Quarterly report pursuant to Section 13 or 15(d)

REVENUE RECOGNITION AND REIMBURSABLE COSTS

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REVENUE RECOGNITION AND REIMBURSABLE COSTS
 6 Months Ended
Feb. 28, 2021
REVENUE RECOGNITION AND REIMBURSABLE COSTS [Abstract]  
REVENUE RECOGNITION AND REIMBURSABLE COSTS
NOTE 3 – REVENUE RECOGNITION AND REIMBURSABLE COSTS

The Company disaggregates revenue by major product line as reported on the condensed consolidated statement of operations and comprehensive income, which the Company believes best depicts the nature, timing, and uncertainty of the Company’s revenue and cash flows.

The Company primarily generates revenues through two lines of business, its water and wastewater resource development business and through the sale of finished lots in its land development business, both of which are described below.

Water and Wastewater Resource Development Segment

The Company’s water and wastewater resource development segment provides wholesale municipal water and wastewater services, through the Rangeview Metropolitan District (the “Rangeview District”) and Elbert and Highway 86 Metropolitan District (the “Elbert 86 District”) to end use customers for fees, described below. The Rangeview District services Sky Ranch and other customers on the Lowry Range. The Elbert 86 District services Wild Pointe, a subdivision in Elizabeth, Colorado.

Monthly water usage and wastewater treatment fees – The Company provides water to customers, collects wastewater from those customers and treats that wastewater which is reused for irrigation purposes. For these services, the Company charges customers monthly potable and reuse water fees that are comprised of a base charge and a usage charge based on actual amounts of water delivered to the customer using a tiered structure that results in higher fees for higher usage. Wastewater treatment services incur flat monthly fees. The Company recognizes these revenues at a point in time upon delivering water to the end use customers.

Water and wastewater tap fees – A tap constitutes a right to connect a residential or commercial building or property to the Company’s water and wastewater systems. Once granted, the customer may make a physical tap into the service line(s) to connect its property to the Company’s systems to obtain water and/or wastewater service. The right stays with the property. The Company has no obligation to physically connect the property to the lines, which is typically done by the home builder or commercial owner. Once connected to the water and/or wastewater systems, the customer has live service to receive metered water deliveries from the Company’s system and send wastewater to the Company. Thus, the customer has full control of the connection right as it can obtain all the benefits from this right. As such, tap fees are deemed separate and distinct performance obligations that are recognized as revenue at a point in time.

Land Development Segment

Sale of finished lots – The Company sells lots at its Master Planned Community, Sky Ranch, pursuant to distinct agreements with each home builder. These agreements follow one of two formats. One format is the sale of a finished lot, whereby the home builder pays for a ready-to-build finished lot and the sales price is paid in a lump-sum upon completion of the finished lot that is permit ready. The Company recognizes revenues at the point in time of the closing of the sale of a finished lot in which control transfers to the builder as the transaction cycle is complete and the Company has no further obligations for the lot.

The second format is the sale of a finished lot pursuant to a lot development agreement with builders, whereby the Company receives payments in stages that include: (i) payment upon the delivery of a platted lot (which requires the Company to deliver deeded title to individual lots), (ii) a second payment upon the completion of certain infrastructure milestones, and (iii) final payment upon the delivery of the finished lot. Ownership and control of the platted lot passes to the builder once the Company closes the sale of the platted lots. Because the builder takes control and legal ownership of the lot at the first closing, and subsequent improvements made by the Company improve the builder’s lot as construction progresses, the Company accounts for revenue over time with progress measured based upon costs incurred to date compared to total expected costs. Any revenue in excess of amounts entitled to be billed is reflected on the balance sheet as a contract asset, and amounts received in excess of revenue recognized are recorded as deferred revenue.

Reimbursable public improvement costs – The Sky Ranch Community Authority Board (the “Sky Ranch CAB”) is obligated to construct certain public improvements at Sky Ranch. Public improvements are items that are not associated with one lot or one home, but can be used by the public, whether living in Sky Ranch or not. Public improvements include items such as roads, curbs, sidewalks, landscaping, and parks but also includes items such as water distribution systems, sewer collection systems, storm water systems, and drainage improvements. These public improvements are constructed pursuant to design standards specified by local governmental jurisdictions including the Sky Ranch Metropolitan District Nos. 1, 3, 4 and 5 (collectively, the “Sky Ranch Districts”), the Sky Ranch CAB and Arapahoe County, and, after inspection and acceptance, are turned over to the applicable governmental entity to operate and maintain.

Pursuant to agreements between the Company and the Sky Ranch CAB (see Note 8 – Related Party Transactions), the Company is obligated to provide funding to the Sky Ranch CAB related to the construction of these public improvements. Because public improvements are utilized by more than just a single home, the costs are typically reimbursed through property tax assessments. During the initial development filing at Sky Ranch, the Sky Ranch CAB expended $29.4 million to build these public improvements, including construction support activities, for which the Company provided the funding. Pursuant to the funding agreement between the Company and the Sky Ranch CAB, the expended $29.4 million along with the accrued interest income and project management fees are payable to the Company since the Company provided the initial funding. In November 2019, the Sky Ranch CAB issued $13.2 million of bonds to recover a portion of the total $32.4 million expected to be received related to the public improvements constructed for the initial filing at Sky Ranch. Upon the issuance of the bonds, the Company received $10.5 million as partial reimbursement for advances the Company made to the Sky Ranch CAB to fund the construction of these public improvements. Additionally, the Sky Ranch CAB paid the Company $0.4 million as a result of unencumbered funds from a 2020 budget surplus. With the first filing nearing completion, the Sky Ranch CAB has established a tax base with revenue generation from tax receipts. Historically, the recognition of these costs was contingent upon the Sky Ranch CAB issuing bonds but as the tax base and subsequent revenues have grown, the Sky Ranch CAB has more funds and ability with which to repay the Company. The Company has determined the reimbursement of public improvement costs, for which the Company has an enforceable right to payment for costs incurred, are probable of collection due to the established and growing tax base and future bonds, and as such, has recognized the reimbursable public improvements costs incurred to date at Sky Ranch. The Company recognized a Note receivable – related party in the amount of $21.5 million which bears an interest rate of 6% per annum and recognized $1.6 million as Project management revenue, $1.0 million as Interest income, and $18.9 million as Other income during the three and six months ended February 28, 2021. This receivable will be reviewed each reporting period for impairment.

For the second phase and beyond, the Company will continue to assess the collectability of reimbursable public improvement expenditures. The Sky Ranch CAB has an obligation to repay the Company but the ability of the Sky Ranch CAB to repay the Company before the contractual termination of December 31, 2060 is dependent upon the establishment of a tax base or other fee generating activities sufficient to recover reimbursable costs incurred. Public improvements are considered contract fulfillment costs and will be recognized in a separate Land development inventories account as funds are expended. Once collectability is deemed to be reasonably assured, the public reimbursable expenditures will be reclassified out of Land development inventories and into Notes receivable - related party. The Company will evaluate any balance in Notes receivable - related party for impairment each reporting period and an impairment charge will be incurred for any amounts deemed uncollectible. The reimbursable public improvement costs bear an interest rate of 6% per annum.

Project management services – Pursuant to two Service Agreements for Project Management Services (the “Project Management Agreements”) with the Sky Ranch CAB, the Company acts as the project manager and provides the services required to deliver the Sky Ranch CAB-eligible public improvements (see discussion of reimbursable public improvements above), including but not limited to Sky Ranch CAB compliance; planning design and approvals; project administration; contractor agreements; and construction management and administration. The Company is responsible for all expenses it incurs in the performance of the Project Management Agreements and is not entitled to any reimbursement or compensation except as set forth in the Project Management Agreements, unless otherwise approved in advance by the Sky Ranch CAB in writing. The Company receives a project management fee of five percent (5%) of actual construction costs of Sky Ranch CAB-eligible public improvements. The project management fee is based only on the actual costs of the improvements; thus, items such as fees, permits, review fees, consultant or other soft costs, and land acquisition or any other costs that are not directly related to the cost of construction of Sky Ranch CAB-eligible public improvements are not included in the calculation of the project management fee. Soft costs and other costs incurred by the Company that are not directly related to the construction of Sky Ranch CAB-eligible public improvements are included in Land development inventories and accounted for in the same manner as construction support activities as described below. Per the Project Management Agreements, no payment is required by the Sky Ranch CAB with respect to project management fees unless and until the Sky Ranch CAB and/or the Sky Ranch Districts have funds or issue municipal bonds in an amount sufficient to reimburse the Company for all or a portion of advances provided, or expenses incurred for construction of public improvements that qualify as reimbursable expenses. Historically, the recognition of project management revenue was deferred as the payment was deemed contingent on a sufficient tax base and or the issuance of municipal bonds for collectability to be reasonably assured. With the first phase nearing completion, the Sky Ranch CAB has an established tax base, with which Management believes provides reasonable assurance the Sky Ranch CAB can repay the Company for qualifying expenditures. The Company has determined that payment from the Sky Ranch CAB is probable and as such, the Company has recognized project management revenue for all reimbursable construction costs incurred to date of $1.6 million and will recognize future project management revenue each period based on actual construction costs related to the public improvements when collectability is deemed to be reasonably assured. The $1.6 million was recognized as a Notes receivable - related party. Future amounts will be added to Land development inventories or Notes receivable – related party, dependent upon whether collectability is deemed to be reasonably assured.

Construction support activities – The Company performs certain construction activities at Sky Ranch. The activities performed include construction and maintenance of the grading erosion and sediment control best management practices and other construction-related services. These activities are invoiced to the Sky Ranch CAB upon completion and will be recognized as Land development inventories or Notes receivable – related party, dependent upon whether collectability is deemed to be reasonably assured.

The following table summarizes the amounts the Company paid, what was repaid by the Sky Ranch CAB and amounts still owed to the Company by the Sky Ranch CAB:

   
As of February 28, 2021
  
   
Costs incurred to date
    
Payments repaid by
Sky Ranch CAB
    
Amounts payable to Pure Cycle by the Sky Ranch CAB
  
   
(In thousands)
  
Phase 1
                  
Public improvements
  
$
28,565
    
$
10,505
    
$
18,060
  
Accrued interest
    
1,433
      
400
      
1,033
  
Project management services
    
1,539
      
—
      
1,539
  
Construction support activities
    
834
      
—
      
834
  
Phase 1 reimbursable costs
  
$
32,371
    
$
10,905
    
$
21,466
  
                         
Phase 2
                        
Public improvements
  
$
315
    
$
—
    
$
315
  
Phase 2 reimbursable costs
  
$
315
    
$
—
    
$
315
  

Public improvements and construction support activities accrue interest of 6% per annum, which was not previously recognized as the interest payments were deemed contingent on a sufficient tax base and or the issuance of municipal bonds for collectability to be reasonably assured. This interest was recognized as a portion of the recognition of $21.5 million of reimbursable costs as collection is probable. Project management fees do not accrue interest. The Company expects to incur an additional $0.9 million through the end of the calendar year 2021, with an estimated $0.6 million for construction costs related to public improvements to complete the first development phase of the initial 506 lots and expects that amount to be reimbursed to the Company along with the amounts noted in the table above as the Sky Ranch CAB issues bonds, collects fees, or property tax assessments.

Deferred Revenue

As noted above, the Company recognizes certain lot sales over time as construction activities progress for lots sold pursuant to lot development agreements and not when payment is received. Based on this, the Company will frequently receive milestone payments before revenue can be recognized (i.e. prior to the Company completing cumulative progress which faithfully represents the transfer of goods and services to the customer) which results in the Company recording deferred revenue. The Company recognizes this revenue into income as construction activities progress measured based on costs incurred to total expected costs of the project which management believes is a faithful representation of the transfer of goods and services to the customer.

In fiscal 2018 and 2019, the Company received up-front payments for certain oil and gas leases which permitted an oil and gas operator priority rights to water deliveries over a specified period of time. As the Company was not required to perform on its delivery obligations when the payments were received, recognition of revenue was deferred and is being recognized on a straight-line basis over the agreement term. The 2018 payment has been fully recognized as of the first quarter of fiscal 2021.

The Company also received an up-front payment from an oil and gas industrial customer to reserve priority water for their operations, which the Company is recognizing this revenue based either on actual usage each reporting period or based on amounts which have expired pursuant to the agreement. The customer had up to one year from the invoice date to use such water. The customer did not use the water in the contract period which ended in January 2021, and such water was forfeited by the customer resulting in the Company recognizing revenue of $0.4 million.

Deferred revenue by segment is as follows:

   
February 28, 2021
    
August 31, 2020
  
   
(In thousands)
  
Land development segment
  
$
995
    
$
1,636
  
Water and wastewater resource development segment
    
260
      
1,965
  
Balance, end of period
  
$
1,255
    
$
3,601
  

Changes in deferred revenue were as follows:

   
February 28, 2021
  
   
(In thousands)
  
Balance, August 31, 2020
  
$
3,601
  
Deferral of revenue
    
2,231
  
Recognition of unearned revenue
    
(4,577
)
Balance, February 28, 2021
  
$
1,255
  

Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. During November 2020, the Company received the final payment of $2.2 million, including $1.6 million for outstanding open contracts in the first development filing at Sky Ranch, which represents the final lot sales in the first filing at Sky Ranch, and $0.6 million for neighborhood amenities.