March 15, 2006
Mr. Jim Allegretto
Senior Assistant Chief Accountant
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Mr. Allegretto:
This letter is in response to the Commission’s comment letter dated February 23,
2006, regarding a review of Pure Cycle Corporation’s (the “Company”) Annual
Report on Form 10-KSB for the year ended August 31, 2005 and the
Company’s Form 10-Q for the three months ended November 30, 2005. For
your convenience, we set forth each comment from your comment letter in bold
typeface and include the Company’s response below it.
We acknowledge that (i) the Company is responsible for the
adequacy and accuracy of the disclosure in the filing; (ii) staff comments
or changes to disclosure in response to staff comments do not foreclose the
Commission from taking any action with respect to the filing; and (iii) the
Company may not assert staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities laws of
the United States.
Form 10-KSB for the Fiscal Year Ended August 31,
2005: Financial Statements:
Balance Sheet page 28:
1. Since you have
treasury stock, the number of common shares outstanding should not equal the
number of common shares issued as you have disclosed on the face of your
balance sheet. Please revise the number of shares
outstanding as of each balance sheet date to include shares issued
less those held in treasury.
Company response:
The caption shares outstanding
on the balance sheet does include shares held in treasury. As of August 31,
2005 and November 30, 2005, the Company held 73,154 shares and 88,154
shares, respectively, in treasury. Both of these amounts represent less than 1%
of the total shares outstanding. Therefore, by not reducing the shares
outstanding caption in the balance sheet, the result is immaterial to the
financial statements. Additionally, investors could utilize the statement of
changes in stockholders’ equity to reconcile these figures. The Company concurs
with the Commission’s conclusion and proposes to correct this in future filings
beginning with the Form 10-Q for the three months ending February 28,
2006.
8451 Delaware St., Thornton, CO 80260
Telephone (303) 292-3456 Telecopier (303)
292-3475
Statements of Cash Flows, page 31:
1. Please tell us your
basis for classifying changes in restricted cash as an operating activity as
opposed to a financing activity and Sky Ranch option payments received as
investing activities as opposed to operating activities. Please also explain
why the contingent obligation payments made during the quarterly period ending November 30,
2005 are not reflected as financing activity outflows in your statement of cash
flows for the quarterly period.
Company response:
Restricted Cash
The “restricted cash” on the Company’s balance sheet represented cash
received by the Company which was to be remitted to an escrow agent pursuant to
the Comprehensive Amendment Agreement No. 1 (the “CAA”). Per the CAA, the
first $8.0 million of proceeds from the sale of Export Water is to be paid
directly to the escrow agent by the purchaser and then distributed by the
escrow agent to the CAA parties in order of priority (see CAA discussion below).
In August 2005, the Company received fees from the sale of Export Water. Instead
of these funds being paid directly to the escrow agent, the payors made the
funds payable to Pure Cycle and sent directly to us. We deposited the checks
(entry was a Debit to Cash and a
Credit to Payable to Escrow Agent)
and then remitted the funds to the escrow agent (entry was a Debit to Payable to Escrow Agent and a Credit to Cash). Since the receipt of the cash and
the payment to the escrow agent occurred in separate accounting periods,
management determined that the cash, which was being held in the Company’s
operating account, should be disclosed separately due to the unique nature of
the cash receipt and required payment. The cash that was received by the
Company was legally “owned” by the Company at August 31, 2005 and was
related to a transaction completed in the ordinary course of business (Export
Water sales). Therefore, since the Company had legal ownership of the cash on
hand without restriction, and its receipt related to a transaction which occurs
normally in our line of business, management concluded that the cash received
was accurately reflected as cash flows from operations. Consistent with the
treatment of the receipt, the Company reflected the payment to the escrow agent
as cash used by operating activities, which is labeled with the caption “cash
released from restrictions” in the cash flow statement for the first quarter of
2006.
Not withstanding the description above, the Company believes the
caption “restricted cash” may not be an appropriate caption to describe
the nature of this balance. Thus, the Company proposes that, beginning with the
Form 10-Q for the three months ending February 28, 2006, the captions
on these transactions be changed to the following: For all balance sheets presented beginning with
the period noted above, the restricted cash caption will be renamed “Export
Water revenues to be remitted to escrow agent”; and for all statements of cash
flows presented beginning with the period noted above, the restricted cash and
cash released from restrictions captions will be renamed “Cash received on
behalf of escrow agent” and “Cash remitted to escrow agent,” respectively. The
Company believes this will more clearly indicate the nature of this balance and
the cash transactions.
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The Company believes the classification of the cash receipt and
subsequent payment were properly reflected as items related to the operations
of the Company in light of these circumstances and the guidance provided in SFAS
95.
Sky Ranch option payments
The Company received the Sky Ranch option payments from the developer
of Sky Ranch to reserve the right of Sky Ranch to purchase a portion of the
Company’s Export Water at a date in the future. Per SFAS 95, investing activities
include the acquisition and disposition of “property, plant, and equipment and
other productive assets, that is, assets held for or used in the production of
goods or services by the enterprise.”
Receipt of the option payments allows Sky Ranch the right to purchase
certain of the Company’s water assets, which are assets used in the production
of water services, in the future. Accordingly, the Company has accounted for
this transaction as an investing activity.
Notes to Financial Statements:
Note 3 – Water, Water Systems and Service
Agreements, page 36:
2. You indicate on page 40
that the State Engineer began a review of your Paradise Water Supply during
fiscal 2005 to determine if you are “diligently pursuing the development of the
water rights.” You further indicate that
an unfavorable outcome could result in cancellation of your conditional rights
which would have a material adverse effect on your financial statements. Please
tell us in detail the status and latest findings of the review. If the review
has been completed, tell us the outcome of the review and how the results have
been considered in assessing whether an impairment of the Paradise assets
exists.
Company response:
Pursuant to Colorado water law, holders of conditional water rights are
required to undergo a periodic review of the status of the development of the
water rights every six years. This is the fourth such review the Company’s
Paradise Water Supply has undergone. Each of the first three reviews resulted
in a satisfactory Finding of Reasonable Diligence, which means the Company’s
conditional water rights were upheld. At the filing dates for the Company’s Form 10-KSB
and its November 30, 2005 Form 10-Q, management was not aware of any
items in this latest review which indicate impairment of the Paradise Water
Supply.
Subsequent to the filing of the November 30, 2005 Form 10-Q,
the Company has been made aware of two objectors to its conditional rights. At
this time, the objectors have only requested additional information regarding
the Company’s rights, intended use, and development efforts over the past six
years. Neither the Company, nor the Company’s water rights attorney, is aware
of the reasons for the objections. The Company expects to learn more about the
basis for these objections at a status conference scheduled for May 2006.
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As of the date of this letter, there is no additional information that
indicates the Company’s impairment analysis conducted as of August 31, 2005
is not valid and applicable. Consistent with the Company’s policies and
procedures, immediately following the status conference in May 2006, the
Company will reassess the likelihood of an unfavorable outcome and determine
the need for an updated impairment analysis in accordance with GAAP. The
Company will include a discussion on the latest developments of the review in
its Form 10-Q for the three months ending February 28, 2006.
Note 4 – Participating Interests in Export
Water, page 40:
3. Regarding
participating interests in Export Water under the terms of the Comprehensive
Amendment Agreement No. 1 (the “CAA”) and the Water Commercialization
Agreement (the “WCA”), please provide us with the following information:
• Please tell us your basis in GAAP for ratably
allocating 35% of proceeds from the sale of export water and your fiscal 2004
rights acquisition to principal and the remaining 65% to the contingent
obligation. Please tell us why the allocation is pro rata as opposed to some
other method. Please specifically indicate whether the 35% and 65% allocation
percentages are specified in the CAA, the WCA, and/or other note holder
agreements, and;
• Please tell us how you determined only 30% of proceeds
received from the sale of export water during fiscal 2005 should be applied to
third party obligations and the remaining 70% should be retained.
In order to facilitate our review, please
provide us with the authoritative guidance you utilized and the related journal
entries you recorded when accounting for the following transactions
• The acquisition of rights to $8.2 million of CAA
obligations and the settlement agreement with LCH, Inc. Please ensure that
your response clearly indicates how you calculated the $217,000 and $909,000
extinguishment charges, and:
• The January 2005 transaction with your former
CEO, Thomas Clark.
In this regard, you may want to provide
us a background description of this transaction including the underlying
business purpose.
Company response:
Background
The purchase of the Company’s Rangeview Water Supply commenced with the
signing of the WCA, and was finalized when the WCA was amended and renamed the
CAA.
The third parties to the CAA have the right to receive a total of
$31,807,732 from the eventual sale of the Company’s Export Water. For financial
reporting purposes, this $31.8 million is comprised of two components:
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i. $11,090,630
– Cash proceeds received by the Company from the parties to the CAA which was
reflected as a liability on the Company’s financial statements.
ii. $20,717,102 –
Contingent return to the CAA holders if the Company is able to sell Export
Water.
Accounting Treatment
The $11,090,630 of cash proceeds received by the Company was recorded
as a Debit to Cash and a Credit
to Participating Interests in Export Water (a
liability account). In accordance with SFAS 5 Accounting
for Contingencies, the $20,717,102 contingent return is not
reflected as a liability because the ultimate repayment of the obligation is
based on the future sale of Export Water, the timing and dollar amount of which
was not known at the inception of the CAA. Therefore, the contingent obligation
is not reflected in the Company’s financial statements but is prominently
disclosed in the notes to the financial statements and the Management’s
Discussion and Analysis section.
Therefore, of the total amount potentially payable to the CAA holders,
34.87% (which is $11,090,630 divided by $31,807,732) relates to the recorded
liability balance, and 65.13% (which is $20,717,102 divided by $31,807,732)
relates to the contingent return to the CAA holders. Based on this accounting
treatment, future payments against the total obligation are also recorded in
this manner, such that 34.87% of the repayments to external CAA holders is
recorded as a reduction to the Participating Interests liability account, and
65.13% is charged against Export Water revenues recognized.
Consistent with Accounting Principles Board Opinion No. 26, (“APB
26”) paragraph 20, the difference between the reacquisition price of an
obligation and its carrying amount is recognized as a gain or loss in the
statement of operations. Since the extinguishment of each dollar of the total
obligation ($31.8 million) relates to a portion of each dollar originally
received ($11.1 million), the pro rata method was deemed to be the only logical
method to account for components of the obligation extinguished since it
represents both a portion of the original amount received and the contingent
return.
2004 Repurchases
In 2004, the Company negotiated the repurchase of certain CAA
obligations payable to two unrelated CAA holders at various priority levels. The
purchase of these obligations was done with both cash and stock (the stock was
valued at the closing price on the date of the transaction). Since $11.1
million of the CAA obligation is a recorded liability, the reacquisitions were
accounted for in accordance with APB 26, and the amounts paid in excess of the
recorded liability were reflected as a loss in the statement of operations at
the date of extinguishment. To account for this, the Company had to calculate
the % of the Participating Interest balance that the selling parties had rights
to, as follows:
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Total obligations reacquired:
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$
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8,199,333
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Total potential obligation:
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$
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31,807,732
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% of total obligations the Company reacquired:
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25.77
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% (rounded)
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Therefore, since the total potential obligation held by the selling
parties was 25.77%, the total amount of the Participating Interests liability
associated with these parties is also 25.77% and that is the percentage by
which the Participating Interests account was reduced.
The consideration paid in excess of the $2,858,920 reduction to the
Participating Interests was recorded as a net extinguishment loss during the
year ended August 31, 2004, which is illustrated as follows:
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Total consideration paid to selling CAA
holders:
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$
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3,076,122
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Reduction of the recorded liability:
(25.77% * $11,090,630) (rounded)
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$
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2,858,920
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Purchase price less recorded obligation
(loss):
($3,076,122 – $2,858,920)
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$
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217,202
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Retention of 70%:
One of the parties which held a participating interest reacquired by
the Company in 2004, held the rights to $5.6 million of the first $8.0 million
of proceeds from the sale of Export Water. Since the Company now owns this
interest, the Company retained the rights to this party’s CAA obligations in
the existing priority level. Following the acquisition, the Company owns rights
to a first priority $5.6 million. Therefore, of the first $8.0 million of
Export Water proceeds, the Company retains 70% and other parties receive 30%. The
additional $2.6 million acquired by the Company in 2004 is comprised of various
lower priority participation rights.
The LCH Agreement:
Subsequent to the signing of the CAA, the Company entered into the LCH
Agreement with LCH, Inc. (“LCH”). The LCH Agreement called for the Company
to remit $4.0 million of proceeds from the sale of Export Water to LCH after
repayment of the CAA. Consistent with the CAA, this $4.0 million contingent
payment was not recorded on the Company’s balance sheet because the timing and
ultimate likelihood of repayment was not probable.
Additionally, in the late 1980’s, the Company borrowed $950,000 from
LCH. The notes payable to LCH were recorded as liabilities and the Company
accrued interest on these notes until repayment.
In 2004, the Company and LCH agreed to a combined settlement of the
$4.0 million contingent obligation and repayment of the notes payable and
accrued interest. The consideration for this was paid by way of the Company’s
former CEO, T. Clark, surrendering 306,279 shares of Pure Cycle common stock to
LCH (which were pledged as collateral against the notes payable) for the
accrued interest and contingent obligation, and the Company repaying the
principal balance of the $950,000 notes.
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Since T. Clark surrendered the stock on behalf of the Company, the
Company recorded a payable to T. Clark, at August 31, 2004, for
$2,465,555, the value of the stock he surrendered (repaid in January 2005
as noted below). The offsetting debits for this entry were to extinguish the
accrued interest payable (approximately $1.56 million) and a loss on
extinguishment of contingent obligations account in the statement of operations
(approximately $909,000).
January 2005 Transaction with T. Clark
In January 2005, in settlement of the August 31, 2004 liability
of $2,465,555 described above, the Company paid T. Clark $50,555 in cash and
issued him 300,000 shares.
Note 11 – Related Party Transactions, page 45
4. We note that you
receive rent from your former CEO at no cost to the Company. Please tell us how
you account for the donated rent, including whether the fair value of the rent
is expensed and treated as contributed capital and the reasons for your
accounting. Please reference the applicable authoritative literature which
supports your accounting.
Company response:
In September 2004 the Company began paying its former CEO monthly
rental payments totaling $1,000 for approximately 2,000 square feet of office
space (previously reported as 1,800 square feet which will be updated in future
filings; the increase was due to the use of an additional office). Prior to September 2004,
the Company’s verbal agreement for occupying this space was to pay all the
operating expenses and utilities associated with the facilities due to the fact
that the Company’s (former) CEO had leased portions of the building to other
businesses. Therefore, although the Company was not specifically paying rent,
it was paying operating costs for the entire building which approximated what
the Company would have paid for rent and utilities for its portion of the use
of the building. Therefore, there was not deemed to be any material donated
rent to be accounted for. In September 2004, the Company hired a new
employee and began using an additional office, so it was deemed necessary to
start paying rent to the former CEO.
As a result, the occupancy cost for the space utilized by the Company
has been properly reflected in our statement of operations and there is no need
to reflect rent expense as a contribution of capital in accordance with Staff
Accounting Bulletin 79 Accounting for
Expenses or Liabilities Paid by Principal Stockholders.
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Form 10-Q for the Fiscal Quarter Ended November 30,
2005: Management’s Discussion and
Analysis of Financial Condition and Results of Operations: Notes to Financial Statements:
Note 8 – Subsequent Events, page 10:
5. We note that you
expect to record a gain on the early extinguishment of debt during the second
quarter of fiscal 2006. Please tell us whether you expect to record this gain
in income or as a capital transaction. See footnote 1 to paragraph 20 of APB 26.
If you expect to record the gain in income, please justify your proposed
treatment by citing authoritative accounting guidance that supports your
position.
Company response:
The Note that was extinguished in December 2005 was payable to the
estate of our former CEO. Due to the estate potentially being a related party,
pursuant to APB 26, the gain related to the early extinguishment of this debt
will be recorded as a capital contribution in the Company’s second quarter of
fiscal 2006.
Please do not hesitate to contact me regarding the above responses.
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Sincerely,
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/s/ Mark W. Harding
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Mark W. Harding
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President and Chief Financial Officer
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Cc:
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Wanda Abel, Davis Graham & Stubbs
LLP
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Gregory Anton, Anton Collins Mitchell LLP
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Ted Harms, KPMG, LLP
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