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Note 7 - Long-Term Debt and Operating Lease
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Aug. 31, 2012
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| Debt and Capital Leases Disclosures [Text Block] |
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
Company’s Tap Participation Fee liability represents
the estimated discounted fair value of the Company’s
obligation to pay HP A&M twenty percent (20%) of the
Company’s 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
Company’s targeted service area over an estimated
development period. Projecting new home
development in the Company’s 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 Company’s service area and
actual future tap fees inevitably will vary significantly
from the Company’s estimates, which could have a
material impact on the Company’s financial statements
as well as its results of operations. An important component
in the Company’s 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 Company’s
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.
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&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
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 and reduced the
2012 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 Company’s 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 Company’s
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
Company’s 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 there from (the
“Pledged Shares”) which were pledged by HP
A&M pursuant to a pledge agreement (the
“Seller’s 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.
Future
Maturities
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.
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