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Note 4 - Water Assets
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Aug. 31, 2012
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| Property, Plant and Equipment Disclosure [Text Block] |
NOTE
4: WATER
ASSETS
The
Company’s water and water systems consist of the
following approximate costs and accumulated depreciation and
depletion as of August 31:
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
Company’s 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:
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 Company’s 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 Company’s 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 1800’s 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 “Company’s Pledged
Shares”), (iii) the certificates representing the
Company’s Pledged Shares, (iv) the land associated
with the water represented by the Company’s Pledged
Shares, and (v) all rights to money or property which
the Company now has or hereafter acquires in respect of the
Company’s 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
Agreement’s 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&M’s
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.
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
Company’s land and water. The
Company terminated the Property Management Agreement with
HP A&M effective August 3, 2012. 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.
See Note 15 - Subsequent
Events - Sale of Assets Held for Sale.
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 Company’s
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:
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.
Services
on the Lowry Range
Pursuant
to the Rangeview Water Agreements, the Company designs,
finances, constructs, operates and maintains the
District’s water and wastewater systems to provide
service to the District’s 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 District’s wastewater tap fees and 90% of the
District’s 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 Company’s 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.
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 asset’s 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:
Table
Notes
The
assets acquired by the Company are being depreciated
consistent with the Company’s 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
Company’s 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 Company’s 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.
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.
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