TURV Two Rivers Water and Farming Company (CE)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2017 and September 30, 2016

(Unaudited)

NOTE 1 – ORGANIZATION AND BUSINESS

Unless the context requires otherwise, references in these notes to “Two Rivers,” the “Company,” “we,” “our,” “us” and similar terms are to Two Rivers Water & Farming Company and its subsidiaries.

Corporate Evolution

In 2014, we formed a new company, TR Capital Partners, LLC or TR Capital, which issued all its common units to Two Rivers Water & Farming Company, and our direct and indirect subsidiaries entered into a series of related transactions as the result of which assets and operations of those subsidiaries were transferred to TR Capital. As a result, TR Capital operates or controls all of the operations formerly conducted by those subsidiaries, and we classify TR Capital as Two Rivers Water & Farming Company for purposes of our financial statements. Two Rivers has divided its operations into our traditional lines of business of farming and water, which are operated by us, and our cannabis-focused business, which is operated by our subsidiary GrowCo, Inc., or GrowCo.

Overview

In 2009, we began acquiring and developing irrigated farmland and associated water rights and infrastructure. As of September 30, 2017, we owned 6,942 gross acres.

In May 2014, we formed GrowCo, which issued 20,000,000 shares of its common stock to Two Rivers. In August 2014, we announced that we were reserving 10,000,000 of the GrowCo shares for distribution to holders of our Common Stock as of four record dates (January 1, 2015; April 1, 2015; July 1, 2015 and October 1, 2015) after a registration statement covering GrowCo common shares has been filed and declared effective, which has not yet occurred. On each record date, we recorded a pending distribution of 2,500,000 GrowCo common shares on a pro rata basis to holders of Common Stock.

On January 20, 2015, GrowCo Partners 1, LLC, or GCP1, completed a $4.4 million financing for the first greenhouse project, which consists of a 90,000 square foot greenhouse and 15,000 square foot processing and warehouse facility on 40 acres of land. GCP1’s greenhouse was partially occupied in September with lease revenue beginning September 1, 2015. On April 14, 2016, we received notice from the Marijuana Enforcement Division of the Colorado Department of Revenue that the then current tenant, Suncanna, LLC (“Suncanna”), had received a suspension order. This suspension, in addition to non-payment of back due lease payments owed, caused Suncanna to be in violation of its lease with GCP1. Therefore, GCP1 began the eviction process against Suncanna. Due to the eviction process, during the nine months ended September 30, 2016, we wrote off $743,000 in Lease Revenues – Related Party, wrote off $587,000 in advances to Suncanna, and did not recognize any Lease Revenues – Related Party. During the nine months ended September 30, 2016, we recognized $25,000 in greenhouse lease revenue from a payment received from Suncanna in early April 2016. The total write off of $1.330 million was partially offset by a $350,000 reduction in the amount owed to the GCP1 preferred unit holders. On July 22, 2016 GCP1 received a Writ of Restitution from the Pueblo County Colorado District Court ordering Suncanna to vacate GCP1’s greenhouse by September 6, 2016. On August 31, 2016, a lawsuit was filed by Aaron Van Wingerden, owner of Suncanna, in Pueblo County Colorado District Court against GrowCo, GrowCo Business Development, LLC., GCP1, GrowCo Funding, LLC., TR Capital, Two Rivers and certain current and former employees, and associates. The Company believes that the suit has no merit and will have no material impact on the Company’s financial condition.

Our second greenhouse project will also consist of a 90,000 square foot greenhouse and 15,000 square foot processing and warehouse facility on an additional 40 acres of land. Upon completion, this project will be operated, as a landlord, by GrowCo Partners 2, LLC, or GCP 2. GCP 2’s greenhouse structure was ordered in 2016. Construction on this greenhouse began in early January 2016 with an expected completion in mid-2018.

During the third quarter of 2015, GrowCo completed a $4.0 million private placement of debt securities, with proceeds to be used to partially fund the second greenhouse and provide working capital.

In December 2015, GrowCo completed a $5.1 million private placement of equity interests of GCP Super Units, LLC, which will invest directly in various assets of GrowCo, with proceeds to be used to complete the construction of the first greenhouse, partially fund the second greenhouse and provide working capital. Our investment in GCP Super Units, LLC is reflected on our balance sheet as a non-controlling equity interest.

In the first quarter of 2016, GrowCo obtained $300,000 in subscriptions and associated payments in a promissory note offering of up to $1.5 million. In September 2016 GrowCo changed the offering to two series of promissory notes with aggregate principal amounts of up to either $6 million or $7 million, in each case together with warrants to purchase, at a price of $0.25 per share, 1.00 GrowCo common shares for each dollar invested in the related promissory notes. The initial four investors in the $6 million version of the notes received warrants to purchase one TURV share for each $1.00 invested at a price of $0.50 per share. Of the $300,000 principal amount of notes issued earlier, $200,000 were exchanged for the new note and warrant packages and $100,000 remain outstanding. As of March 7, 2017, GrowCo had raised $5.0 million, including the $200,000 of notes issued in exchange for the earlier offered notes, at which time the offering was closed. A $2M offering was subsequently initiated in March 2017 with substantially the same terms for the purposes of finishing the second greenhouse. As of November 7, 2017, $1,520,000 had been raised in this offering.

Water Redevelopment Company

We formed Water Redevelopment Company (“Water Redev”) in February 2017 for the purpose of separating our water assets from the rest of our business and to enable additional raising of capital for the purpose of investing in our water assets. Water Redevelopment Company is a subsidiary of Two Rivers and focuses on development and redevelopment of infrastructure for water management and delivery. Water is one of the most basic, core assets. Water Redev’s first area of focus is in the Huerfano-Cucharas river basin in southeastern Colorado.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of Two Rivers along with its farming, water and greenhouse operations. All significant inter-company balances and transactions have been eliminated in consolidation.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Item 210 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by U.S. GAAP for complete financial statements, although the Company believes that the disclosures made are adequate to make the information not misleading. In the opinion of management, all adjustments (consisting of only normal recurring accruals) considered necessary for a fair presentation for the periods presented have been included as required by Regulation S-X, Rule 10-01. Operating results for the nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ended December 31, 2017. It is suggested that these condensed consolidated financial statements be read in conjunction with the Company’s consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission on March 30, 2017.

In 2015, $152,000 of TR Capital Preferred Membership units were exchanged, pursuant to a pre-existing exchange agreement, for Two Rivers’ common shares and $60,000 of Two Rivers Farms F-2, Inc. (“F-2”) membership units converted into Two Rivers’ common shares. Two Rivers also formed three LLC special entities (TR Cap 20160630 Distribution, TR Cap 20160930 Distribution, and TR Cap 20161231) to provide in-kind distributions totaling $1,452,000 to holders of TR Capital Preferred Membership units.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ materially from those estimates.

Cash and Cash Equivalents

For purposes of reporting cash flows, Two Rivers considers cash and cash equivalents to include highly liquid investments with original maturities of 90 days or less. Those are readily convertible into cash and not subject to significant risk from fluctuations in interest rates. The recorded amounts for cash equivalents approximate fair value due to the short-term nature of these financial instruments.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed principally on the straight-line method over the estimated useful life of each type of asset, which ranges from three to twenty-seven and a half years. Maintenance and repairs are charged to expense as incurred; improvements and betterments are capitalized. Upon retirement or disposition, the related costs and accumulated depreciation are removed from the accounts, and any resulting gains or losses are credited or charged to income.

Below is a summary of premises and equipment:

Land

Land acquired for farming or water rights is recorded at cost. Expenditures for leveling the land are added to the cost of the land. Irrigation is not capitalized in the cost of Land ( Property and Equipment above). Land is not depreciated. However, once per year or whenever events and circumstances indicate the carrying value may not be recoverable, Management will assess the value of land held, and in their opinion, if the land has become impaired, Management will establish an allowance against the land.

Water Rights and Infrastructure

Management periodically evaluates the carrying value of its assets including water rights and infrastructure, and if the carrying value is in excess of fair market value, the Company will establish an impairment allowance. Currently, there is a $30,000 impairment reserve on the Company’s land and water shares. No amortization or depreciation is taken on the water rights.

Intangibles

Two Rivers recognizes the estimated fair value of water rights acquired by the Company’s purchase of stock in Huerfano Cucharas Irrigation Company (“HCIC”) and Orlando Reservoir No. 2 Company, LLC (“Orlando”). These intangible assets will not be amortized because they have an indefinite remaining useful life based on many factors and considerations, including the historical upward valuation of water rights within Colorado.

Revenue Recognition

Lease Revenues

The lease between GCP1, a subsidiary of TR Cap, and its related party lessee, Suncanna, was classified as an operating lease under ASC 840. Our lease with Johnny Cannaseed, our current tenant and a related party, is also classified as an operating lease. Payments under the lease agreements with Johnny Cannaseed are deferred for seven months after occupancy and these deferred rent payments will be repaid over a period of 24 months after payments begin.

On April 14, 2016, we received notice from the Marijuana Enforcement Division of the Colorado Department of Revenue that Suncanna had received a suspension order. This caused Suncanna to be in violation of its lease with GCP1. Therefore, GCP1 began an eviction process against Suncanna. Due to the eviction process, during the nine months ended September 30, 2016, we wrote off $743,000 in Lease Revenues – Related Party, wrote off $587,000 in advances to Suncanna, and did not recognize any Lease Revenues – Related Party. The total write off of $1.330 million is partially off-set by a $350,000 reduction in the amount owed to the GCP1 preferred unit holders.

On July 22, 2016 GCP1 received a court ordered Writ of Restitution from the Pueblo County Colorado District Court ordering Suncanna, the Company’s then tenant in its marijuana-focused greenhouse, to vacate the greenhouse by September 6, 2016. On September 6, 2016, the Company took possession of the greenhouse and began re-conditioning it for the new tenant which began growing operations in one half of the greenhouse in December 2016.

Member Assessments

Once per year the HCIC board estimates HCIC’s expenses, less anticipated water revenues, and establishes an annual assessment per ownership share. One-half of the member assessment is recorded in the first quarter of the calendar year and the other one-half of the member assessment is recorded in the third quarter of the calendar year. Assessments paid by Two Rivers Water Company to HCIC are eliminated in consolidation of the condensed consolidated financial statements. The assessments that are not eliminated are included in Other revenue.

HCIC does not reserve against any unpaid assessments. Assessments due, but unpaid, are secured by the member’s ownership of HCIC. The value of this ownership is significantly greater than the annual assessments.

Stock Based Compensation

Beginning January 1, 2006, the Company adopted the provisions of ASC 718 and accounts for stock-based compensation in accordance with ASC 718. Under the fair value recognition provisions of this standard, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which generally is the vesting period. The Company elected the modified-prospective method, under which prior periods are not revised for comparative purposes. The valuation provisions of ASC 718 apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified.

Net (Loss) per Share

Basic net (loss) per share is computed by dividing net income (loss) attributed to Two Rivers available to common shareholders for the period by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share is computed by dividing the net income for the period by the weighted average number of common and potential common shares outstanding during the period.

The dilutive effect of the outstanding 118,000 RSUs, 6,163,315 options, and 17,533,944 warrants at September 30, 2017, has not been included in the determination of diluted earnings per share since, under ASC 260 they would anti-dilutive.

Recently Issued Accounting Pronouncements

In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, “Leases”. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018 which includes interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The adoption of this ASU is expected to result in all operating leases being capitalized in the Company’s financial statements. Due to the GrowCo leases, management believes that this ASU will have an impact on its financials and is in the process of analyzing its impact.

In August 2015, the FASB issued ASU 2015-14 which updated (to defer the effective date by one year) previously issued ASU 2014-09, “ Revenue from Contracts with Customers ”, which amended revenue recognition guidance to clarify the principles for recognizing revenue from contracts with customers. The guidance requires an entity to recognize revenue to record the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. Expanded additional disclosures are required relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This accounting guidance is effective for the Company beginning in the first quarter of fiscal year 2018 using one of two prescribed retrospective methods. Early adoption is not permitted. At this point, due to the Company having no revenue contracts with customers, except for leasing agreements, Management believes that there will be no material impact on its financial statements.

Management does not believe that any other recently issued, but not effective, accounting standards if currently adopted would have a material effect on the accompanying consolidated financial statements.

NOTE 3 – INVESTMENTS AND LONG-LIVED ASSETS

Land

Upon purchasing land, the value is recorded at the purchase price or fair value, whichever is more appropriate. Costs incurred to prepare the land for the intended purpose are also capitalized in the recorded cost of the land. No amortization or depreciation is taken on land. However, the land is reviewed by management at least once per year to ascertain if a further analysis is necessary for any potential impairments.

Water Rights and Infrastructure

The Company has acquired both direct flow water rights and water storage rights. It has obtained water rights through the purchase of shares in a mutual ditch company, which it accomplished through its purchase of shares in HCIC, or through the purchase of an entity holding water rights, which it effected through its purchase of a membership interest of Orlando. The Company may also acquire water rights through outright purchase. In all cases, such rights are recognized under decrees of the Colorado water court and administered under the jurisdiction of the Office of the State Engineer.

Subsequent to purchase, management periodically evaluates the carrying value of its assets, and if the carrying value is in excess of fair market value, the Company will establish an impairment allowance. Currently, there are no impairments on the Company’s land and water shares. No amortization or depreciation is taken on the water rights.

GrowCo, GCP1, GCP2 Greenhouse Construction in Progress

Construction costs are capitalized, and not amortized or depreciated until the construction is completed in accordance with ASC 360 and 835. The Company has completed the construction of its first greenhouse (90,000 square feet plus a 1,000 square feet boiler/mechanical room) and related warehouse facilities (15,000 square feet).

Construction costs are as follows:

The Company estimates an additional expenditure of $3.5 million is required for the completion of the GCP2 greenhouse and warehouse.

The Company elected to adopt early FASB ASU 2016-03, whereby debt issuance costs are recorded as a deduction from the carrying value of liability, and not recorded as an asset. The debt issuance costs are amortized using the effective interest method. As of September 30, 2017 and December 31, 2016, the total debt discount was $645,000 and $530,000, respectively.

HCIC Carry Back Loan

For the nine months ended September 30, 2017, the Company is in technical default on $6,382,000 of the HCIC carry back notes due to non-payment of principle. Consequently, the entire amount of the notes have been classified as current. Management has been in contact with the various holders about an extension to July 1, 2019. As of September 30, 2017, management has received written commitments to extend $5,653,000 of these notes to July 1, 2019.

GrowCo $4M Notes

The $4.0 million of GrowCo notes are classified as current liabilities. The notes are due April 1, 2020 however, the holders have the right to request full payment of the principal balance with a 60-day notice.

NOTE 5 – Information on Business Segments

We organize our business segments based on the nature of the products and services offered. We focus on the Water and Greenhouse business with Two Rivers Water & Farming Company as the Parent company. Therefore, we report our segments by these lines of businesses: Greenhouse and Water. Greenhouse contains our leasing of state of the art greenhouses to cannabis growers. Water contains our Water Business (HCIC and Orlando). Our Parent category is not a separate reportable operating segment. Segment allocations may differ from those on the face of the income statement. The Farming Business has been discontinued and therefore the operating losses and assets have been summarized.

In the following tables of financial data, the total of the operating results of these business segments is reconciled, as appropriate, to the corresponding consolidated amount. There are some corporate expenses that were not allocated to the business segments, and these expenses are contained in the “Total Operating Expenses” under Parent.

Operating results for each of the segments of the Company are as follows (in thousands):

NOTE 6 – LEGAL PROCEEDINGS

In 2016, the Suncanna lease arrangement was the subject of administrative and judicial proceedings:

Management believes that this case is without merit and has filed a cross-complaint to recover amounts owed by Suncanna under the Suncanna lease agreement.

The Company, the State of Colorado (Office of the State Engineer and the local Division Engineer), and neighboring water rights holders have been involved in litigation concerning water rights and claims by the State concerning an existing dam in Huerfano County, Colorado, and a demand by the State to breach the dam structure. ( Two Rivers Water and Farming Co. vs. Welton Land and Water Co ., (Pueblo Water Court)). As part of the litigation, Two Rivers has sought certain water rights demands by the neighboring water rights holders deemed wasteful. In the quarter ending June 30, 2016, the Company entered into a stipulation agreement with the State, settling the State’s claims, whereby the Company agreed to take the existing dam structure down to the sediment level. This is anticipated to begin in 2018. The Company also intends to work with the Colorado State Engineer to construct a new dam close to the prior dam structure, pending financing. The remainder of the litigation between the Company and the neighboring water rights holders awaits a trial setting.

On August 8, 2017, a summons was issued in the Arapahoe County District Court on behalf of former board members Dennis Channer, Rockey Wells and John Stroh demanding the Company pay $139,000 in attorneys’ fees owed to Ryley Carlock & Applewhite for services rendered to the former board members at their behest while members of the board. At present, there are ongoing motions filed by both parties that have not been ruled upon by the cour t. The $139,000 is included in our accounts payable on the balance sheet.

On October 18, 2017, at the Company filed a lawsuit against former employees of the its DF P farming operation for alleged theft. At present, no response has been filed.

NOTE 7 – IMMATERIAL ERROR CORRECTIONS

This Quarterly Report on Form 10-Q of the Company for the nine months ended September 30, 2017, includes the restatement of the Company’s previously filed consolidated balance sheets for the fiscal year ended December 31, 2016.

The Company’s management has concluded that in the Assets section of the Balance Sheet, Long Term Assets for Land and Water, and under Liabilities the Liabilities for Discontinued Operations and Notes Payable, net of current portion were misstated and that for comparative purposes in 2017 filings these figures should be re-stated but that the adjustments are not material modifications. Accordingly, the Company has determined that prior financial statements should be corrected, even though such revisions are immaterial with respect to the prior year financial statements. Furthermore, the Company has determined that correcting prior year financial statements for immaterial changes would not require previously filed reports to be amended.

Under Long Term Assets, while the Assets of Discontinued Operations Held for Sale as well as Total Assets were stated correctly, due to a mis-classification of which assets were being held for sale, Land was understated by $952,000 and Water was overstated by the same amount. Discontinued Operations - Notes Payable was overstated by $798,000, while Notes Payable, net of current portion was understated by the same amount due to a loan that was improperly classified as a Liability of Discontinued Operations Held for Sale. While total assets of discontinued operations held for sale was correctly stated, under Long Term Assets, Land was understated by $952,000 and Water Assets was overstated by the same amount. Neither Net Income or Shareholders Equity were affected by these mis-statements. The effect of these restatements on the Company’s 2016 full year balance sheet as reported on the Form 10-K reports, are as follows:

NOTE 8 – DISCONTINUED OPERATIONS

During the fourth quarter of 2016, we decided to discontinue operations of our Dionisio Farms and Produce (DFP) subsidiary. We decided to sell all assets associated with this business due to the sustained losses incurred.

The assets and liabilities of the discontinued operations are presented separately under the captions “Assets of discontinued operations held for sale” and Liabilities of discontinued operations held for sale,” respectively, in the accompanying Consolidated Balance Sheets at September 30, 2017 and December 31, 2016 consist of the following:

The income from discontinued operations presented in the statements of operations consist of the following for the nine months ended September 30, 2017 and September 30, 2016:

On March 3, 2017, the Company’s land and water assets associated with farming operations were auctioned off. Gross proceeds from the auction were $1,740,000 with net proceeds of $1,611,000. Proceeds were used to pay off secured debt first with the residual proceeds used to pay unsecured debt.

NOTE 9 – GOING CONCERN

The consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company has not generated significant revenues and has incurred net losses (including significant non-cash expenses) of approximately $10,700,000 and $6,157,000 during the years ended December 31, 2016 and 2015, respectively. At September 30, 2017, the Company has a working capital deficit and a stockholders’ deficit of approximately $19,370,000 and $87,393,000, respectively. The HCIC seller carry back debt is in technical default.

These factors raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability or classification of assets or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern. These consolidated financial statements do not include any adjustments that might arise for this uncertainty. The following paragraphs describe management’s plans to mitigate.

The $4M GrowCo Note is classified as current due to the holders’ right to call the note upon 60-days notice. The HCIC debt of $6.4 million is secured by water and land assets that are valued at approximately $26 million. Should the holders of the HCIC debt demand payment, management believes the value of these assets makes the debt re-financeable.

Since December 31, 2016 to November 7, 2017 the Company has collected $1,820,000 under its GrowCo Exchange Note offerings. On May 2, 2017, the company received the proceeds from an unsecured bridge loan totaling $279,000. Beginning the third quarter of 2017, GrowCo began receiving rent payments on the first greenhouse. The first use of these funds will be to pay GCP1 accounts payable. On August 4, 2017, the Company received the proceeds from a secured loan totaling $275,000.

Additionally, we have substantially reduced by general and administrative and cash required for our operations as we have sold our irrigating farming business and reduced staff.

Management Plans

The Company is implementing a new strategy focusing on its water assets along with associated capital raises. On March 13, 2017, we raised $257,000 as the first round of preferred funding for our new Water Redevelopment Company. Another $200,000 was raised in a second round of preferred investment in Water Redevelopment. On August 4, 2017, the Company raised $275,000 in secured debt from CEO Wayne Harding and two other private investors. On September 14, 2017, the Company signed definitive documents with a private investor whereby up to $5 million in capital can be raised from an Equity Purchase Agreement (EPA) whereby the company will sell up to $250,000 per tranche of registered shares into the public market for a total of $5 million over three years. On October 4, 2017, the Company filed Form S1 with the Securities and Exchange Commission (SEC) for the establishment of the EPA. On August 17 ^th , 2017, the Company signed a term sheet with an investment banking firm regarding the issuance of a private placement for our Water Redev subsidiary which is anticipated to raise $5,000,000 in the fourth quarter of 2017. In 2018, the Company plans to follow that offering with a Regulation A Plus offering which combined is expected to raise an additional $5,000,000.

We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results and satisfying our estimated liquidity needs 12 months from the issuance of the financial statements. However, we cannot predict, with certainty, the outcome of our actions to generate liquidity, including the availability of additional financing, or whether such actions would generate the expected liquidity as currently planned.

NOTE 10 – RELATED PARTY

During the Nine Months Ended September 30, 2017 the following related party transactions occurred: