NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
November 30, 2019
NOTE 1 – PRESENTATION OF INTERIM INFORMATION
The November 30, 2019 consolidated balance sheet, the consolidated statements of operations and comprehensive income for the three months ended November 30, 2019 and 2018, the consolidated statements of shareholders’
equity for the three months ended November 30, 2019 and 2018, and the consolidated statements of cash flows for the three months ended November 30, 2019 and 2018 have been prepared by Pure Cycle Corporation (the “Company”) and have not been audited.
The unaudited consolidated financial statements include all adjustments that are, in the opinion of management, necessary to present fairly the financial position, results of operations and cash flows at November 30, 2019, and for all periods
presented.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed
or omitted. It is suggested that these consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2019 (the “2019
Annual Report”) filed with the Securities and Exchange Commission (the “SEC”) on November 12, 2019. The results of operations for interim periods presented are not necessarily indicative of the operating results for the full fiscal year. The August
31, 2019 balance sheet was derived from the Company’s audited consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates are used to account for
certain items such as revenue recognition, reimbursable costs and expenses, costs of revenue for lot sales, share-based compensation, deferred tax asset valuation, and the recoverability of long lived assets. Actual results could differ from those
estimates.
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid debt instruments with original maturities of three months or less. The Company’s cash equivalents are comprised entirely of money market funds maintained at a
reputable financial institution and U.S. Treasury debt securities. At various times during the three months ended November 30, 2019, the Company’s main operating account exceeded federally insured limits. To date, the Company has not suffered a loss
due to such excess balance.
Land Development Inventories
Inventories primarily include land held for development and sale. Inventories are stated at cost. Capitalized lot development costs at Sky Ranch are costs incurred to construct lots at Sky Ranch that meet the Company’s
capitalization criteria for improvements to a lot and are capitalized as incurred. The Company capitalizes certain legal, engineering, design, permitting, land acquisition, and construction costs related to the development of lots at Sky Ranch. The
Company accumulates land development costs and allocates costs to each lot to determine the cost basis for each lot sale. The Company records all land cost of sales over time based on inputs of costs incurred to date to total estimated costs to
complete.
In accordance with Accounting Standards Codification (“ASC”) Topic 360, Property, Plant and Equipment (“ASC 360”), the Company values land held for sale at the lower of the
carrying value or net realizable value. In determining net realizable value, the Company primarily relies upon the most recent negotiated price that is a Level 2 input (see Note 3 – Fair Value Measurements for
definitions of fair value inputs). If a negotiated price is not available, the Company will consider several factors, including, but not limited to, current market conditions, recent comparable sales transactions and market analysis studies. If the
net realizable value is lower than the current carrying value, the land is written down to its estimated net realizable value.
Contract Asset
Contract receivables are recorded at the invoiced amount and do not bear interest. Credit is extended based on the evaluation of a customer’s financial condition and collateral is not
required. Contract asset is revenue which has been earned but not yet invoiced. The contract assets are transferred to the receivables when the Company has the right to bill such amounts and they are invoiced.
Investments
Management determines the appropriate classification of its investments in U.S. Treasury debt securities at the time of purchase and re-evaluates such determinations each reporting period.
Securities that the Company does not have the positive intent or ability to hold to maturity, including U.S. Treasury debt securities, are reported at their fair value. Changes in value of such securities are recorded
as a component of Accumulated other comprehensive income (loss). The cost of securities sold is based on the specific identification method. As of November 30, 2019, the Company’s U.S. Treasury debt
securities had no maturity dates greater than 90 days and were classified as cash and cash equivalents in the Balance Sheet.
Concentration of Credit Risk and Fair Value
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and investments. From time to time, the Company places its cash in money market
instruments, certificates of deposit and U.S. Treasury obligations. To date, the Company has not experienced significant losses on any of these investments.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value.
Cash and Cash Equivalents – The Company’s cash and cash equivalents are reported using the values as reported by the financial institution where the funds are
held. These securities primarily include balances in the Company’s operating and savings accounts. The carrying amount of cash and cash equivalents approximate fair value.
Trade Accounts Receivable – The Company records accounts receivable net of allowances for uncollectible accounts and the carrying value approximate fair value
due to the short-term nature of the receivables.
Investments – The carrying amounts of investments are recorded at fair value. Investments are described further in Note 2 – Fair Value Measurements.
Accounts Payable – The carrying amounts of accounts payable approximate fair value due to the relatively short period to maturity for these instruments.
Long-Term Financial Liabilities – The Comprehensive Amendment Agreement No. 1 (the “CAA”) is comprised of a recorded
balance sheet and an off-balance sheet or “contingent” obligation associated with the Company’s acquisition of its “Rangeview Water Supply” (as defined in Note 4 – Water and Land Assets in Part II, Item 8 of
the 2019 Annual Report). The amount payable is a fixed amount but is repayable only upon the sale of “Export Water” (as defined in Note 4 – Water and Land Assets in Part II, Item 8 of the 2019 Annual Report).
Because of the uncertainty of the sale of Export Water, the Company has determined that the contingent portion of the CAA does not have a determinable fair value. The CAA is described further in Note 4 – Long-Term
Obligations and Operating Lease – Participating Interests in Export Water Supply.
Notes Receivable – Related Parties – The carrying amounts of the Notes receivable
– related parties (including with the Rangeview Metropolitan District (the “Rangeview District”) and the Sky Ranch Community Authority Board (the “CAB”)) approximate their fair value because the interest rates on the notes approximate
market rates.
Off-Balance Sheet Instruments – The Company’s off-balance sheet instruments consist entirely of the contingent portion of the CAA. Because repayment of this
portion of the CAA is contingent on the sale of Export Water, which is not reasonably estimable, the Company has determined that the contingent portion of the CAA does not have a determinable fair value. See further discussion in Note 4 – Long-Term Obligations and Operating Lease – Participating Interests in Export Water Supply.
Revenue Recognition
The Company disaggregates revenue by major product line as reported on the consolidated statements of operations and comprehensive income.
Wholesale Water and Wastewater Fees
The Company generates revenues through two lines of business. Revenues are derived through its wholesale water and wastewater business and through the sale of developed land primarily for residential lots, both of
which businesses are described below.
The Company generates revenues through its wholesale water and wastewater business predominantly from three sources: (i) monthly wholesale water usage fees and wastewater service fees, (ii) one-time water and wastewater tap fees and
construction fees/Special Facility funding, and (iii) consulting fees. Because these items are separately delivered and distinct, the Company accounts for each of the items separately, as described below.
In addition to providing domestic water, the Company provides raw water for hydraulic fracturing to industrial customers in the oil and gas industry that are located in and adjacent to its service
areas. Frack water revenues are recognized at a point in time upon delivering water to a customer.
The Company delivered 748,000 and 114.5 million gallons of water to customers during the three months ended November 30, 2019 and 2018, respectively, of which 6% and 86% was used for oil and gas
exploration.
The Company recognizes wastewater treatment revenues monthly based on a flat monthly fee and actual usage charges. The monthly wastewater treatment fees are shown net of amounts retained by the
Rangeview District. Costs of delivering water and providing wastewater service to customers are recognized as incurred.
The Company recognizes construction fees, including fees received to construct “Special Facilities,” over time as the construction is completed because the customer is generally able to use the
property improvement to enhance the value of other assets during the construction period. Special Facilities are facilities that enable water to be delivered to a single customer and are not otherwise classified as a typical wholesale facility or
retail facility. Temporary infrastructure required prior to construction of permanent water and wastewater systems or transmission pipelines to transfer water from one location to another are examples of Special Facilities. Management has determined
that Special Facilities are separate and distinct performance obligations because these projects are contracted to construct a specific water and wastewater system or transmission pipeline and typically do not include multiple performance obligations
in a contract with a customer. No Special Facilities revenue has been recognized during the three months ended November 30, 2019 or 2018.
Land Development Activities
The Company generates revenues through the sale of finished lots at its Sky Ranch development primarily from several sources of revenues: (i) the sale of finished lots, (ii) construction support activities, (iii) project management services, and
(iv) reimbursable expenses incurred to develop certain public improvements.
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(i)
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Land development through the sale of finished lots – The Company acquired approximately 930 acres of land zoned as a Master Planned Community known as Sky Ranch along the I-70 corridor east of Denver, Colorado. The Company has
entered into purchase and sale agreements with three separate home builders pursuant to which the Company agreed to sell, and each builder agreed to purchase, residential lots at the property. The Company began construction of lots in
March 2018 and segments its reporting of the activity relating to the costs and revenues from the construction and sale of lots at Sky Ranch.
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The Company sells lots at Sky Ranch pursuant to distinct agreements with each builder. These agreements follow one of two formats. One format is the sale of a finished lot, whereby the purchaser pays
for a ready-to-build finished lot and payment is a lump-sum payment upon completion of the finished lot that is permit ready. The Company will recognize 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 will be complete and the Company will have no further obligations for the lot. During the three months ended November 30, 2019, the Company received payment and recognized revenue of $1,430,600 from
one home builder in exchange for the delivery of 21 finished lots. No revenue was recognized for lot sales at a point in time for the three months ended November 30, 2018.
The Company’s second format is the sale of finished lots pursuant to a development agreement with builders, whereby the Company receives payments in stages that include (i) payment upon the delivery
of platted lots (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 lots pass to the builders once the Company closes the sale of the platted lots. Because the builder (i.e., the customer) takes control 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. As of November 30, 2019, the Company had received cumulative payments of approximately $18 million under development
agreements relating to 293 lots from two home builders, of which approximately $17.0 million of revenue was recognized over time based on the costs incurred to date compared to total expected costs for full completion of the 293 lots. For the three
months ended November 30, 2019 and 2018, the Company recognized $7,111,000 and $1,381,200 of lot sales over time, respectively. The Company had deferred revenue related to lot sales of $1,143,800 as of November 30, 2019. The Company had a contract asset of $1,020,100 as of November 30, 2018. The Company does not have any material significant payment terms as all payments are expected to be received within 12
months after the delivery of each platted lot. The Company adopted the practical expedient for financing components and does not need to account for a financing component of these lot sales as the delivery of lot sales is expected to occur within
one year or less.
The Company and the CAB have agreed that no payment is required with respect to advances made by the Company or expenses incurred related to construction of public improvements unless and until the CAB and/or the Sky Ranch Districts issue bonds
in an amount sufficient to reimburse the Company for all or a portion of the advances made and expenses incurred. Due to this contingency, the reimbursable costs for the construction of public improvements, including reimbursable costs for
construction support activities, are included in Inventories and subsequently expensed through Land development construction costs until the point in time when the
CAB reimburses the Company for such public improvements. The Company submits specific costs for reimbursement to the CAB. Based on the specific costs being reimbursed by the CAB, the Company records those costs that have been previously expensed
in cost of sales as other income and those costs that remain capitalized as inventory costs as a reduction of the related inventory costs held in Inventories. Any
reimbursable costs repaid after all capitalized expenses and lot revenues have been fully recognized will be recorded as other income.
All amounts owed under the 2018 FFAA (as defined in Note 6 – Related Party Transactions) bear interest at a rate of 6% per annum. No payment is required of
the CAB for advances made to the CAB or expenses incurred related to construction of public improvements unless and until the CAB and/or Sky Ranch Districts issue bonds in an amount sufficient to reimburse the Company for all or a portion of advances
or other expenses incurred. Due to this contingency, interest is accrued to Interest Income with a corresponding allowance until the point in time when bonds are issued. At that point, the allowance will be
reversed for the portion of the accrued interest repaid and the accrued interest will be recognized. To date, the Company has accrued $1,031,700 for accrued interest for advances made to the CAB.
On November 19, 2019, the CAB sold tax-exempt, fixed rate senior bonds in the aggregate principal amount of approximately $11,435,000 and tax-exempt, fixed-rate subordinate bonds in the aggregate
principal amount of approximately $1,765,000 (collectively, the “Bonds”). Upon the sale of the Bonds approximately $10.5 million of the net proceeds from the Bonds were used to partially reimburse the Company for advances it made to the CAB pursuant
to the 2018 FFAA to fund the construction of public improvements to the Sky Ranch property. Approximately $2.7 million of the bond proceeds were retained by the CAB in cash in order to repay debt service through 2021, when the CAB expects to generate
enough revenue through mill levies, to repay bond holders.
The Company applied approximately $4.2 million of the net proceeds to partially reduce the remaining capitalized expenses in Inventories and the excess of the capitalized
public improvement expenses of approximately $6.3 million was recognized as Income from reimbursement of construction costs (related party) in other income. As a result of the reimbursed costs, the margin
from land development revenues is expected to increase to approximately 27%.
The Company records all reimbursable costs to Inventories and subsequently expenses these costs through Land development
construction costs. All unpaid reimbursable costs, that the Company believes are recoverable from the CAB are accrued to a Note Receivable from the CAB pursuant to the 2018 FFAA. Each period, the Company performs an impairment analysis on
the recoverability of the outstanding reimbursable costs. The following table summarizes all reimbursable costs incurred to date, payments made from the CAB and any outstanding reimbursable amounts.
The Company expects to incur approximately an additional $6.0 million of construction costs related to public improvements and expects to be reimbursed approximately an additional $18.5 million.
The Company evaluated disaggregation of revenue and has determined that no additional disaggregation of revenue is necessary.
Contract asset by segment is as follows:
The Company did not have a contract asset at November 30, 2019 or August 30, 2019. The contract asset at November 30, 2018, related solely to the Company’s land development activities.
Changes in contract asset were as follows:
Deferred revenue by segment is as follows:
The current portion of deferred revenue for oil and gas leases and water sales payment as of November 30, 2019 and August 31, 2019, is $1,548,063 and $706,464, respectively. There were no water segment deferred
revenues as of November 30, 2019 and August 31, 2019.
Changes in deferred revenue were as follows:
The recognition of unearned revenue was $8,541,643 and $5,920,319 from land development activities and $1,981,127 and $3,567,493 from oil and gas leases and water sales payments for the three months ended November 30,
2019 and August 31, 2019, respectively.
Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized (“contracted not recognized revenue”), which includes unearned revenue and amounts that will be
invoiced and recognized as revenue in future periods. At November 30, 2019, the Company had outstanding open contracts for $13,739,100, which primarily related to the sale of 506 lots at Sky Ranch. The Company expects to recognize approximately 84%
of such revenue over the next 12 months.
Inventories
Inventories primarily include land held for development and sale, which the Company has begun developing and are stated at cost. Capitalized lot development costs at Sky Ranch are costs incurred to construct finished
lots at Sky Ranch that meet the Company’s capitalization criteria for improvements to a lot and are capitalized as incurred. The Company capitalizes certain legal, engineering, design, permitting, land acquisition, and construction costs related to
the development of lots at Sky Ranch. The Company uses the specific identification method for purposes of accumulating land development costs and allocates costs to each lot to determine the cost basis for each lot sale. The Company records all land
cost of sales when a lot is completed and sold on a lot-by-lot basis. Costs included in Inventories include common area costs that the Company funded through the CAB. The Company expects that such costs will
be reimbursable by the CAB. The Company will record future reimbursements as a reduction of reimbursable capitalized costs remaining in Inventories once the CAB has the ability to reimburse the costs (i.e.,
once the Sky Ranch Districts and/or the CAB has issued bonds).
In accordance with ASC 360, the Company measures land held for sale at the lower of the carrying value or net realizable value. In determining net realizable value,
the Company primarily relies upon the most recent negotiated price. If a negotiated price is not available, the Company will consider several factors, including, but not limited to, current market conditions, recent comparable sales transactions
and market analysis studies. If the net realizable value is lower than the current carrying value, the land is written down to its net realizable value.
Royalty and Other Obligations
Revenues from the sale of Export Water are shown gross of royalties payable to the Land Board. Revenues from the sale of water on the Lowry Range are invoiced directly by the Rangeview District, and a percentage of
such collections are then paid to the Company by the Rangeview District. Water revenue from such sales are shown net of royalties paid to the Land Board and amounts retained by the Rangeview District.
Oil and Gas Lease Payments
As described in Note 2 – Summary of Significant Accounting Policies in Part II, Item 8 of the 2019 Annual Report, the Company entered into a Paid-Up Oil and Gas Lease (the “Sky
Ranch O&G Lease”) and a Surface Use and Damage Agreement that were subsequently purchased by a wholly owned subsidiary of ConocoPhillips Company. Six wells have been drilled within the Company’s mineral interest and placed into service (four new
wells beginning in fiscal 2020) and are producing oil and gas and accruing royalties to the Company. During the three months ended November 30, 2019 and 2018, the Company received $269,500 and $31,400 net of taxes, respectively, in royalties
attributable to these wells. The Company classifies income from oil and gas lease and royalty payments as Other income in the statement of operations and comprehensive income as the Company does not consider
these arrangements to be a primary operating business activity.
Deferred Revenue
In July 2019, the Company received an up-front payment of $573,700 from an Agreement on Locations of Oil and Gas Operations for a pad site covering approximately 16 acres with the operator of the Sky Ranch O&G
Lease (the “OGOA”), which will be recognized as income on a straight-line basis over three years. If after three years the operator has not spud at least one well on the OGOA, the operator may extend the right to the OGOA one additional year by
paying $75,000 to the Company. The operator may only extend the OGOA for two additional years for a total of five years. The Company recognizes the up-front payments on a straight-line basis over the terms of the respective agreements. During the
three months ended November 30, 2019, the Company recognized $47,800 of income related to the up-front payments received pursuant to the OGOA. No revenue was recognized for the three months ended November 30, 2018 related to the up-front payments
received pursuant to the OGOA. As of November 30, 2019, and August 31, 2019 the Company had deferred revenue of $499,700 and $547,500, respectively, related to the OGOA.
In September 2017, the Company entered into a Paid-Up Oil and Gas Lease with Bison Oil and Gas, LLP (the “Bison Lease”). Pursuant to the Bison Lease, the Company received an up-front payment of $167,200 in October
2017, which will be recognized as income on a straight-line basis over the three year term of the lease. The Company recognized lease income of $13,900 during the three months ended November 30, 2019 and 2018 related to the up-front payment received
pursuant to the Bison Lease. As of November 30, 2019, and August 31, 2019, the Company had deferred revenue of $46,500 and $60,400, respectively, related to the Bison Lease that will be recognized as income ratably through September 2020.
The Company also received a payment of $425,800 in fiscal 2019 from one of its industrial water customers and $822,500 in the quarter ended November 30, 2019, to reserve first priority water for its oil and gas fracking needs for defined periods
during 2020. As the Customer uses the forecasted volumes each month, the Company will recognize revenue based on the volumes used. The Customer may take such volumes up to one year from invoice date. If the Customer does not take the forecasted
volumes in the anticipated period, such volumes are forfeited by the Customer. At that time, any payments received for unused volumes will be recognized as revenue. As of November 30, 2019, the Company had deferred revenue of $1.2 million as a
result of these advanced water purchase payments.
Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the eventual use of the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Capitalized Costs of Water and Wastewater Systems and Depletion and Depreciation of Water Assets
Costs to construct water and wastewater systems that meet the Company’s capitalization criteria are capitalized as incurred, including any interest, and depreciated on a straight-line basis over their estimated useful
lives of up to 30 years. The Company capitalizes design and construction costs related to construction activities, and it capitalizes certain legal, engineering and permitting costs relating to the adjudication and improvement of its water assets.
The Company depletes its groundwater assets that are being utilized on the basis of units produced (i.e., thousands of gallons sold) divided by the total volume of water adjudicated in the water decrees.
Share-Based Compensation
The Company maintains a stock option plan for the benefit of its employees and non-employee directors. The Company records share-based compensation costs as expense over the applicable vesting period of the stock award
using the straight-line method. The compensation costs to be expensed are measured at the grant date based on the fair value of the award. The Company has adopted the alternative transition method for calculating the tax effects of share-based
compensation, which allows for a simplified method of calculating the tax effects of employee share-based compensation. The impact on the income tax provision for the granting and exercise of stock options during the three months ended November 30,
2019 was a tax expense of approximately $26,000. Because the Company had a full valuation allowance on its deferred tax assets as of November 30, 2018 there was no effect on the tax provision during the period. The Company recognized $105,400 and
$103,500 of share-based compensation expense during the three months ended November 30, 2019 and 2018, respectively.
Income Taxes
The Company uses a “more-likely-than-not” threshold for the recognition and de-recognition of tax positions, including any potential interest and penalties relating to tax positions taken by the Company. The Company
did not have any significant unrecognized tax benefits as of November 30, 2019.
As a result of H.R.1, commonly known as the Tax Cuts and Jobs Act (the “Tax Act”), signed into law on December 22, 2017, the Company has a $282,000 alternative minimum tax (“AMT”) deferred tax asset for which it did
not have a valuation allowance as of November 30, 2019 and August 31, 2019. The Company expects to receive the AMT as a refund in future years. Most, if not all, of this credit will be refundable starting with the filing of the 2018 (fiscal year
ending 2019) through 2021 (fiscal year ending 2022) tax returns, subject to limitations of Internal Revenue Code Section 382 (arises with ownership changes) and the sequestration limitation of the Balanced Budget Act of 1997.
The Company’s effective tax rate was 24.7% for the three months ended November 30, 2019. The effective tax rate was 0% for the three months ended November 30, 2018 due to the valuation allowance the
Company maintained on its net deferred tax asset.
The Company records deferred tax assets and liabilities for the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying
consolidated balance sheets, as well as operating loss and tax credit carry-forwards. The Company measures deferred tax assets and liabilities using enacted tax rates expected to be applied to taxable income in the years in which those temporary
differences are expected to be recovered or settled.
The Company maintained a valuation allowance on the net deferred tax asset other than AMT credits as of November 30, 2018, as the Company had determined it was more likely than not that the Company
would not realize its deferred tax assets as of November 30, 2018. Such assets primarily consisted of operating loss carryforwards. The Company assessed the realizability of its deferred tax asset using all available evidence. In particular, the
Company considered both historical results and projections of profitability for the reasonably foreseeable future periods. The Company is required to reassess its conclusions regarding the realization of its deferred tax assets at each financial
reporting date. As a result of the evaluation, the Company concluded that all of the valuation allowance was no longer necessary as of August 31, 2019 and released the valuation allowance.
The Company files income tax returns with the Internal Revenue Service and the State of Colorado. The tax years that remain subject to examination are fiscal year 2015 through fiscal year 2018.
The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. At November 30, 2019, the Company did not have any accrued interest or
penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the three months ended November 30, 2019 or 2018.
Income per Common Share
Income per common share is computed by dividing net income by the weighted average number of shares outstanding during each period. Common stock options of 224,097 and 223,962 common share equivalents as of the three months ended November 30,
2019 and 2018, respectively, were included in the calculation of income per common share as dilutive common stock equivalents using the treasury stock method. Common stock options aggregating 50,000 common share equivalents as of the three months
ended November 30, 2018, have been excluded from the calculation of income per common share as their effect is anti-dilutive.
Recently Issued Accounting Pronouncements
The Company continually assesses any new accounting pronouncements to determine their applicability. When it is determined that a new accounting pronouncement affects the Company’s financial reporting, the Company undertakes a study to determine
the consequence of the change to its consolidated financial statements and to ensure that there are proper controls in place to ascertain that the Company’s consolidated financial statements properly reflect the change. New pronouncements assessed
by the Company recently are discussed below:
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). ASU 2016-02 provides
guidance on the recognition, measurement, presentation and disclosure of leases. The new standard supersedes the present GAAP standard on leases and requires substantially all leases to be reported on the balance sheet as right-of-use assets and
lease obligations. This standard is effective for fiscal years beginning after December 15, 2018. The Company adopted the standard effective September 1, 2019, and recorded a right-of-use asset of approximately $258,900 and a lease obligation
liability of approximately $252,300.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Among other things,
these amendments require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Companies will now use
forward-looking information to better inform their credit loss estimates. The standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently assessing the
provisions of the standard and the impact of the adoption on its consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, Income Statement — Reporting Comprehensive Income (Topic 220); Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The
amendments in ASU 2018-02 allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act. Consequently, the amendments eliminate the stranded tax effects resulting from
the Tax Act and will improve the usefulness of information reported to financial statement users. The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is
permitted in any interim period after issuance of the standard. The Company believes the impact of this standard on its condensed consolidated financial statements is immaterial.
In June 2018, the FASB issued ASU 2018-07, Compensation — Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. ASU 2018-07 is intended to reduce cost and
complexity and to improve financial reporting for share-based payments issued to nonemployees. This standard expands the scope of ASC Topic 718, Compensation — Stock Compensation, which currently only
includes share-based payments issued to employees, to include share-based payments issued to nonemployees for goods and services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU
2018-07 supersedes ASC Subtopic 505-50, Equity — Equity-Based Payments to Non-Employees. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods
within these fiscal years. The Company believes that the impact of this standard on its consolidated financial statements is immaterial.
NOTE 2 – FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the principal or most
advantageous market. The Company uses a fair value hierarchy that has three levels of inputs, both observable and unobservable, with use of the lowest possible level of significant input to determine where within the fair value hierarchy the
measurement falls.
Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the NASDAQ Stock Market. The Company had no Level 1 assets or liabilities as of November 30, 2019 or August 31, 2019.
Level 2 — Valuations for assets and liabilities obtained from readily available pricing sources via independent providers for market transactions involving similar assets or liabilities. The Company had zero and one
Level 2 assets as of November 30, 2019 and August 31, 2019, respectively, which consisted of U.S. Treasury debt securities.
Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker-traded transactions. Level 3
valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. The Company had one Level 3 liability, the contingent portion of the CAA, as of November 30, 2019 and August 31, 2019.
The Company has determined that the contingent portion of the CAA does not have a determinable fair value (see Note 4 – Long-Term Obligations and Operating Lease).
The Company maintains policies and procedures to value instruments using what management believes to be the best and most relevant data available.
Level 2 Asset – Investments. The Company’s debt securities are the Company’s only financial asset measured at fair value on a recurring basis. The fair value of investment securities
is based on the values reported by the financial institutions where the funds are held. Investment securities include U.S. Treasury debt securities.
The Company’s non-financial assets measured at fair value on a non-recurring basis when assessing recoverability consist entirely of its investments in water and water systems and other long-lived assets. See Note 3 – Water and Land Assets below.
The following table provides information on the assets and liabilities measured at fair value on a recurring basis as of November 30, 2019:
The following table provides information on the assets and liabilities measured at fair value on a recurring basis as of August 31, 2019:
The Company also held a certificate of deposit that is not carried at fair value on the consolidated balance sheets and is classified as a held-to-maturity security. As of November 30, 2019, the carrying amount of
held-to-maturity securities was $0. As of August 31, 2019, the carrying amount of held-to-maturity securities was $192,800 and is recorded as short-term investments in the accompanying consolidated financial statements.
NOTE 3 – WATER AND LAND ASSETS
The Company’s water rights and current water and wastewater service agreements are more fully described in Note 4 – Water and Land Assets in Part II, Item 8 of the 2019 Annual
Report. There have been no significant changes to the Company’s water rights or water and wastewater service agreements during the three months ended November 30, 2019.
Investment in Water and Water Systems
The Company’s Investments in Water and Water Systems consist of the following costs and accumulated depreciation and depletion at November 30, 2019 and August 31, 2019:
|
|
November 30, 2019
|
|
|
August 31, 2019
|
|
|
|
Costs
|
|
|
Accumulated
Depreciation
and Depletion
|
|
|
Costs
|
|
|
Accumulated
Depreciation
and Depletion
|
|
Rangeview Water Supply
|
|
$
|
14,827,000
|
|
|
$
|
(15,000
|
)
|
|
$
|
14,823,800
|
|
|
$
|
(14,700
|
)
|
Sky Ranch water rights and other costs
|
|
|
7,452,100
|
|
|
|
(811,500
|
)
|
|
|
7,371,500
|
|
|
|
(757,400
|
)
|
Fairgrounds water and water system
|
|
|
2,899,800
|
|
|
|
(1,173,000
|
)
|
|
|
2,899,800
|
|
|
|
(1,151,000
|
)
|
Rangeview water system
|
|
|
5,644,200
|
|
|
|
(425,900
|
)
|
|
|
5,617,800
|
|
|
|
(372,300
|
)
|
Water Supply – Other
|
|
|
4,761,200
|
|
|
|
(916,400
|
)
|
|
|
4,758,200
|
|
|
|
(860,100
|
)
|
Wild Pointe service rights
|
|
|
1,631,800
|
|
|
|
(489,800
|
)
|
|
|
1,631,800
|
|
|
|
(489,800
|
)
|
Sky Ranch pipeline
|
|
|
5,727,200
|
|
|
|
(459,300
|
)
|
|
|
5,723,700
|
|
|
|
(411,600
|
)
|
Lost Creek water supply
|
|
|
3,342,600
|
|
|
|
—
|
|
|
|
3,324,000
|
|
|
|
—
|
|
Construction in progress
|
|
|
9,507,000
|
|
|
|
—
|
|
|
|
8,176,600
|
|
|
|
—
|
|
Totals
|
|
|
55,792,900
|
|
|
|
(4,290,900
|
)
|
|
|
54,327,200
|
|
|
|
(4,056,900
|
)
|
Net investments in water and water systems
|
|
$
|
51,502,000
|
|
|
|
|
|
|
$
|
50,270,300
|
|
|
|
|
|
Capitalized terms in this section not defined herein are defined in Note 4 – Water and Land Assets in Part II, Item 8 of the 2019 Annual Report.
Construction in progress primarily consists of the Sky Ranch water reclamation facility. The Company anticipates the facility will be placed in service during the second quarter of 2020.
Depletion and Depreciation
The Company recorded depletion charges of $300 and $600 during the three months ended November 30, 2019 and 2018, respectively. The depletion was related entirely to the Rangeview Water Supply.
The Company recorded $303,800 and $238,700 of depreciation expense during the three months ended November 30, 2019 and 2018, respectively. These figures include $84,800 and $88,000 of depreciation expense for other
equipment not included in the table above in the three months ended November 30, 2019 and 2018, respectively.
NOTE 4 – LONG-TERM OBLIGATIONS AND OPERATING LEASE
The Participating Interests in Export Water Supply is an obligation of the Company that has no scheduled maturity date. Therefore, maturity of this liability is not disclosed in tabular format but is described below.
Participating Interests in Export Water Supply
The Company acquired its Rangeview Water Supply through various amended agreements entered into in the early 1990s. The acquisition was finalized with the signing of the CAA in 1996. Upon entering into the CAA, the
Company recorded an initial liability of $11.1 million, which represented the cash that the Company received from the participating interest holders that was used to purchase the Company’s Export Water (described in greater detail in Note 4 – Water and Land Assets in Part II, Item 8 of the 2018 Annual Report). The Company agreed to remit a total of $31.8 million of proceeds received from the sale of Export Water to the participating interest holders
in return for their initial $11.1 million investment. The obligation for the $11.1 million was recorded as debt, and the remaining $20.7 million contingent liability was not reflected on the Company’s balance sheet because the obligation to pay this
is contingent on the sale of Export Water, the amounts and timing of which are not reasonably determinable.
The CAA obligation is non-interest bearing, and if the Export Water is not sold, the parties to the CAA have no recourse against the Company. If the Company does not sell the Export Water, the holders of the Series B
preferred stock of the Company are also not entitled to payment of any dividend and have no contractual recourse against the Company.
As the proceeds from the sale of Export Water are received and the amounts are remitted to the external CAA holders, the Company allocates a ratable percentage of this payment to the principal portion (the
Participating Interests in Export Water Supply liability account), with the balance of the payment being charged to the contingent obligation portion. Because the original recorded liability, which was $11.1
million, was 35% of the original total liability of $31.8 million, approximately 35% of each payment remitted to the CAA holders is allocated to the recorded liability account. The remaining portion of each payment, or approximately 65%, is allocated
to the contingent obligation, which is recorded on a net revenue basis.
From time to time, the Company reacquired various portions of the CAA obligations, which retained their original priority, including the Land Board’s CAA interest which was assigned and relinquished to the Company in
2014. The Company did not make any CAA acquisitions during the three months ended November 30, 2019 and 2018.
The Company is currently allocated approximately 88% of the total proceeds from the sale of Export Water after payment of the Land Board royalty. As a result of the acquisitions and consideration from cumulative sales
of Export Water as detailed in the table below, the remaining potential third-party obligation at November 30, 2019, is approximately $1 million.
The CAA includes contractually established priorities which call for payments to CAA holders in order of their priority. This means that the first payees receive their full payment before the next priority level
receives any payment and so on until full repayment. Of the next approximately $6.4 million of Export Water payouts, which based on current payout levels would occur over several years, the Company will receive approximately $5.6 million of revenue.
Thereafter, the Company will be entitled to all but approximately $220,000 of the proceeds from the sale of Export Water after deduction of the Land Board royalty.
WISE Partnership
The Company, through the Rangeview District, entered into the Amended and Restated WISE Partnership – Water Delivery Agreement, dated December 31, 2013 (the “WISE Partnership Agreement”), among the City and County of
Denver acting through its Board of Water Commissioners (“Denver Water”), the City of Aurora acting by and through its Utility Enterprise (“Aurora Water”), and the South Metro WISE Authority (“SMWA”). The SMWA was formed by the Rangeview District and
nine other governmental or quasi-governmental water providers pursuant to the South Metro WISE Authority Formation and Organizational Intergovernmental Agreement, dated December 31, 2013 (the “SM IGA”), to enable the members of SMWA to participate in
the regional water supply project known as the Water Infrastructure Supply Efficiency partnership (“WISE”) created by the WISE Partnership Agreement. The SM IGA specifies each member’s pro rata share of WISE and the members’ rights and obligations
with respect to WISE. The WISE Partnership Agreement provides for the purchase of certain infrastructure (i.e., pipelines, water storage facilities, water treatment facilities, and other appurtenant facilities) to deliver water to and among the 10
members of the SMWA, Denver Water and Aurora Water.
Pursuant to the terms of the Rangeview/Pure Cycle WISE Project Financing Agreement (the “WISE Financing Agreement”) between the Company and the Rangeview District, the Company has an agreement to fund the Rangeview
District’s participation in WISE effective as of December 22, 2014. The Company’s cost of funding the Rangeview District’s purchase of its share of existing infrastructure and future infrastructure for WISE and funding operations and water deliveries
related to WISE is projected to be approximately $7 million over the next five years. See further discussion in Note 6 – Related Party Transactions.
Lease Commitments
Under Topic 842, operating lease expense is generally recognized evenly over the term of the lease. Effective as of February 2018, the Company entered into an operating lease for approximately 11,393 square
feet of office and warehouse space. The lease has a three-year term with payments of $6,600 per month and an option to extend the primary lease term for a two-year period at a rate equal to a 12.5% increase over the primary base payments. The change
in the lease costs is not material to the Company’s operations.
The Company did not enter into any new leases in the three months ended November 30, 2019. Rent expense consisted of operating lease expense of $21,300 for the three months ended November 30, 2019. There was no
sublease rental income for the three months ended November 30, 2019. We paid $19,800 against Lease obligations — operating leases in the three months
ended November 30, 2019.
Leases with an initial term of twelve months or less are not recorded on the consolidated balance sheet. For lease agreements entered into or reassessed after the adoption of Topic 842, the Company combines the lease and
non-lease components in determining the lease liabilities and right-of-use (“ROU’) assets.
The Company’s lease agreements generally do not provide an implicit borrowing rate; therefore, an internal incremental borrowing rate is determined based on information available at lease commencement date for
purposes of determining the present value of lease payments. The Company used the incremental borrowing rate of 6% on August 31, 2019, for all leases that commenced prior to that date. We also elected the
hindsight practical expedient to determine the lease term for existing leases. Our election of the hindsight practical expedient resulted in the lengthening of the lease term related to our lease.
ROU lease assets and lease liabilities for the Company’s operating leases were recorded in the consolidated balance sheet as follows:
NOTE 5 – SHAREHOLDERS’ EQUITY
The Company maintains the 2014 Equity Incentive Plan (the “2014 Equity Plan”), which was approved by shareholders in January 2014 and became effective on April 12, 2014. Executives, eligible employees, consultants and
non-employee directors are eligible to receive options and stock grants pursuant to the 2014 Equity Plan. Pursuant to the 2014 Equity Plan, options to purchase shares of stock and restricted stock awards can be granted with exercise prices, vesting
conditions and other performance criteria determined by the Compensation Committee of the board of directors. The Company has reserved 1.6 million shares of common stock for issuance under the 2014 Equity Plan. The Company began awarding options
under the 2014 Equity Plan in January 2015. Prior to the effective date of the 2014 Equity Plan, the Company granted stock awards to eligible participants under its 2004 Incentive Plan (the “2004 Incentive Plan”), which expired on April 11, 2014. No
additional awards may be granted pursuant to the 2004 Incentive Plan; however, awards outstanding as of April 11, 2014, will continue to vest and expire and may be exercised in accordance with the terms of the 2004 Incentive Plan.
The following table summarizes the combined stock option activity for the 2004 Incentive Plan and 2014 Equity Plan for the three months ended November 30, 2019:
The following table summarizes the combined activity and value of non-vested options under the 2004 Equity Plan and 2014 Incentive Plan as of and for the three months ended November 30, 2019:
All non-vested options are expected to vest.
Stock-based compensation expense was $105,400 and $103,500 for the three months ended November 30, 2019 and 2018, respectively.
At November 30, 2019, the Company had unrecognized compensation expenses totaling $713,500 relating to non-vested options that are expected to vest. The weighted-average period over which these options are expected to
vest is approximately two years.
NOTE 6 – RELATED PARTY TRANSACTIONS
The Rangeview District is a quasi-municipal corporation and political subdivision of Colorado formed in 1986 for the purpose of providing water and wastewater service to the Lowry Range and other approved areas. The
Rangeview District is governed by an elected board of directors. Eligible voters and persons eligible to serve as a director of the Rangeview District must own an interest in property within the boundaries of the Rangeview District. The Company owns
certain rights and real property interests which encompass the current boundaries of the Rangeview District. Sky Ranch Metropolitan District Nos. 1, 3, 4 and 5 (collectively, the “Sky Ranch Districts”) and the CAB are quasi-municipal corporations and
political subdivisions of Colorado formed for the purpose of providing service to the Company’s Sky Ranch property. The current members of the board of directors of each of the Rangeview District, the Sky Ranch Districts and the CAB consist of three
employees of the Company and one independent board member.
The Rangeview District
On December 16, 2009, the Company entered into a Participation Agreement with the Rangeview District, whereby the Company agreed to provide funding to the Rangeview District in connection with the Rangeview District
joining the South Metro Water Supply Authority (“SMWSA”). The Company provides funding pursuant to the Participation Agreement annually with $17,400 and $22,200 being provided during fiscal years 2020 and 2019, respectively.
Through the WISE Financing Agreement, the Company agreed to fund the Rangeview District’s cost of participating in the regional water supply project known as the WISE partnership. The Company anticipates spending approximately $7 million over
the next five fiscal years to fund the Rangeview District’s purchase of its share of the water transmission line and additional facilities, water and related assets for WISE and to fund operations and water deliveries related to WISE. To date, the
Company has capitalized the funding provided pursuant to the WISE Financing Agreement because the funding has been provided to purchase capacity in the WISE infrastructure. The Company’s total investment in the WISE assets as of November 30, 2019,
is approximately $3.5 million.
In 1995, the Company extended a loan to the Rangeview District. The loan provided for borrowings of up to $250,000, is unsecured, and bears interest based on the prevailing prime rate plus 2% (7.50% at November 30,
2019). The maturity date of the loan is December 31, 2020. In January 2014, the Rangeview District and the Company entered into a funding agreement that allows the Company to continue to provide funding to the Rangeview District for day-to-day
operations and accrue the funding into a note that bears interest at a rate of 8% per annum and remains in full force and effect for so long as the 2014 Amended and Restated Lease Agreement remains in effect. Of the November 30, 2019 balance in Notes receivable - related parties, $972,500 includes borrowings by the Rangeview District of $553,400 and accrued interest of $419,100.
Sky Ranch Community Authority Board
Pursuant to that certain Community Authority Board Establishment Agreement, as the same may be amended from time to time, Sky Ranch Metropolitan District Nos. 1 and 5 formed the CAB to, among other things, design,
construct, finance, operate and maintain certain public improvements for the benefit of the property within the boundaries and/or service area of the Sky Ranch Districts. In order for the public improvements to be constructed and/or acquired, it is
necessary for each Sky Ranch District, directly or through the CAB, to be able to fund the improvements and pay its ongoing operations and maintenance expenses related to the provision of services that benefit the property.
On September 18, 2018, the parties entered into a series of agreements, including a Facilities Funding and Acquisition Agreement with an effective date of November 13, 2017 (the “2018 FFAA”), which supersedes and
consolidates the previous funding agreements between the Company and the CAB and the Company and Sky Ranch Metropolitan District No. 5 pursuant to which
All amounts owed under the 2018 FFAA bear interest at a rate of 6% per annum. No payment is required of the CAB for advances made to the CAB or expenses incurred related to construction of public improvements unless
and until the CAB and/or Sky Ranch Districts issue bonds in an amount sufficient to reimburse the Company for all or a portion of advances or other expenses incurred. Due to this contingency, interest is accrued to Interest
Income with a corresponding allowance until the point in time when bonds are issued. At that point, the allowance will be reversed for the portion of the accrued interest repaid and the accrued interest will be recognized. The CAB agrees to
exercise reasonable efforts to issue bonds to reimburse the Company subject to certain limitations. In addition, the CAB agrees to utilize any available moneys not otherwise pledged to payment of debt, used for operation and maintenance expenses, or
otherwise encumbered, to reimburse the Company. Any advances not paid or reimbursed by the CAB by December 31, 2058, shall be deemed forever discharged and satisfied in full.
As of November 30, 2019, the balance of the Company’s advances, net of reimbursed costs in November 2019, to the CAB totaled $12.5 million, of which $2.9 million is included in Inventories and $9.6
million was expensed through Land development construction costs of revenues. The advances have been used by the CAB to pay for construction of public improvements. The Company submits specific costs for
reimbursement to the CAB. Based on the specific costs being reimbursed by the CAB, the Company records those costs that have been previously expensed in cost of sales as other income and those costs that remain capitalized as inventory costs as a
reduction of the related inventory costs held in Inventories. Any reimbursable costs repaid after all capitalized expenses and lot revenues have been fully recognized will be recorded as other income.
Refer to Note 1 – Presentation of Interim Information - Revenue Recognition - Land Development Activities for a summary of reimbursable costs incurred to date, payments made
from the CAB and any outstanding reimbursable amounts.
In September 2018, effective as of November 13, 2017, the Company entered into an Operation Funding Agreement with the CAB obligating the Company to advance funding to the CAB for operation and maintenance expenses for the 2018 and 2019 calendar
years. All payments are subject to annual appropriations by the CAB in its absolute discretion. The advances by the Company accrue interest at the rate of 6% per annum from the date of the advance. $27,400 of the balance of the Notes receivable – related parties at November 30, 2019, includes borrowings by the CAB of $25,500 and accrued interest of $1,900.
NOTE 7 – SIGNIFICANT CUSTOMERS
Water and Wastewater
Pursuant to the Rangeview Water Agreements (defined in Note 4 – Water and
Land Assets in Part II, Item 8 of the 2019 Annual Report) and an Export Service Agreement entered into with the Rangeview District dated June 16, 2017, the Company provides water and
wastewater services on the Rangeview District’s behalf to the Rangeview District’s customers. Sales to the Rangeview District accounted for 51% and 5% of the Company’s total water and wastewater revenues for the three months ended November 30, 2019
and 2018, respectively. The Rangeview District has one significant customer, the Ridgeview Youth Services Center. The Rangeview District’s significant customer accounted for 38% and 3% of the Company’s total water and wastewater revenues for the
three months ended November 30, 2019 and 2018, respectively.
Revenues related to the provision of water for the oil and gas industry to one customer accounted for approximately 30% of the Company’s water and wastewater revenues for the three months ended November 30, 2019.
Revenues related to the provision of water for the oil and gas industry to two customers represented approximately 52% and 42%, respectively, of the Company’s water and wastewater revenues for the three months ended November 30, 2018.
Land Development
Revenues from three customers represented 100% of the Company’s land development revenues for the three months ended November 30, 2019. The three customers represented 74%, 17% and 9%, respectively, of the Company’s
land development revenues for the three months ended November 30, 2019. Revenues from two customers represented 100% of the Company’s land development revenues for the three months ended November 30, 2018. The two customers represented 66% and 34%,
respectively, of the Company’s land development revenues for the three months ended November 30, 2018.
Accounts Receivable
The Company had accounts receivable from the Rangeview District which accounted for 74% and 40% of the Company’s trade receivables balances at November 30, 2019 and August 31, 2019, respectively. The Company had
accounts receivable from one other customer which accounted for approximately 15% and 57% of its trade receivable balances at November 30, 2019 and August 31, 2019, respectively. Accounts receivable from the Rangeview District’s largest customer
accounted for 6% and 5% of the Company’s water and wastewater trade receivables as of November 30, 2019 and August 31, 2019, respectively.
NOTE 8 – ACCRUED LIABILITIES
At November 30, 2019, the Company had accrued liabilities of $3,519,400, of which $64,300 was for current operating lease obligations, $98,100 was for estimated property taxes, $33,500 was for professional fees, and
$3,323,500 was for operating payables, of which $2,654,700 is payable to the CAB for the development of Sky Ranch. These costs are also included in Inventories or expensed through Land development construction costs.
At August 31, 2019, the Company had accrued liabilities of $3,428,400, of which $460,500 was for accrued compensation, $94,000 was for estimated property taxes, $70,000 was for professional fees and the remaining
$2,803,900 was related to operating payables, of which $1,399,600 is payable to the CAB for the development of Sky Ranch. These costs were also included in Inventories or expensed through Land development construction costs.
NOTE 9 – COMMITMENTS AND CONTINGENCIES
The Company has historically been involved in various claims, litigation and other legal proceedings that arise in the ordinary course of its business. The Company records an accrual for a material loss contingency
when its occurrence is probable and damages can be reasonably estimated based on the anticipated most likely outcome or the minimum amount within a range of possible outcomes. The Company makes such estimates based on information known about the
claims and experience in contesting, litigating and settling similar claims. Disclosures are also provided for reasonably possible losses that could have a material effect on the Company’s financial position, results of operations or cash flows. The
Company was not involved in litigation or other legal proceedings and had no contingencies where the risk of material loss was reasonably possible as of November 30, 2019, or August 31, 2019.
NOTE 10 – SEGMENT INFORMATION
An operating segment is defined as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the Chief Operating Decision Maker (the “CODM”), or decision-making
group, to evaluate performance and make operating decisions. The Company has identified its CODM as the Chief Executive Officer.
During the year 2018, the Company began construction of lots at Sky Ranch, which the Company has identified as a segment. Currently, the Company operates its wholesale water and wastewater services segment and land
development activities at Sky Ranch as its two lines of business.
The wholesale water and wastewater services business includes selling water service to customers, which water is provided by the Company using water rights owned or controlled by the Company, and developing
infrastructure to divert, treat and distribute that water and collect, treat and reuse wastewater.
As part of the Company’s land development activities at Sky Ranch, the Company entered into contracts for the sale of lots (see Note 2 – Summary of Significant Accounting Policies in
Part II, Item 8 of the 2019 Annual Report). The Company identified land development and lot sales as a separate segment beginning in the fiscal year 2018.
Oil and gas royalties and licenses are a passive activity and not an operating business activity and, therefore, are not classified as a segment.
The following table summarizes wholesale water and wastewater services and land development revenue information by segment:
The following table summarizes wholesale water and wastewater services and land development pretax income by segment:
The following table summarizes total assets for the Company’s wholesale water and wastewater services business and land development business by segment. The assets consist of water rights and water and wastewater
systems in the Company’s wholesale water and wastewater services segment and land, inventories and deposits in the Company’s land development segment. The Company’s other assets (“Corporate”) primarily consist of cash and cash equivalents, equipment,
mineral rights, related party notes receivables and a deferred tax asset.
NOTE 11 – INCOME TAXES
The Company recorded income tax expense of $1,887,100 and $0 for the three months ended November 30, 2019 and 2018, respectively. The net expense during the three months ended November 30,
2019 consisted of current income tax expense of $1,168,300 and deferred income tax expense of $718,800. The current tax expense consists of income tax primarily from our Gain from reimbursement of
construction costs (related party). The deferred tax expense consists of the usage of the Company’s remaining $2.5 million net operating loss carryforwards and payment of deferred compensation in the current
period.
The income tax provision for interim periods is determined using an estimate of the annual effective tax rate, adjusted for discrete items. At November 30, 2019 the Company is currently estimating an annual effective tax rate of approximately 25%.
Each quarter, the estimate of the annual effective tax rate is updated, and if the estimated effective tax rate changes, a cumulative adjustment is made. There is a potential for volatility of the effective tax rate due to various factors.
The provision for income taxes is recorded at the end of each interim period based on the Company’s best estimate of its effective income tax rate expected to be applicable for the full fiscal year. The Company’s effective income tax rate was
24.7% for the three months ended November 30, 2019. The company did not record income tax expense for the three months ended November 30, 2018.
No taxes were paid during the three months ended November 30, 2019 and 2018, respectively.
Deferred income taxes reflect the tax effects of net operating loss carryforwards and temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of the Company’s deferred tax assets as of November 30, 2019 and August 31, 2019 are as follows:
The Company maintained a valuation allowance on the net deferred tax asset other than AMT credit carryforwards as of August 31, 2018. For the fiscal year ended August 31, 2019, the Company has
determined it is more likely than not that the Company will realize its deferred tax assets, which consist primarily of net operating loss carryforwards. The Company assessed the realizability of its deferred tax assets using all available evidence;
considering both historical results and projections of profitability for the reasonably foreseeable future periods. As a result of the Company’s annual reassessment of its conclusions regarding the realization of its deferred tax assets at each
financial reporting date, the Company concluded that its deferred tax assets are realizable, and therefore, the valuation allowance is no longer necessary.
At August 31, 2019, the Company had $2.5 million of net operating loss carryforwards available for income tax purposes. The net operating loss carryforwards expire at various times beginning in 2036 and ending in 2038 for federal income tax
purposes and expire at various times beginning in 2035 and ending in 2036 for state income tax purposes. As of November 31, 2019, the Company used the remaining balance of its net operating loss carryforwards.