, as well as mineral interests, up to 25% of which are owned by the Company and up to 75% of which are currently owned by HP A&M. The Company did not assume any of these
promissory notes and is not legally responsible for making any of the required payments under these notes. This responsibility remains solely with HP A&M. In the event of default by HP A&M, at the Companys sole discretion, the Company
may make payments on any or all of the notes and cure any or all of the defaults. If the Company does not cure the defaults, it will lose the properties and water rights securing the defaulted notes.
As of fiscal year end 2012 and since that date, HP A&M has defaulted on over 50% of the notes and informed the Company that it does not intend to pay
any of the remaining notes. HP A&M owes approximately $9.6 million of principal and accrued interest secured by approximately 14,000 acres of farm 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 and that unless such defaults were cured within thirty 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 Companys remedies at law and under the Arkansas River
Agreement and related agreements include, but are 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 Sellers 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 attorneys fees.
On August 3, 2012, the Company formally terminated the Property Management Agreement. Additionally, subsequent to fiscal 2012 year end, the Pledged Shares were sold at auction in a foreclosure sale
for $2.35 per share, yielding approximately $3.5 million to the Company.
Subsequent to fiscal year end 2012, the Company began acquiring the
defaulted and non-defaulted notes that are payable by HP A&M. See Note 15
Subsequent Events
below for details regarding these note acquisitions.
F-22
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Future Maturities
|
|
|
|
|
Mortgage notes held and defaulted on by HP A&M
|
|
$
|
5,093,400
|
|
Mortgage notes, interest at 5%, due various dates in 2017
|
|
|
4,456,900
|
|
|
|
|
|
|
Total
|
|
|
9,550,300
|
|
Less: current portion
|
|
|
(5,340,900
|
)
|
|
|
|
|
|
Total long-term mortgage payable
|
|
$
|
4,209,400
|
|
|
|
|
|
|
Future Maturities
|
|
|
|
|
2013
|
|
$
|
5,340,900
|
|
2014
|
|
|
1,064,500
|
|
2015
|
|
|
1,064,500
|
|
2016
|
|
|
1,064,500
|
|
2017
|
|
|
1,015,900
|
|
|
|
|
|
|
Total
|
|
$
|
9,550,300
|
|
|
|
|
|
|
Operating Lease
Effective December 29, 2010, the Company entered into an operating lease for 1,200 square feet of office space. The lease has a three year term with payments of $1,500 per month.
NOTE 8:
SHAREHOLDERS EQUITY
Sale of common stock and issuance of common stock upon conversion of Convertible Note
Related Party
See Note 4 above regarding the issuance of the common stock and the issuance of stock upon conversion of the Convertible Note
Related Party, both done in connection with the Sky Ranch acquisition.
Preferred Stock
The Companys non-voting Series B Preferred Stock has a preference in liquidation of $1.00 per share less any dividends previously paid.
Additionally, the Series B Preferred Stock is redeemable at the discretion of the Company for $1.00 per share less any dividends previously paid. In the event that the Companys proceeds from sale or disposition of Export Water rights exceed
$36,026,232, the Series B Preferred Stock holders will receive the next $432,513 of proceeds in the form of a dividend.
Equity
Compensation Plan
The Company maintains the 2004 Incentive Plan (the Equity Plan), which was approved by shareholders in April
2004. Executives, eligible employees and non-employee directors are eligible to receive options and restricted stock grants pursuant to the Equity Plan. Under the Equity Plan, options to purchase shares of stock and restricted stock awards can be
granted with exercise prices and vesting periods determined by the Compensation Committee of the Board. The Company initially reserved 1.6 million shares of common stock for issuance under the Equity Plan. At August 31, 2012, the Company
had 1,350,811 shares that can be granted to eligible participants pursuant to the Equity Plan.
F-23
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
The Company estimates the fair value of share-based payment awards on the date of grant using the
Black-Scholes option-pricing model (Black-Scholes model). Using the Black-Scholes model, the value of the portion of the award that is ultimately expected to vest is recognized as a period expense over the requisite service period in the
statement of operations. Option forfeitures are to be estimated at the time of grant and revised if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company does not expect any forfeiture of its option grants
and therefore the compensation expense has not been reduced for estimated forfeitures. During fiscal year 2012, 29,500 options were forfeited by option holders and an additional 48,000 options expired. No options were forfeited during the two fiscal
years ended August 31, 2011 and 2010. The Company attributes the value of share-based compensation to expense using the straight-line single option method for all options granted.
The Companys determination of the estimated fair value of share-based payment awards on the date of grant is affected by the following variables and assumptions:
|
|
|
The grant date exercise price is the closing market price of the Companys common stock on the date of grant;
|
|
|
|
Estimated option lives based on historical experience with existing option holders;
|
|
|
|
Estimated dividend rates based on historical and anticipated dividends over the life of the option;
|
|
|
|
Life of the option based on historical experience option grants have lives between 8 and 10 years;
|
|
|
|
Risk-free interest rates with maturities that approximate the expected life of the options granted;
|
|
|
|
Calculated stock price volatility calculated over the expected life of the options granted, which is calculated based on the weekly closing
price of the Companys common stock over a period equal to the expected life of the option; and
|
|
|
|
Option exercise behaviors based on actual and projected employee stock option exercises and forfeitures.
|
In January 2012, the Company granted its non-employee directors options to purchase a combined 12,500 shares of the Companys common stock pursuant
to the Equity Plan. The options vest one year from the date of grant and expire ten years from the date of grant. The Company calculated the fair value of these options at $15,400 using the Black-Scholes model with the following variables: weighted
average exercise price of $1.85 (which was the closing sales price of the Companys common stock on the date of the grant); estimated option lives of ten years; estimated dividend rate of 0%; weighted average risk-free interest rate of 1.87%;
weighted average stock price volatility 73.2%; and an estimated forfeiture rate of 0%. The $15,400 of stock-based compensation is being expensed monthly over the vesting periods.
In January 2011, the Company granted its non-employee directors options to purchase a combined 17,500 shares of the Companys common stock pursuant to the Equity Plan. 12,500 of the options vest one
year from the date of grant and expire ten years from the date of grant. 5,000 of the options vest one-half at the first anniversary of the grant date and one-half at the second anniversary of the grant date. The Company calculated the fair value of
these options at $54,500 using the Black-Scholes model with the following variables: weighted average exercise price of $3.67 (which was the closing sales price of the Companys common stock on the date of the grant); estimated option lives of
ten years; estimated dividend rate of 0%; weighted average risk-free interest rate of 3.37%; weighted average stock price volatility of 84.7%; and an estimated forfeiture rate of 0%. The $54,500 of stock-based compensation is being expensed monthly
over the vesting periods.
In January 2010, the Company granted its non-employee directors options to purchase a combined 12,500 shares of the
Companys common stock pursuant to the Equity Plan. The options vested one year from the date of grant and expire ten years from the date of grant. The Company calculated the fair value of these options at $31,200 ($2.49 per option) using the
Black-Scholes model with the following variables: weighted average exercise price of $2.88 (which was the closing sales price of the Companys common stock on the date of the grant); estimated option lives of ten years; estimated dividend rate
of 0%; weighted average risk-free interest rate of 3.74%; weighted average stock price volatility of 88.4%; and an estimated forfeiture rate of 0%. The $31,200 of stock-based compensation was expensed monthly over the vesting period.
No options were exercised during the fiscal years ended August 31, 2012 or 2011.
F-24
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
The following table summarizes the stock option activity for the Equity Plan for the fiscal year ended
August 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Options
|
|
|
Weighted-
Average
Exercise Price
|
|
|
Weighted-
Average
Remaining
Contractual
Term
|
|
|
Approximate
Aggregate
Instrinsic
Value
|
|
Oustanding at beginning of period
|
|
|
280,000
|
|
|
$
|
6.10
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
12,500
|
|
|
$
|
1.85
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
Forfeited or expired
|
|
|
(77,500
|
)
|
|
$
|
6.03
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at August 31, 2012
|
|
|
215,000
|
|
|
$
|
5.88
|
|
|
$
|
4.98
|
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at August 31, 2012
|
|
|
192,500
|
|
|
$
|
6.12
|
|
|
$
|
4.59
|
|
|
|
*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
Intrinisic value less than $0
|
The following
table summarizes the activity and value of non-vested options as of and for the fiscal year ended August 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
Number of
Options
|
|
|
Weighted-
Average
Grant Date
Fair Value
|
|
Non-vested options oustanding at beginning of period
|
|
|
49,500
|
|
|
$
|
2.86
|
|
Granted
|
|
|
12,500
|
|
|
|
1.23
|
|
Vested
|
|
|
(22,500
|
)
|
|
|
3.11
|
|
Forfeited
|
|
|
(17,000
|
)
|
|
|
2.83
|
|
|
|
|
|
|
|
|
|
|
Non-vested options outstanding at August 31, 2012
|
|
|
22,500
|
|
|
$
|
1.72
|
|
|
|
|
|
|
|
|
|
|
All non-vested options are expected to vest. The total fair value of options vested during the fiscal years ended
August 31, 2012, 2011 and 2010 was $66,000, $74,700 and $79,700, respectively. The weighted average grant date fair value of options granted during the fiscal years ended August 31, 2012, 2011 and 2010 was $1.23, $3.11 and $2.49,
respectively.
Share-based compensation expense for the fiscal years ended August 31, 2012, 2011 and 2010, was $54,600, $94,600 and
$87,600, respectively.
At August 31, 2012, the Company had unrecognized expenses relating to non-vested options that are expected to
vest totaling $13,200. The weighted-average period over which these options are expected to vest is less than two years. The Company has not recorded any excess tax benefits to additional paid in capital.
Warrants
As of August 31, 2012,
the Company had outstanding warrants to purchase 92 shares of common stock at an exercise price of $1.80 per share. These warrants expire six months from the earlier of:
(i)
|
The date all of the Export Water is sold or otherwise disposed of,
|
(ii)
|
The date the CAA is terminated with respect to the original holder of the warrant, or
|
(iii)
|
The date on which the Company makes the final payment pursuant to Section 2.1(r) of the CAA.
|
No warrants were exercised during fiscal 2012, 2011 or 2010.
F-25
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
Pledged Common Stock Owned by HP A&M
Pursuant to the Arkansas River Agreement, HP A&M pledged, transferred, assigned and granted to the Company a security interest in and to the Pledged Shares, consisting of 1,500,000 shares of Pure
Cycle common stock and the proceeds there from. Due to the HP A&M default, subsequent to fiscal 2012 the Pledged Shares were sold pursuant to a foreclosure sale for $3.5 million or $2.35 per share. See Note 15
Subsequent
Events
below.
Registration Rights Agreement
Pursuant to the Arkansas River Agreement the Company granted HP A&M one demand right to request the registration of 750,000 shares of Pure Cycle common stock and piggyback rights, which were exercised
in 2007, to register an additional 750,000 shares of Pure Cycle common stock. The demand rights expired August 31, 2011.
NOTE 9:
SIGNIFICANT CUSTOMER
The Company sells wholesale water and wastewater services to the District pursuant to the Rangeview Water Agreements. Sales to the
District accounted for 86%, 91%, and 94% of the Companys total revenues for the years ended August 31, 2012, 2011 and 2010, respectively. The District had one significant customer, the Ridgeview Youth Services Center. Pursuant to the
Rangeview Water Agreements the Company is providing water and wastewater services to this customer on behalf of the District. The Districts significant customer accounted for 53%, 60% and 64% of the Companys total revenues for the years
ended August 31, 2012, 2011 and 2010, respectively.
The Company had accounts receivable from the District which accounted for 16% and
87% of the Companys trade receivables balances at August 31, 2011 and 2010, respectively. Accounts receivable from the Districts largest customer accounted for 13% and 74% of the Companys trade receivables as of
August 31, 2012 and 2011, respectively.
NOTE 10:
INCOME TAXES
There is no provision for income taxes, because the Company has incurred operating losses. Deferred income taxes reflect the tax
effects of net operating loss carryforwards and temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Companys
deferred tax assets as of August 31 are as follows:
|
|
|
|
|
|
|
|
|
|
|
For the Fiscal Years Ended August 31,
|
|
|
|
2012
|
|
|
2011
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
5,948,300
|
|
|
$
|
5,259,200
|
|
Imputed interest on Tap Participation Fee
|
|
|
8,852,500
|
|
|
|
7,558,000
|
|
Deferred revenue
|
|
|
560,700
|
|
|
|
702,000
|
|
Impairment charges
|
|
|
2,408,800
|
|
|
|
|
|
Depreciation and depletion
|
|
|
2,425,700
|
|
|
|
301,600
|
|
Other
|
|
|
45,000
|
|
|
|
38,900
|
|
Valuation allowance
|
|
|
(20,241,000
|
)
|
|
|
(13,859,700
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax asset
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
The Company has recorded a valuation allowance equal to the excess of the deferred tax assets over the deferred tax
liability as the Company is unable to reasonably determine if it is more likely than not that deferred tax assets will ultimately be realized.
Income taxes computed using the federal statutory income tax rate differs from our effective tax rate primarily due to the following for the fiscal years
ended August 31:
F-26
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Fiscal Years Ended August 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
Expected benefit from federal taxes at statutory rate of 34%
|
|
$
|
(5,922,300
|
)
|
|
$
|
(2,045,500
|
)
|
|
$
|
(1,833,000
|
)
|
State taxes, net of federal benefit
|
|
|
(574,800
|
)
|
|
|
(198,500
|
)
|
|
|
(177,900
|
)
|
Expiration of net operating losses
|
|
|
90,000
|
|
|
|
121,000
|
|
|
|
147,900
|
|
Permanent and other differences
|
|
|
25,800
|
|
|
|
37,800
|
|
|
|
(27,100
|
)
|
Change in valuation allowance
|
|
|
6,381,300
|
|
|
|
2,085,200
|
|
|
|
1,890,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax expense / benefit
|
|
$
|
|
|
|
$
|
|
|
|
$
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At August 31, 2012, the Company has $16 million of net operating loss carryforwards available for income tax
purposes, which expire between fiscal 2013 and 2032. Utilization of these net operating loss carryforwards may be subject to substantial annual ownership change limitations provided by the Internal Revenue Code. Such an annual limitation could
result in the expiration of the net operating loss carryforwards before utilization.
Net operating loss carryforwards of $241,200, $324,500
and $396,500 expired during the fiscal years ended August 31, 2012, 2011 and 2010, respectively.
NOTE 11:
401(k) PLAN
Effective July 25, 2006, the Company adopted the Pure Cycle Corporation 401(k) Profit Sharing Plan (the Plan), a
defined contribution retirement plan for the benefit of its employees. The Plan is currently a salary deferral only plan, and at this time the Company does not match employee contributions. The Company pays the annual administrative fees of the
Plan, and the Plan participants pay the investment fees. The Plan is open to all employees, age 21 or older, who have been employees of the Company for at least six months. During the fiscal years ended August 31, 2012, 2011 and 2010, the
Company paid fees of $3,400, $2,600 and $2,400, respectively, for the administration of the Plan.
NOTE 12:
LITIGATION LOSS CONTINGENCIES
The Company is involved in various claims, litigation and other legal proceedings that arise in the ordinary course of its business. In
accordance with ASC 450,
Contingencies
, an accrual is recorded 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 Companys financial position, results of operations or cash flows.
Because each of the lawsuits below involves
complex legal issues and uncertainties and are in the early stages, the Company has recorded no accrual for loss related to the lawsuit and is unable to estimate a reasonably possible loss or range of loss.
As discussed in a Form 8-K filed on December 19, 2011, on that date the Company and the District filed a lawsuit against the State of Colorado by
and through the Land Board. The complaint was filed with the District Court, City and County of Denver, State of Colorado. The Company and the District are claiming that the Land Board breached, and will breach, agreements entered into by the Land
Board with the Company and the District in connection with a 1996 settlement agreement. Those agreements include (i) the Amended and Restated Water Lease, dated as of April 4, 1996, between the Land Board and the District and (ii) the
Service Agreement of the same date between the Company and the District. As initially reported in a Current Report on Form 8-K filed on November 29, 2011, the Land Board issued a Request for Proposal that included a draft lease agreement
related to oil and gas rights at the Land Boards Lowry Range. The Company believes the draft lease agreement did not adequately address or protect the Companys exclusive right to provide water to the Lowry Range. The Land Board
subsequently entered into an oil and gas lease for the Lowry Range, which, like the draft lease, does not protect the Companys exclusive rights. As a result of this breach, the Company and the District are claiming damages which will be proven
at trial.
F-27
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
As disclosed in two Form 8-Ks, one filed on February 16, 2012 and one filed on
February 29, 2012, HP A&M initiated a lawsuit against the Company in District Court, City and County of Denver, State of Colorado on February 27, 2012 alleging breaches of representations made in connection with the Arkansas River
Agreement. The HP A&M claims relate to the issues currently being litigated between the Company and the Land Board regarding the Companys exclusive right to provide water service to the Land Boards Lowry Range property. The Company
believes the allegations are without merit, and intends to vigorously defend against them.
NOTE 13:
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES
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For the Fiscal Years Ended August 31,
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2012
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2011
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2010
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Mortgage payable and related party receivable recorded upon HP A&M default
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9,550,200
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Farm revenue allocated against the Tap Participation Fee liability and additional paid in capital thru August 3,
2012
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189,700
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Issuance of shares of restricted common stock upon conversion of the Convertible Note - Related Party
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5,351,700.00
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$
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9,739,900.0
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$
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5,351,700.0
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$
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NOTE 14:
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 joining the South Metro Water Supply Authority (SMWSA). During the year ended August 31, 2012, the Company provided funding of $115,500. During the year ended August 31,
2011, the Company provided funding of $25,000. The $115,500 and $25,000 of funding were expensed in the general and administrative expenses lines in the accompanying statements of operations for the years ended August 31, 2012, and 2011,
respectively.
The Company incurred an expense related to HP A&M in the amount of $8,100, $7,100, and $16,700 during the fiscal years
ended August 31, 2012, 2011 and 2010, respectively. This is predominately due to the Company paying 50% of the salary and expenses for work performed by an HP A&M employee on behalf of the Company related to operations of the agricultural
property owned by the Company in the Arkansas River Valley. The amount paid to HP A&M in fiscal 2012 versus fiscal 2011 decreased $7,000 and the amount paid to HP A&M in fiscal 2011 versus fiscal 2010 decreased $9,600, due mainly to the HP
A&M employee becoming an employee of the Company on January 1, 2010, and on that date HP A&M began reimbursing the Company for half of said employees salary and expenses. Effective as of the first quarter 2013, HP A&M will no
longer be considered a related party due to the foreclosure sale of the Pledged Shares. See additional information regarding the HP A&M default and sale of the Pledged Shares in Note 15
Subsequent Events
.
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 August 31, 2012) and matures on December 31, 2012. The $543,900 balance of the note receivable at August 31, 2012 includes borrowings of $229,300 and accrued interest of $314,600. The $531,900
balance of the note receivable at August 31, 2011 includes borrowings of $229,300 and accrued interest of $302,600. The Company extended the due date to December 31, 2013, and accordingly the note has been classified as non-current.
NOTE 15:
SUBSEQUENT EVENTS
As described in Note 7
Long Term Debt and Operating Lease
, HP A&M began defaulting on promissory notes secured
by deeds of trust on the Companys Arkansas River properties and water rights in June 2012. 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 and a default of a material covenant under the Arkansas River Agreement. On August 3, 2012, the Company formally terminated the Property Management Agreement. The consequences of such termination are described in more
detail below.
F-28
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
AUGUST 31, 2012, 2011 and 2010
As of the date of this filing, HP A&M has defaulted on over 50% of the notes and informed the
Company that it does not intend to pay any of the remaining notes. HP A&M currently owes approximately $9.6 million of principal and accrued interest on notes secured by approximately 14,000 acres of farm land and 16,882 FLCC shares representing
water rights owned by the Company.
Foreclosure Sale of Common Stock Pledged by HP A&M
Due to the default by HP A&M in fiscal 2012 on the promissory notes secured by the Companys Arkansas River properties, the Company foreclosed on
the Pledged Shares. The Pledged Shares were sold at an auction open only to pre-qualified accredited investors for $3.5 million, or $2.35 per share, on September 27, 2012.
After the sale of the HP A&M Pledged Shares, HP A&M is no longer considered to be a related party of the Company. Subsequent to the sale of the Pledged Shares, HP A&M owns 1.5 million
shares of the Companys common stock which is approximately 6%. This 6% ownership level falls short of the 10% criteria to continue to be considered a related party of the Company.
Refinancing of HP A&M Mortgages
Subsequent to fiscal 2012, the Company began acquiring
the defaulted and non-defaulted promissory notes that are payable by HP A&M. As of the filing date, the Company has successfully acquired $5.1 million of the notes payable by HP A&M in exchange for a combination of cash and secured notes.
The majority of the notes issued by the Company have a five-year term, bear interest at an annual rate of five percent (5%) and require Semi-annual payments with a straight-line amortization schedule. The notes purchased by the Company continue
to be due and payable by HP A&M to the Company as the new note holder.
F-29