ITEM 1. BUSINESS
Overview
“As water becomes ever more scant the world needs to conserve it, use it more efficiently and establish clear rights over who owns the stuff.” - Liquidity Crisis, The Economist, Nov 5, 2016
Since 2009, we have acquired strategic water assets and land in the Huerfano and Cucharas river basins in southeastern Colorado, thus the name Two Rivers. In October 2016 we began to focus on monetizing our assets by investing strategically in assets that we believe offer opportunities for significant future returns for our shareholders and by selling those assets we determine will not yield those returns. As the result of that process, the management of water has become our core business., Our water asset total drainage area spans over 1,500 square miles and drops in elevation from over 14,000 feet to 4,500 feet at the confluence of the Arkansas River, just east of Pueblo, Colorado. We operate in a natural, gravity fed water alluvial, which is is the last undeveloped basin along the front range of Colorado. As our first water-focused project, we plan to develop this basin to properly manage the water contained therein and serve the community while providing returns to our investors. Our water development operations and strategy are described below under “─Our Water Operations.”
Our principal investments since commencing operations in 2009, and the status of those investments following the implementation of our monetization strategy in 2016, are described below:
● HCIC: From 2009 to 2010 we purchased 95% of the outstanding shares of Huerfano-Cucharas Irrigation Company, or HCIC, in a series of transactions for $24.2 million in cash, promissory notes and Two Rivers’ common stock. HCIC is a mutual ditch company formed in 1944, and we have used its water rights and facilities to supply some of our farmland with irrigation water. In the future, we will use these water rights to supply water to farmland we lease to others and to implement our new water strategy.
● Additional Farmland: From 2009 to 2011 we acquired 2,753 acres of farmland served by HCIC’s ditch system for purchase prices totaling $1.4 million in cash and seller carry back financing. In 2012 we acquired 1,584 acres in Butte Valley for $509,000 in cash and seller carry back financing. In 2016, we returned 187 acres of Butte Valley land back to the holder of seller carry back financing in exchange for forgiveness on $187,000 of debt and associated accrued interest.
● Orlando: In 2011 we acquired Orlando Reservoir No. 2 Company, LLC, or Orlando, for $3.45 million in cash, promissory notes and common stock. Our ownership of Orlando increases the reliability of water supplies for our farmland in the Huerfano and Pueblo river basins. We undertook a program to refurbish and restore Orlando’s diversion structure, storage reservoirs and conveyance system. During the period from November 2011 to February 2012, we constructed new outlet works, and in 2012 we reconstructed the diversion structure, which takes water from the Huerfano River for storage in the Orlando reservoir and then conveyance to irrigate our nearby leased farmland. Additional renovation projects will be completed as necessary to provide reliable water supplies for farmland we lease to others and community use.
● DFP (discontinued operations): In 2012 we acquired Dionisio Farms & Produce, Inc., or DFP, for $3.4 million in cash and promissory notes. DFP, which has operated for more than 60 years, produces high-value fruits and vegetables as well as fodder crops. Through this acquisition, we obtained 146 acres of irrigable farmland, 146 shares of the Bessemer Ditch Irrigation Company, a senior water right holder on the main stem of the Arkansas River and 2 supplemental ground water wells. As part of the acquisition, we entered into leases for an additional 279 irrigable acres. In late 2016, based on three years of operational losses, we decided to sell DFP assets and wind down our produce growing and distribution business, and during the first quarter of 2017 we sold the DFP irrigated farmland and the associated DFP produce business that no longer served our strategic vision of water management
● GrowCo: We formed GrowCo, Inc., or GrowCo, in May 2014 for the purpose of constructing state-of-the-art computer controlled greenhouses to be leased to licensed marijuana growers throughout the United States. GrowCo is not a licensed marijuana grower or retailer. GrowCo does not “touch the plant” and only provides growing infrastructure as a landlord for licensed marijuana grower tenants along with support and administrative services. In August 2014 we announced we were reserving 10 million of the GrowCo shares for distribution to holders of common stock as of four record dates (January 1, 2015; April 1, 2015; July 1, 2015 and October 1, 2015) after a registration statement for GrowCo common shares has been filed and declared effective, which has not yet occurred. Currently, GrowCo has approximately 35 million common shares outstanding.
● Water Redev: We formed Water Redevelopment Company, or Water Redev, in February 2017 to separate our water assets from the rest of our business and to enable additional raising of capital solely for the purpose of investing in our water assets. Water Redev is a subsidiary of Two Rivers and focuses on development and redevelopment of infrastructure for water management and delivery, as further described in “─Our Water Operations” below.
Our Water Operations
Colorado allocates water based on the Prior Appropriation Doctrine, whereby water rights are unconnected to land ownership. The first person to use a quantity of water from a water source for a beneficial use has the right to continue to use that quantity of water for that purpose. Subsequent users can use the remaining water for their own beneficial purposes provided that they do not impinge on the rights of previous users. Water rights can be developed, managed, purchased and sold much like real property, and the seniority of water rights are a significant consideration when we acquire additional irrigated farmland. Water rights include the ability to divert stream flow, build a storage reservoir, pump ground water and create augmentation water supplies to offset depletions of water taken out of priority.
Since 2009 we have acquired a portfolio of water rights in the Arkansas River Basin in connection with our purchases of irrigated farmland. With our initial marijuana greenhouse projects gaining traction, in the third quarter of 2016 we determined to investigate whether our water assets might have revenue potential of their own, separate from use in irrigating our farmland, that could benefit our stakeholders, including our shareholders and the communities near where our water assets are located.
As a result of that investigation, we made water management our top priority. We believe there are several opportunities to capitalize on water assets that we currently own or can acquire, in order to address serious storage and supply challenges faced by municipalities, ranches, farmlands and other commercial enterprises in the Arkansas River Basin. In order to address these opportunities, we have identified the following within the local communities we serve:
● We will seek to address the need for municipal water storage.
● We believe there are a variety of opportunities to lease, both short term and long term, our water assets.
● We have identified underutilized land that, along with the water we own, can be leased for agriculture activities.
● We plan to execute on a water supply agreement we entered into in January 2011, with a real estate development company in Huerfano County by beginning to supply raw water for water taps.
Our principal water rights include the following:
● As noted in “─Overview” above, we acquired control of HCIC in order to use its water rights and facilities to supply some of our farmland with irrigation water. The HCIC farmland became fallow in the mid-twentieth century when coal mines in Huerfano County, Colorado, were shut down. The coal mines had continuously pumped water from the Vermejo/Trinidad Formation, which contained a renewable underground aquifer that is fed by Sangre de Cristo Mountains snowmelt. The U.S. Geological Service estimates that the Raton Vermejo Basin, where we have water rights, contains an estimated 12 trillion gallons or 36 million acre-feet of relatively untapped, clean and renewable water. HCIC owns the Cucharas and Huerfano Valley Reservoirs and two ditch systems located in Pueblo County, Colorado. The HCIC ditch systems have the right to distribute water over approximately 30,000 acres in Pueblo County, Colorado.
● The Orlando water rights include the senior-most direct flow water right on the Huerfano River, or #1 priority, along with the #9 priority and miscellaneous junior water rights. The seniority of those water rights allowed the production of crops during most of the recent drought years. The Orlando assets also include the Orlando reservoir, which is situated on the Huerfano branch of the Huerfano River and has a storage capacity of 3,100 acre-feet.
An acre-foot, or A.F., of water is the amount of water required to cover one acre to a depth of one foot. An acre-foot of water contains 325,851 gallons, generally considered enough water to supply two average households for a year. Annual irrigation in Southeastern Colorado, depending on the crops, consumes approximately three to six acre-feet of water per acre of crop.
By capturing water in reservoirs and releasing it later for irrigation purposes, we are able to retime the delivery of water throughout the irrigation season and ameliorate some of the inconsistencies of seasonal and annual water availability for the farmland we manage.
Surface Water Rights
Tributary ground water is any underground water that is hydraulically connected to a stream system and that influences the rate or direction of flow in that stream system. Any new ground water diversions that are tributary to an over-appropriated stream system require augmentation to offset out-of-priority depletions. In 2013, many well water users on the Arkansas River and its tributaries were unable to use their wells, as drought conditions made augmentation water unavailable. In response, an augmentation provider requested that we assist in building a more efficient and plentiful augmentation supply. We had intended to assist with an augmentation supply, but due to capital requirements, we terminated those plans.
We own the following surface water rights:
“Consumptive use” is the term for the portion of a water diversion right that is actually consumed by its beneficial use. Where the beneficial use is agricultural irrigation, consumptive use represents the amount of water consumed by the irrigated crop or evaporated on the farm. After deducting consumptive use from the amount of water diverted and applied to irrigation, the remainder is described as “return flow” to the system. Such return flows are generally subject to appropriation downstream. Only the consumptive use portion of a given water right is subject to transfer (that is, a change in the point of diversion, place of use, or purpose of use). Therefore, water rights are often assigned monetary value based on the consumptive use portion. Although consumptive use varies by crop, rainfall, temperature and other factors, in southeastern Colorado, crops generally consume about two acre-feet of applied water for each acre planted, depending on the crops planted. In order to provide that amount of consumptive use water, an irrigator must generally apply three acre-feet of water (allowing for predictable return flow equal to about one-third of the applied water). We measure our water rights both in terms of the amount of the diversion or storage right, as the case may be, but also in terms of the historic consumptive use.
Storage Rights and Infrastructure
The following table presents our holdings of storage water rights:
* See description below regarding pending litigation.
** This is a conditional right while the engineering and construction of structures are completed to perfect a water right, in this case to physically store the water. The conditional right establishes a seniority date but allows time for completion of the project. Conditional rights are reviewed every six years by the water court to confirm that progress is being made on the effort to perfect the right. When a conditional water right is perfected, which can be done incrementally in the case of storage, the water right becomes absolute. In addition, the Cucharas Valley Reservoir has Conditional rights to 34,404 A.F. of additional storage.
Two Rivers, the State of Colorado (Office of the State Engineer and the local Division Engineer), and neighboring water rights holders have been involved in litigation in the Colorado Division 2 Water Court 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 to have certain water rights demands by the neighboring water rights holders deemed wasteful. We also intend to work with the Colorado State Engineer to construct a new dam close to the prior dam structure, pending financing. In the quarter ending March 31, 2016, Two Rivers entered into a stipulation agreement with the State, settling the State's claims, whereby Two Rivers agreed to take the existing dam structure down to the sediment level by March 31, 2018. Two Rivers has been able to empty all the water in the Dam, but it will not be able to meet the requirements of the stipulation agreement by March 31, in part due to lack of capital. On April 3, 2018, Two Rivers was notified that the State had filed a motion for the issuance of a contempt of court citation based upon its failure to comply with the consent decree by March 31, 2018. Two Rivers intends to defend against the sanctions sought in the contempt motion, based in part upon those sanctions being unnecessary and unduly punitive. A hearing has been set for the contempt proceedings on May 10, 2018.
As part of our comprehensive water system we utilize storage reservoirs and ditches. Reservoirs allow water owners to store their water and plan the water’s distribution throughout the growing season. We currently own reservoirs associated with HCIC and Orlando. The development and improvement of storage reservoirs in the area will allow us to offer storage to other water users in the area for a storage leasing fee. Through water exchanges and other water-related transactions, the reservoirs can potentially increase and strengthen our existing water rights.
All of our reservoirs are used for irrigation in a similar manner to other reservoirs in the region, with the exception of Pueblo Reservoir, which was also constructed for flood control. Direct flow rights generally are senior to most storage rights but typically do not divert early in the spring when storage rights fill. The Arkansas River below Pueblo Reservoir operates a Winter Storage Program that re-allocates winter direct flow rights to storage in reservoirs from November 15 to March 15 each year.
Because our water rights and operating structures are located at succeeding elevations in the watershed, the system moves water supplies from point of diversion, through storage, to place of use primarily by means of gravity, making our more economical to operate than systems requiring energy to pump water for beneficial use.
In order to use these rights and structures most efficiently, we have planned and begun to implement a program of renovation and integration. For example, we began construction of new outlet works for the 1905 Orlando Reservoir in November 2011. The work was completed and successfully tested in February 2012, approximately a year after we acquired Orlando. Also in February 2012, we commenced reconstruction of the diversion structure, which takes water from the Huerfano River for storage in the Orlando reservoir, and to irrigate our nearby farmland. Additional water facility renovation projects are planned on a phased basis as necessary to provide reliable irrigation for agricultural operations and eventually commercial use.
We currently have the operable right to store 5,000 acre-feet of water within the Huerfano and Cucharas Rivers watershed in three separate reservoirs, subject to repair, or removal and rebuilding, limitations. When our reservoirs on the Huerfano and Cucharas Rivers have been fully restored, we will have the operable capacity and legal right to store in excess of 70,000 acre-feet of water. Similarly, based on our portfolio of water rights, we have the right to divert from the natural flows of the two rivers in excess of 90 cubic feet per second. Seasonal variability in the natural flow of the rivers, as well as the priorities of other water users in the system, limits our ability to divert the decreed amounts of water on a continuous basis. Our current water rights produce a long-term average annual diversion of 15,000 acre-feet of water.
The 15,000 acre-feet average is based on a record period of more than 50 years and also relies on historic studies of these rights by a variety of engineers at various times. It is common practice within the water industry in Colorado to use long periods of time to create reliable averages of water flow. We believe that using averages relating to only recent years can be misleading because an average could be skewed if only one of those years was particularly dry or wet. For example, in three out of the last ten years, there has been an extreme drought in our area of operations. Due to this drought condition, our flow averages for the most recent ten, five and three years are 8,200 acre-feet, 10,500 acre-feet and 10,400 acre-feet, respectfully. A similar request for the same averages for the decade beginning in 1980 would result in averages of 5,900 acre-feet, 18,500 acre-feet and 17,200 acre-feet. During 2017, which was a wet year, an estimated 50,000 acre-feet flowed through the Cucharas dam site. Normal flow through the Cucharas is approximately 22,000 acre-feet per year.
New Strategic Initiative
With our initial marijuana greenhouse projects gaining traction, in the third quarter of 2016 we determined to investigate whether our water assets might have revenue potential of their own, separate from use in irrigating farmland, that could benefit our stakeholders, including our shareholders and the communities near where our water assets are located. On September 30, 2016, our board of directors established a board-level task force to identify opportunities for our existing water assets, and perhaps acquired water assets. As a result of that investigation, water is a new top-priority for our Company.
Based on findings from our water task force, we believe we have several opportunities to capitalize on water assets that we currently own or can acquire, in order to address serious storage and supply challenges faced by municipalities, ranches, farmlands and other commercial enterprises in the Arkansas River Basin. In order to address these opportunities, we have identified the following:
● We will seek to address the need for both agricultural and municipal water storage. As discussed in the 2015 Colorado Water Plan and its Executive Summary Colorado has set a goal of attaining and additional 400,000 acre feet of storage by 2050. (Board)
● We believe there are a variety of opportunities to lease, both short term and long term, our water assets.
● We have identified underutilized land and water that we own that could be used to lease to agricultural operators including growers of marijuana and hemp.
● In January 2011, we entered into a water supply agreement to supply water resources for real estate development in Huerfano County, Colorado. In late 2018 we intend to begin the development and legal process to begin to deliver raw water to this development.
Our Greenhouse Operations
With the legalization of recreational marijuana usage in Colorado in 2012, we identified the potential use of certain of our farmland for lease to licensed marijuana growers. In May 2014, we formed GrowCo to focus and lead our efforts to take advantage of the rapidly growing demand for marijuana, both medical and recreational, within the state of Colorado.
Presently the majority of Colorado marijuana is grown in converted warehouses. Sophisticated growers understand that a warehouse production facility is not the most ideal for production. This has given rise to a strong demand for greenhouse space for marijuana production. Early estimates show a greenhouse can produce at least twice the amount of product at less than 50% of the cost compared to warehouse production. However, there are only a limited number of counties in Colorado that allow for new greenhouse construction. New construction needs to be tied to water supply. Pueblo County, where we have the majority of our land and associated water rights, allows for new greenhouse construction for lease to marijuana growers.
GCP1 - First Greenhouse
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. TR Capital and GrowCo own all of the outstanding common shares of GCP1, and GCP Super Units and financial investors own all of the outstanding preferred shares of GCP1.
The first greenhouse facilities were leased to Suncanna, LLC, or Suncanna, and were occupied in September 2015 with lease revenue accrued beginning September 1, 2015. In 2016, the Suncanna lease arrangement was the subject of administrative and judicial proceedings:
● On April 14, 2016 we were notified that Suncanna had received a notice of suspension from the Marijuana Enforcement Division of the Colorado Department of Revenue. This suspension remains in place until a hearing.
● This suspension, in addition to non-payment of back due lease payments owed, caused Suncanna to be in violation of its lease with GCP1. On April 25, 2016, GCP1 terminated Suncanna’ s lease and began an eviction process against Suncanna. Due to the eviction process, during the first quarter of 2016, we wrote off $743,000 in Lease Revenues - Related Party and $587,000 in advances to Suncanna and we 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 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 the 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. We believe that the suit has no merit and will have no material impact on our financial condition.
● On September 6, 2016, in accordance with the Writ of Restitution, Suncanna vacated the greenhouse and GCP1 took possession and began re-conditioning its greenhouse for a new tenant, which began growing operations in December, 2016.
● On October 27, 2016, in a contempt of court hearing, a Pueblo County Colorado District Court judge ruled in favor of plaintiff Aaron Van Wingerden and against GCP1 in a matter regarding the prevention of Suncanna’s access to GCP1’s greenhouse prior to Suncanna vacating the premises on September 6, 2016. We believe that this ruling was in error and are appealing this decision.
Pending the eviction of Suncanna, on August 4, 2016 GCP1 entered into a lease agreement with a related party Johnny Cannaseed, LLC, or Johnny Cannaseed, which is owned predominantly by our former Chief Executive Officer John McKowen. Under the terms of the lease, one half of the GCP1 greenhouse was sublet to a licensed marijuana grower on December 1, 2016. The second half of the greenhouse was leased to a second licensed marijuana grower on March 1, 2017. At December 31, 2016 we had recorded lease receivables of $240,000 from Johnny Cannaseed.
Johnny Cannaseed was not able to obtain a license to grow marijuana. Therefore, Johnny Cannaseed subleased, with the approval of GCP1’s board, to two tenants. In 2017 GCP1 expended $308,000 to divide the greenhouse into two areas referred to as GCP1-1 and GCP1-2. As reported by Johnny Cannaseed, for 2017 the GCP1-1 tenant paid to Johnny Cannaseed $620,000, which in turn was paid to GCP1. The GCP1-2 tenant did not pay any rent and was subsequently evicted by Johnny Cannaseed. Johnny Cannaseed has advised us it is seeking to collect back due rent from the GCP1-2 tenant. GCP1 is working with Johnny Cannaseed on how funds will be shared, if any collection occurs. For 2017 our consolidated income only recognizes the actual rent received of $620,000.
GCP2, LLC - Second Greenhouse
Our second greenhouse project is being developed by GrowCo Partners 2, LLC, or GCP2, a subsidiary of GrowCo, with the intention of leasing to licensed marijuana growers. This project will consist of a 90,000 square foot greenhouse, a 15,000 square foot processing and warehouse facility, and an extraction facility on 40 acres of land within our Pueblo grow complex. The GCP2 greenhouse structure was ordered in 2015 and construction began in January 2016. During 2016 and 2017, GCP2 raised capital for completion, but has additional capital to raise before GCP2’s greenhouse can be completed, which completion is unknown, subject to additional capital to be raised. Our construction costs for the GCP2 greenhouse totaled $3.4 million through December 31, 2017. We estimate that an additional expenditure of $3.0 million will be required to complete construction. For a summary of financing activities in connection with the GCP2 greenhouse, please see “-Liquidity and Capital Resources”.
On August 4, 2016 GCP2 entered into a lease agreement with Johnny Cannaseed. Under the terms of that agreement, rent will begin when the greenhouse is completed and ready for occupancy. If Johnny Cannaseed remains without a license to grow marijuana, then it is anticipated that Johnny Cannaseed and GCP2 will terminate the lease and obtain another grower or growers for the GCP2 facilities.
Our Organizational Structure
Since commencing operations as a farming and water company in 2009, we have built an organizational structure that enabled us to raise capital for specific projects completed by our direct and indirect subsidiaries.
In January 2014, the board of directors approved a plan to reorganize our subsidiaries in a more integrated manner based on functional operations. We formed TR Capital Partners, LLC or TR Capital, which issued all of its common units to the Two Rivers. In a series of transactions from January to September 2014, TR Capital entered into Membership Interest Purchase Agreements pursuant to which it issued and sold a total of 30,158,815 preferred units to investors in exchange for consideration comprised of $6.0 million in cash and $18.9 million of outstanding equity and equity-related securities of our subsidiaries other than HCIC Holdings, LLC and Huerfano-Cucharas Irrigation Company.
The TR Capital Partners Limited Liability Company Agreement dated as of January 31, 2014 provides that holders of preferred units generally will be entitled to receive distributions each fiscal year in an amount equal to the lesser of (a) 12% of the preferred unit holders’ aggregate capital contributions and (b) TR Capital’s Adjusted Gross Margin (as defined) for such fiscal year. Regardless of TR Capital’s operating results, however, preferred unit holders are entitled to a minimum distribution for each full fiscal year equal to 8% of their aggregate capital contributions, payable in equal quarterly installments. If TR Capital’s Adjusted Gross Margin for a fiscal year is less than 12% of the preferred unit holders’ aggregate capital contributions, the shortfall will not be payable in any subsequent fiscal year. Distributions for fiscal year 2014 for each preferred unit were prorated for the portion of the year that the preferred unit was outstanding.
Pursuant to an Exchange Agreement dated as of January 31, 2014 entered into with TR Capital and Two Rivers, any holder may surrender a TR Capital preferred unit to Two Rivers at any time for consideration consisting of (a) accrued but unpaid preferred distributions on the preferred unit through the exchange date, (b) one share of common stock and (c) a warrant to purchase an additional one-half share of common stock at a price of $2.10 per share. TR Capital may require (with limited exceptions) each of its outstanding preferred units to be surrendered to Two Rivers in exchange for such consideration at any time after January 31, 2017, at which (1) for a period of 20 trading days, at least 250,000 shares of common stock have been traded on a national securities exchange for a closing price of at least $3.00 and (b) a registration statement filed by us with the SEC is effective with respect to the shares of common stock, including shares purchasable pursuant to warrants, issuable upon such exchanges. Each warrant issued upon any such exchange generally will be exercisable at any time on or before January 31, 2019, subject to our right to redeem the warrant at any time after January 31, 2017, at which (A) for a period of 20 trading days, at least 250,000 shares of common stock have been traded on a national securities exchange for a closing price of at least $3.00 and (B) a registration statement has been filed and is effective with respect to the shares of common stock issuable pursuant to such warrant. Under the Exchange Agreement, Two Rivers also granted holders of preferred units one-time demand registration rights under which Two Rivers may be required to file a registration statement covering shares of common stock (including shares subject to warrants) issued or issuable upon exchanges of TR Capital preferred units. As of March 21, 2017, Two Rivers could be required under Two Rivers to issue and deliver to holders of outstanding TR Capital preferred units, upon exchange, up to 29,963,378 shares of common stock together with warrants to purchase up to an additional 14,168,944 shares of common stock. If Two Rivers receives any TR Capital pursuant to exchanges under the Exchange Agreement, it would be entitled to receive distributions on those preferred units pro rata with other holders of preferred units.
Following the completion of those transactions in September 2014, TR Capital and Two Rivers’ other direct and indirect subsidiaries (excluding HCIC Holdings, LLC and HCIC) entered into a series of related transactions as the result of which control and operation of those other subsidiaries and their businesses transferred to TR Capital, which is the operational division of Two Rivers. On February 16, 2017, Two Rivers’ formed Water Redevelopment Company, a Delaware Corporation. The following chart shows a high level view of our corporate organization as of March 30, 2018. For a more detailed description of ownership structure please refer to exhibit 21.1 filed herewith.
Corporate Information
Two Rivers’ is a Colorado corporation with principal executive offices at 3025 S Parker Rd, Suite 140, Aurora, Colorado, 80014 and our telephone number at that address is (303) 222-1000. Our website address is www.2riverswater.com. The information on our website is not part of this report.
Competition
Water
The rights to use water in Colorado have been fully appropriated to beneficial uses (such as agriculture irrigation and municipal and industrial applications) under court decrees and state regulation according to the prevailing Prior Appropriation Doctrine in which more senior (older) water rights take precedence in times of shortage over junior (newer) water rights. Notwithstanding significant conservation, growth in Colorado with related incremental demands for water has made the rights to divert, convey, store and use water relatively scarce and valuable. There is significant competition for the acquisition and beneficial use of historic water rights. Many competitors for the acquisition of such rights have significantly greater financial resources, technical expertise and managerial capabilities than we do and, consequently, we could be at a competitive disadvantage in assembling, developing and deploying water assets required to support our businesses. Competitors’ resources could overwhelm our efforts and cause adverse consequences to our operational performance. To mitigate such competitive risks, we concentrate our efforts in the Huerfano and Cucharas Rivers watershed where our local knowledge and control of a portfolio of water rights, storage facilities, distribution canals and productive farmland creates a somewhat protected geographic niche. To further mitigate competitive risk, we strive to actively engage with both the farming and municipalities in southeastern Colorado to explore strategies for cooperatively addressing challenges and opportunities faced by those communities-particularly to address the 130,000 acre-foot shortfall in water supplies on the Front Range, without taking valuable farmland out of production.
Leasing
There are a significant number of providers of facilities to lease to cannabis growers. Some are better capitalized than GrowCo. A significant portion of the facilities offered for lease are enclosed, warehouse space. Through GrowCo’s development of state-of-the-art greenhouses, GrowCo believes that it offers a competitive advantage to lessees of warehouse space in terms of increased production (estimated to be three times the growth) and a significantly reduced cost of production (estimated at one-third the cost). Therefore, GrowCo’s main leasing competition are other greenhouse structures offered to lease to cannabis growers. While there could be other large greenhouses for marijuana growing operations, ee are aware of only one other similar size greenhouse in the front range of Colorado. This facility is owned by the same owners of medical and retail outlets. Therefore, they are only growing product for their consumption. There are numerous other small greenhouses and others that are planned, which may be competition for our greenhouses.
Regulation
Water
Background
The right to water in Colorado is a right that can be developed, managed, purchased or sold much like real property subject to appropriate regulation. Water rights are judicially decreed and, under Colorado’s application of the Prior Appropriation Doctrine (“first in time, first in right”), senior water right holders are entitled to the beneficial use of water prior to junior holders. Consequently senior water rights are more consistent, reliable and valuable than junior rights, which may be interrupted, or “called out” in the parlance of Colorado water administration.
Along the Front Range of Colorado, water is a scarce and valuable resource. Natural precipitation varies widely throughout the year and from one year to another. Rivers, which fill, and sometimes flood, with the spring melt from the mountain snowpack, may be refreshed only with the occasional thunderstorm in the heat of the summer growing season. Annual precipitation also varies between surplus and drought. Additionally, the large majority of Colorado’s population resides on the Front Range (east of the Continental Divide) while the large majority of the state’s precipitation falls on the Western Slope (west of the Divide). Over time, many communities, farms and enterprises developed trans-mountain diversions to bring more water to the Front Range. Precipitation on the Front Range, and water diverted from the Western Slope, drain to the Mississippi River through the South Platte and Arkansas Rivers. Water on the Western Slope drains through the Colorado River. All of the state’s rivers are administered pursuant to interstate compacts with neighboring states. As a result of the variability of Colorado’s hydrology, its arrangements for diversions, storage and beneficial use, and its obligations to downstream states, Colorado has developed an integrated and complex water rights administration system.
In Colorado and the Western United States, the right to use water is based on the Prior Appropriation Doctrine, which is often referred to as “first in time, first in right.” Under this doctrine, water use is allocated to satisfy the oldest (“most senior”) water right before water is allocated to the next water right in historic chronology (a “junior water right” in comparison to a water right perfected earlier). Moreover, in Colorado, water rights and their relative priorities are protected by judicial decrees and are administered by the Office of the State Engineer, or the State Engineer, within the Colorado Department of Water Resources. The ability to consistently irrigate farmland, and thus avoid the inconsistencies of rainfall, is therefore tied to the relative seniority of historic water rights. Two Rivers is focused on developing irrigated farmland and maximizing beneficial use of the water rights associated with that farmland.
To manage water uses according to the Prior Appropriation Doctrine, Colorado maintains both judicial oversight through regional water courts and administrative oversight through the State Engineer. Water rights claims are filed in the court, adjudicated as necessary to resolve any adverse claims, and then decreed though an enforceable judgment. The State Engineer is charged with administering the accorded priorities among the various water rights in each of the state’s river systems.
Colorado water law further recognizes two distinct but related prior appropriative rights: direct diversion rights and storage rights. Direct diversion rights permit a user in priority to divert water directly from the river for immediate beneficial use (such as irrigation); storage rights permit a user in priority to divert water from the river and impound the water in a reservoir to re-time the water for later beneficial use. Thus, in Colorado, a direct diversion right must be conveyed to an immediate use; it cannot be stored without a storage right. As a result, both types of appropriative rights are often paired, when possible, so that in priority diversion rights can be re-timed through the exercise of a companion storage right to address seasonal and year-to-year variability in natural supplies. The older the appropriation date of any water right, the more reliable is its yield; similarly, the more effectively a senior diversion right is paired with a senior storage right, the more reliable each becomes.
Administration of Water Rights
In addition to the intra-state administration of water flowing in its rivers, Colorado also has inter-state water administration responsibilities because each of its major rivers (the Colorado, the North Platte and the Arkansas) is governed as well by interstate compacts with downstream states. These compacts are subject to judicial review, interpretation and enforcement under the original jurisdiction of the U.S. Supreme Court to resolve disputes among the states. In 1948, Colorado and Kansas reached an agreement that apportioned the water of the Arkansas River; Colorado was apportioned 60% of the water while Kansas is apportioned 40% of the River’s flow. In order to comply with Colorado’s obligations under the Arkansas River Compact, therefore, water rights on the Arkansas and its tributaries (including the Huerfano and Cucharas Rivers) are administered to assure the compact-required water flows at the Colorado-Kansas state line. When necessary, Colorado’s in-state uses are curtailed, in reverse order of priority, to assure compliance with the compact.
The interstate compacts (beginning with the Colorado River Compact of 1922) increased Colorado’s need to manage its apportioned water to meet the needs of its growing population along the Front Range. Trans-basin diversions (primarily tunnels and canals) were developed, under the Prior Appropriation Doctrine, to divert water from one watershed for conveyance to and use in another. Mainly, water from the Colorado River Basin, west of the Continental Divide, was diverted east to meet the water needs along the earlier developing Front Range by so-called “conservancy districts”. These projects began in the 1930’s and, although many have been in operation for decades, some remain incomplete. Increasingly, further trans-basin diversions are limited not only by competing appropriative water rights in the basins of origin but also by increasingly stringent environmental restrictions.
Stymied in their attempts to import additional surface water from distant watersheds, some municipalities and water providers began to rely on inherently unsustainable ground water “mining” (depleting aquifers for current consumption at a rate in excess of the rate at which natural recharge occurs). After decades of such ground water mining, many of the aquifers on the Front Range have been severely depleted. Some municipalities also purchased farms with water diversion rights and then ceased irrigating the farmland, transferring the water to their urban uses. Because neither the practice of ground water mining nor the practice of “buying up and drying up” farmland is sustainable, Colorado law has placed limits and regulations on both practices.
Recognizing the need for additional water sources along the Front Range, the Colorado Water Conservation Board published its 2050 Municipal and Industrial Gap Analysis in 2011. This report estimates that the Arkansas and South Platte Basins (essentially the Front Range) will have a combined average annual supply shortage of 130,000 acre-feet of water by 2050. The difficulty and expense of incremental trans-mountain diversions coupled with the unsustainability of ground water mining and agricultural-to-urban transfers-as documented by the Colorado Water Conservation Board-motivates Front Range water purveyors to address the projected gap and to identify and develop inherently scarce renewable sources of water.
As early as 2005, the Colorado General Assembly created basin roundtables to convene regional water purveyors to address the looming municipal supply gap. The roundtables were charged to identify “projects and methods to meet the consumptive and non-consumptive needs of the basin.” (Colorado House Bill 05-1177). The potential solutions include Identified Plans and Process or IPPs, Conservation, New Supply Development, and Alternatives to Agricultural Transfers.
The Arkansas River Basin Roundtable has only a few IPPs to meet the water supply gap identified in its basin. The most significant of the Arkansas Basin IPPs is the Southern Delivery System, an $800 million, 62-mile water supply pipeline and associated pumping plants currently under construction by a consortium of four regional water purveyors including Colorado Springs. These purveyors will use a portion of the capacity in the Southern Delivery System to transport water made available to each of them under their respective contracts with the U.S. Bureau of Reclamation. The Southern Delivery System connects the U.S. Bureau of Reclamation’s Pueblo Reservoir on the Arkansas River, the point of delivery under the U.S. Bureau of Reclamation contracts, with the purveyors’ service areas
In order to address a portion of the identified gap between forecast supply and demand within the Arkansas Basin and to provide a substitute source of water for Front Range communities that are too reliant on depleted ground water aquifers, the design and planning for the Southern Delivery System anticipate that other water purveyors will subscribe for pipeline capacity to transport renewable water supplies to their service areas.
Leasing to Cannabis Growers
As of December 31, 2017, 29 states and the District of Columbia allowed their residents to use medical marijuana and voters in the States of Colorado, Washington, Oregon, Alaska, California, Nevada, Maine, Massachusetts and the District of Colombia have approved and implemented regulations to legalize cannabis for adult use.
These state laws are in conflict with the Federal Controlled Substances Act, which classifies marijuana as a Schedule I controlled substance and makes marijuana use and possession illegal on a national level. The U.S. Supreme Court has ruled that the federal government has the right to regulate and criminalize marijuana, even for medical purposes, and thus federal law criminalizing the use of marijuana preempts state laws that legalize its use. The Trump administration has made numerous statements indicating that it is not an efficient use of resources to direct federal law enforcement agencies to prosecute those lawfully abiding by state-designated laws allowing the use and distribution of medical marijuana. However, the Trump administration could change its policy regarding the low-priority enforcement of federal laws and the succeeding administration could decide to enforce the federal laws more stringently.
The development of the GrowCo business model of constructing and leasing greenhouse space to licensed marijuana growers in states where growing marijuana is legal is dependent on Colorado marijuana laws remaining in force and federal laws not being enforced. If Colorado marijuana laws were not to remain in force or if federal marijuana laws were to be enforced, then GrowCo greenhouses could be used to grow organic fruits and vegetables, in which case we estimate the cash flow to GrowCo would decrease by approximately 75% but would still be positive.
Employees
At March 21, 2018, we had three full-time employees, of which two are employed at our Aurora headquarters and one works remotely from Pueblo and Huerfano County area as our ditch manager. None of our employees are covered by a collective bargaining agreement. We consider our relationship with our employees to be good.
Available Information
We file reports with the SEC, which we make available on our website free of charge. These reports include annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports, each of which is provided on our website as soon as reasonably practicable after we electronically file it with the SEC. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains a website (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us.
Item 1A.
Item 1A. Risk Factors
Investing in the common stock involves a high degree of risk. Before you decide to invest in the common stock, you should carefully consider the risk described below. The following risks are not the only ones facing our company. Additional risks and uncertainties may also impair our business operations. If any of the risks described occurs, our business, financial condition, results of operations and future growth prospects could be harmed. In these circumstances, the market price of the common stock could decline, and you may lose all or part of your investment.
Risk Factors Relating to Our Business
We can give no assurance of success or profitability to investors.
There is no assurance that we will generate revenues or profits. We have not been profitable in the past and had an accumulated deficit of $97 million as of December 31, 2017. We incurred net losses from continuing operations before taxes (excluding results from discontinued operations) of $5.7 million in 2016 and $11.7 million in 2017.
Our success will depend, to a large degree, on the expertise and experience of our sole executive officer.
Effective January 17, 2018, the board of directors appointed Wayne Harding, our Chief Executive Officer, to also serve as our interim Chief Financial Officer. Mr. Harding is our sole executive officer. Our success in identifying investment opportunities and pursuing and managing such investments will be, to a large degree, dependent upon Mr. Harding’s expertise and experience and his ability to attract and retain quality personnel. We do not maintain a key person life insurance policy on Mr. Harding. The loss of Mr. Harding would significantly delay or prevent the achievement of our business objectives. If Mr. Harding is unable or unwilling to continue his employment with us, we may not be able to replace him in a timely manner and we will have no executive personnel with experience operating our company. We may incur additional expenses to recruit and retain qualified replacements.
Our current management resources may not be sufficient for the future, and we have no assurance that we can attract additional qualified personnel.
There can be no assurance that the current level of management is sufficient to perform all responsibilities necessary or beneficial for management to perform. Our success in attracting additional qualified personnel will depend on many factors, including our ability to provide them with competitive compensation arrangements, equity participation and other benefits. There is no assurance that we will be successful in attracting highly qualified individuals in key management positions.
Any default on mortgages relating to our water and greenhouse development could have a material impact on our farming business.
Our water rights and facilities owned by our subsidiary GrowCo are subject to mortgages. If we default on a mortgage, we could lose the underlying assets. Currently there is a complaint filed against GrowCo from a large holder of GrowCo’s $4 million secured note for non-payment.
The adequacy of our water supplies depends upon a variety of uncontrollable factors.
The adequacy of our water supplies for farmland leased to others and municipalities varies from year to year depending upon a variety of factors, including:
● rainfall, runoff, flood control and availability of reservoir storage,
● availability of water in the Arkansas River watersheds,
● the amount of useable water stored in reservoirs and ground water basins,
● the amount of water used by our customers and others,
● water quality, and
● legal limitations on production, diversion, storage, conveyance and use.
Population growth and increases in the amount of water used in urban areas have caused increased stress on surface water supplies and ground water basins.
We obtain our water supply from the Cucharas and Huerfano Rivers. Our water supply and storage may be subject to interruption or reduction if there is an interruption or reduction in water supplies available to us. Our supply and storage business is dependent upon our ability to meet the requirements of the Colorado Water Engineer’s office regarding our water rights priorities.
Water shortages may:
● adversely affect our supply thereby limiting our revenue, or
● adversely affect our operating costs, for instance, by increasing the cost to purchase or lease required water if we are obligated to supply water under a lease agreement.
Our water rights may not yield full flow every year.
Water rights in Colorado are subject to the Prior Appropriation Doctrine, which accords lower priority to junior water rights. Water rights that are senior (such as our Butte Valley Ditch Right Number 1 dating from 1862) have priority over junior rights (such as our Huerfano Valley Ditch Right Number 342 dating from 1905) as to use in dry years, and junior rights may not get water or as much water as they wish, if senior rights use it all.
We may be subject to periodic litigation and other regulatory proceedings. These proceedings may be affected by changes in laws and government regulations or changes in the enforcement thereof.
From time to time, we may be involved in lawsuits and regulatory actions relating to our business, certain of which may be in jurisdictions with reputations for aggressive application of laws and procedures against corporate defendants. Some of these actions have the potential for significant statutory penalties, and compensatory, treble or punitive damages. For example, on April 3, 2018, Two Rivers was notified that the State of Colorado had filed a motion for the issuance of a contempt of court citation based upon its failure to comply with a consent decree to bring the Cucharas #5 reservoir down to silt level by March 31, 2018. Moreover, our greenhouse business in particular is subject to numerous federal laws that are in conflict with the State of Colorado and local regulations, and a significant change in enforcement of federal laws could have a material adverse effect on our ability of our tenants to operate the greenhouses and litigation costs and results of operations. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition, and results of operations. In addition, regardless of the outcome of any litigation or regulatory proceedings, these proceedings could result in substantial costs and may require that we devote substantial resources to defend our company. Further, changes in governmental regulations where we operate could have adverse effects on our business and subject us to additional regulatory actions. For a detailed list and explanation of legal proceedings, please refer to the Legal Proceedings section herein.
We are required to maintain water quality standards and are subject to regulatory and environmental risks.
We face the risk that our water supplies may be contaminated or polluted whether through our error or through actions by other agents or through acts of God. In addition, normal farming practices, including the application of pesticides, herbicides and fertilizers, introduce pollutants to waterways through irrigation water runoff. Improved detection technology, increasingly stringent regulatory requirements, and heightened consumer awareness of water quality contribute to an environment of increased risk with the possibility of increased operating costs. We cannot assure you that in the future we will be able to reduce the amounts of contaminants in our water to acceptable levels.
Our water supplies are subject to contamination, including contamination from naturally occurring compounds, pollution from man-made sources and intentional sabotage. We cannot assure you that we will successfully manage these risks, and failure to do so could have a material adverse effect on our future results of operations. We may not be able to recover the costs associated with these liabilities through our sales or insurance or such recovery may not occur in a timely manner.
The water business is heavily regulated and, as a result, decisions by regulatory agencies and changes in laws and regulations could significantly affect our business.
Regulatory decisions may impact prospective revenues and earnings, affect the timing of the recognition of revenues and expenses, may overturn past decisions used in determining our revenues and expenses and could result in impairment of goodwill. Management continually evaluates the assets, liabilities and revenues and provides for allowances and/or reserves as deemed necessary.
We may also be subject to fines or penalties if a regulatory agency determines that we have failed to comply with laws, regulations or orders applicable to our water businesses.
Regulatory agencies may also change their rules and policies, which may adversely affect our profitability and cash flows. We may also be subject to fines or penalties if a regulatory agency determines that we have failed to comply with laws, regulations or orders applicable to our water businesses. The water rights we control provide significant legal and pecuniary benefits. Any change in Colorado law that affects water rights, either in general or specific to our company, could likely have a material impact on us.
We operate in a highly competitive industry and potential competitors could duplicate our business model.
We are involved in a highly competitive industry where we compete with numerous other companies who offer similar facilities to lease to those we offer. There is no aspect of our business, which is protected by patents, copyrights, trademarks, or trade names. As a result, potential competitors could duplicate our business model with little effort. Some of our potential competitors may have significantly greater resources than we have, which may make it difficult for us to compete. There can be no assurance that we will be able to successfully compete against these other entities.
Our operations are geographically concentrated within Colorado.
Our operations are concentrated in Southeastern Colorado. As a result, our financial results are subject to political impacts, regional weather conditions, available water supply, available labor supply, utility cost, regulatory risks, economic conditions and other factors affecting Colorado, our area of operation. Southeastern Colorado has been hard hit by the on-going economic crisis. Colorado is raising taxes in order to balance the state budget and jobs may be lost to other states which are perceived as having a more business friendly climate, thereby exacerbating the impact of the financial crisis in Colorado.
We have substantial competitors who have an advantage over us in resources and management.
Most of our competitors in the water resource management business have significantly greater financial resources, technical expertise and managerial capabilities than us and, consequently, we may be at a competitive disadvantage in identifying and developing or exploring suitable business opportunities and/or acquisitions. Competitors’ resources could overwhelm our restricted efforts and adversely impact our operational performance.
The inability to attract and retain qualified employees could significantly harm our business.
The market for skilled executive officers and employees knowledgeable in water rights is highly competitive and historically has experienced a high rate of turnover. Competition for quality officers and employees may lead to increased hiring and retention costs.
Additional Risk Factors Relating to Our Greenhouse Business
Our proposed greenhouse leasing business is dependent on state laws pertaining to the marijuana industry.
Continued marijuana industry operations are dependent upon continued legislative authorization of marijuana at the state level. Any number of factors could slow or halt progress in this area. Further, progress, while encouraging, is not assured. While there is public support for legislative support of marijuana laws, numerous factors could impact the legislative process. As of December 31, 2017, 29 states, the District of Columbia, Guam and Puerto Rico allowed their residents to use medical marijuana and voters in the States of Colorado, Washington, Oregon, Alaska, California, Nevada, Maine, Massachusetts and the District of Columbia had approved and implemented regulations to legalize cannabis for adult use. The state laws are in conflict with the Federal Controlled Substances Act, which makes marijuana use and possession illegal on a national level. More stringent enforcement of Federal law, as described below under “-Marijuana remains illegal under federal law,” could cause the greenhouse leases to be terminated, or even to be confiscated by the Federal government. If the greenhouses can no longer be used for marijuana production, we plan to use the greenhouses for production of organic fruit and vegetables. This potential change of use would significantly reduce the return of the capital invested in the greenhouses.
Marijuana remains illegal under federal law.
Despite the development of a legal marijuana industry under the laws of certain states, these state laws legalizing medical and adult cannabis use are in conflict with the Federal Controlled Substances Act, which classifies marijuana as a Schedule-I controlled substance and makes marijuana use and possession illegal on a national level. The United States Supreme Court has ruled that it is the federal government that has the right to regulate and criminalize marijuana, even for medical purposes, and thus federal law criminalizing the use of marijuana preempts state laws that legalize its use. On January 4, 2018, U.S. Attorney General Jeff Sessions issued a written memorandum rescinding previous federal guidance to the effect that it was not an efficient use of resources to direct federal law enforcement agencies to prosecute those lawfully abiding by state-designated laws allowing the use and distribution of medical marijuana. The memorandum redirected U.S. prosecutors to enforce the Federal Controlled Substances Act. It is unclear at this time how strongly the federal law will be enforced and which activities will be targeted for enforcement. This significant change in the Federal government’s enforcement policy may cause financial damage to our operations.
We may be unable to develop the properties that are critical to our greenhouse business.
Our business plan involves the acquisition and development of real estate properties and support services. These properties will be used for our traditional irrigated farming business and the development of greenhouses, which will be leased to participants in the marijuana industry. The zoning and operational restrictions on marijuana industry participants may limit the availability of properties suitable for greenhouse development. While we have our Colorado property zoned for cannabis greenhouse production, this zoning can be revoked if construction has not begun. Further, we may be unable to find suitable properties once we expand outside of Colorado.
We may be unable to expand successfully into new markets.
We intend to aggressively pursue our greenhouse development to lease to licensed marijuana growers for the foreseeable future. This expansion into new markets, particularly in states where we do not currently operate, may not succeed. This expansion may expose us to new operational, regulatory or legal risks. In addition, expanding into new states may subject us to unfamiliar or uncertain local regulations that may adversely affect our operations, for example, by applying, obtaining and/or maintaining appropriate licenses. Facilities we open in new markets may also take longer to reach expected revenue and profit levels on a consistent basis and may have higher construction, occupancy or operating costs than facilities we open in existing markets, thereby affecting our overall profitability. New markets may have competitive conditions, consumer preferences and spending patterns that are more difficult to predict or satisfy than our existing markets.
We currently have only one tenant for our two greenhouse.
GCP1, LLC leases our only currently operating greenhouse and warehouse to Amerijuana, pursuant to a lease agreement dated February 1, 2018 and ending August 31, 2020. If Amerijuana’s business operations fail, it might a long period before we could find a replacement tenant. Presently, Amerijuana only occurs approximately ½ of GCP1’s greenhouse. We have leased our second greenhouse to another tenant. The tenant will not take occupancy until construction has been completed and it has received all regulatory approvals. There is no assurance that construction will be completed or that these approvals will be received by the prospective tenant.
The leasing market for marijuana lessees could be volatile.
The lease rate for our current tenant in the first greenhouse is $20 per square foot, triple net. The development and construction cost for this 105,000 square foot greenhouse and facilities was approximately $65 per square foot. If we have to replace the current tenant, or the prospective tenant in the second greenhouse, there can be no assurance that the greenhouses can be leased at the same rate and for a long enough time period to recover our capital cost, thereby decreasing our returns.
Our greenhouse lessees may not be able to fund lease and service payments.
If GrowCo’s tenants incur unforeseen weather, negative crop events, or a major reduction of the price of marijuana, the tenant may not be able to pay lease and service payments. This would cause a legal action to the eviction of the tenant and a search for a new tenant, which may not be successful.
Our future success depends on our ability to attract new greenhouse lessees.
Our immediate plan is to construct additional greenhouses on a 160-acre plat. There is no assurance that our existing tenant will lease the additional greenhouses or that we can attract new tenants.
Our failure to obtain capital may significantly restrict our proposed greenhouse operations.
We need capital to fund our greenhouse expansion. While we have been successful in accessing capital for the first greenhouse, we do not know if future capital raising will be successful. Our failure to obtain the capital, which we require for greenhouse expansion, may result in the slower implementation of our GrowCo business plan.
Tenants of GrowCo may have difficulty accessing the service of banks, which may make it difficult for them to operate and remit payments.
Since the use of marijuana is illegal under federal law, many banks will not accept for deposit funds from businesses involved with marijuana. Consequently, businesses involved in the marijuana industry often have trouble finding a bank willing to accept their business. The inability to open bank accounts may make it difficult for potential tenants of GrowCo to operate. There may also be an issue with GrowCo’s ability to deposit payments from its tenants.
Laws and regulations affecting the medical marijuana industry are constantly changing, which could detrimentally affect our greenhouse leasing operations.
Local, state and federal medical marijuana laws and regulations are broad in scope and subject to evolving interpretations, which could require us to incur substantial costs associated with compliance or alter our business plan. In addition, violations of these laws, or allegations of such violations, could disrupt our business and result in a material adverse effect on our operations. Furthermore, it is possible that regulations may be enacted in the future that will be directly applicable to our leasing activities. We cannot predict the nature of any future laws, regulations, interpretations or applications, nor can we determine what effect additional governmental regulations or administrative policies and procedures, when and if promulgated, could have on our business.
Risk Factors Related to Ownership of Common Stock
We may in the future issue more shares of capital stock, which could cause a loss of control by present management and current shareholders and/or dilution to investors.
There may be substantial dilution to our shareholders as a result of future decisions of the board of directors to issue shares without shareholder approval for cash, services, or acquisitions at prices solely determined by the board. Additionally, upon issuance, such shares could represent a majority of the voting power and equity of our company. The result of such an issuance would be those new shareholders and management would control our company, and persons unknown could replace existing management at such time.
Our common shareholders could face substantial potential dilution from outstanding common stock equivalents.
As of March 29, 2018, 32,749,920 shares of common stock were outstanding. A total of up to 8,000,000 shares of common stock, all of which may be offered from time to time pursuant to this prospectus, may be issued upon conversion of a 12.5% original issue discount convertible promissory note we issued on February 9, 2018 to Powderhorn, LLC, one of the selling shareholders. If holders convert their TR Capital Partners, LLC preferred units into shares of common stock, we would issue up to an additional 29,881,698 shares of common stock and warrants to acquire an additional 14,168,944 shares of common stock at $2.10 per share. In addition, as of March 30, 2018, there were outstanding options to acquire 3,036,500 shares of common stock and restricted stock units, or RSUs, covering 118,000 shares of common stock. As a result, there may be a substantial dilution to our existing shareholders.
We need additional capital in the future to finance our operations, which we may not be able to raise or it may only be available on terms unfavorable to us or our stockholders, which may result in our inability to fund our working capital requirements and harm our operational results.
We have and expect to continue to have substantial capital expenditure and working capital needs. We do not now have funds sufficient to fund our operations at their current level for the next 12 months. We need to raise additional cash to fund our operations and implement our business plan. We are maintaining an on-going effort to locate sources of additional funding, without which we will not be able to remain a viable entity. If we are able to obtain the financing required to remain in business, eventually achieving operating profits will require substantially increasing revenues or drastically reducing expenses from their current levels or both. If we are able to obtain the required financing to remain in business, future operating results depend upon a number of factors that are outside of our control. The expected operating losses, coupled with a lack of liquidity, raise a substantial doubt about our ability to continue as a going concern. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced, and these newly issued securities might have rights, preferences or privileges senior to those of existing stockholders.
The regulation of penny stocks by SEC and FINRA may discourage the tradability of common stock.
We are classified as a “penny stock” company. The common stock currently trades on the OTCQB Market and is subject to an SEC rule that imposes special sales practice requirements upon broker-dealers who sell such securities to persons other than established customers or accredited investors. For purposes of the rule, the phrase “accredited investors” means, in general terms, institutions with assets in excess of $5,000,000, or individuals having a net worth in excess of $1,000,000 (not including the principal residence) or having an annual income that exceeds $250,000 (or that, when combined with a spouse’s income, exceeds $300,000). For transactions covered by the rule, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written agreement to the transaction prior to the sale. Effectively, this discourages broker-dealers from executing trades in penny stocks. Consequently, the rule will affect the ability of purchasers in this offering to sell their securities in any market that may develop therefore because it imposes additional regulatory burdens on penny stock transactions.
In addition, the SEC has adopted a number of rules to regulate “penny stocks,” including Rules 3a51-1, 15g-1, 15g-2, 15g-3, 15g-4, 15g-5, 15g-6, 15g-7 and 15g-9 under the Exchange Act. Common stock constitutes a “penny stock” within the meaning of these rules, and these rules imposes additional regulatory burdens that may affect the ability of holders to sell common stock in any market that may develop.
The market for penny stocks has suffered in recent years from patterns of fraud and abuse, including:
● control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer;
● manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases;
● “boiler room” practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons;
● excessive and undisclosed bid-ask differentials and markups by selling broker-dealers; and
● wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, causing investor losses.
We cannot dictate or anticipate the behavior of the market or of broker-dealers who participate in the market.
Rule 144 sales of common stock in the future may have a depressive effect on our stock price.
Some of the outstanding shares of common stock held by our officers, directors and affiliated shareholders are “restricted securities” within the meaning of Rule 144 under the Securities Act of 1933. As restricted shares, these shares may be resold only pursuant to an effective registration statement or under the requirements of Rule 144 or other applicable exemptions from registration under the Act and as required under applicable state securities laws. Rule 144 provides in essence that a person who has held restricted securities for six months may sell without restriction, except for affiliates which, under certain conditions, may sell every three months, in brokerage transactions, a number of shares that does not exceed the greater of 1.0% of a company’s outstanding common stock or the average weekly trading volume during the four calendar weeks prior to the sale. There is no limit on the amount of restricted securities that may be sold by a non-affiliate after the owner has held the restricted securities for a period of six months. A sale under Rule 144 or under any other exemption from the Securities Act, if available, or pursuant to subsequent registration of shares of common stock of current shareholders, may have a depressive effect upon the price of common stock in any market that may develop. There may be substantial dilution to our shareholders as a result of future decisions of the board of directors to issue shares without shareholder approval for cash, services or acquisitions at prices determined solely by the board.
Our stock is thinly traded and as a result shareholders may be unable to sell at or near ask prices or at all.
Shares of common stock are thinly traded on the OTCQB market, meaning that the number of persons interested in purchasing common stock at or near ask prices at any given time may be relatively small. This situation is attributable to a number of factors, including the fact that we are a small company that is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume and that even if we came to the attention of such persons, they may be risk-averse and reluctant to follow an early stage company or purchase or recommend the purchase of any of our securities until such time as we became more seasoned and profitable. As a consequence, there may be periods of several days or more when trading activity in our securities is minimal or non-existent, as compared to a seasoned issuer which has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect its securities price. We cannot give you any assurance that a broader or more active public trading market for our common securities will be developed or sustained. Due to these conditions, we can give investors no assurance that they will be able to sell their shares at or near ask prices or at all if they desire to liquidate shares of common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTIES
Our corporate headquarters are located in Aurora, Colorado, where we lease 1,554 square feet of office space pursuant to a lease agreement that will expire on March 31, 2020. We believe that our current office facilities will be sufficient to meet our operational needs for the remainder of the existing lease term and that, upon the expiration of our current lease term, we will be able to extend our lease or lease suitable replacement office space as needed on acceptable, commercially reasonable terms. Effective April 1, 2017, we subleased our former office space to McGrow, LLC, a related party.
We operate in the combined watershed area of the Huerfano River and Cucharas River in the Arkansas River Basin, an area encompassing 1,860 square miles on the southern Front Range in Colorado. As of December 31, 2017, we managed a total of 6,682 acres of land that we acquired since 2009, as shown in the following table. The following table presents the number of acres we owned by usage as of the dates indicated:
The following table presents the number of acres we owned by location as of the dates indicated:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Since 2016, the Suncanna lease arrangement was the subject of administrative and judicial proceedings:
● On April 14, 2016 we were notified that Suncanna LLC had received a notice of suspension from the Marijuana Enforcement Division of the Colorado Department of Revenue. This suspension remains in place until a hearing.
● This caused Suncanna to be in violation of its lease with GCP1. On April 25, 2016, GCP1 terminated Suncanna’s lease and began an eviction process against Suncanna. Due to the eviction process, during the three months ended March 31, 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.
● On July 22, 2016 GCP1 received a Writ of Restitution from the Pueblo County Colorado District Court ordering Suncanna to vacate the 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. We believe that the suit has no merit and will have no material impact on our financial condition.
● On September 6, 2016, in accordance with the Writ of Restitution, Suncanna vacated the greenhouse and GCP1 took possession and began re-conditioning its greenhouse for a new tenant, who began growing operations in the fourth quarter of 2016.
● On October 27, 2016, in a contempt of court hearing, a Pueblo County Colorado District Court judge ruled in favor of plaintiff Aaron Van Wingerden and against GCP1 in a matter regarding the prevention of Suncanna’s access to GCP1’s greenhouse prior to Suncanna vacating the premises on September 6, 2016. We believe that this ruling was in error and are appealing this decision.
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.
Two Rivers, 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 to have certain water rights demands by the neighboring water rights holders deemed wasteful. In the quarter ending March 31, 2016, Two Rivers entered into a stipulation agreement with the State, settling the State's claims, whereby Two Rivers agreed to take the existing dam structure down to the sediment level. Two Rivers has been able to empty all the water in the Dam, but it was not be able to meet the requirements of the stipulation agreement by March 31, in part due to lack of capital. On April 3, 2018, Two Rivers was notified that the State had filed a motion for the issuance of a contempt of court citation based upon its failure to comply with the consent decree by March 31, 2018. Two Rivers intends to defend against the sanctions sought in the contempt motion, based in part upon those sanctions being unnecessary and unduly punitive. A hearing has been set for the contempt proceedings on May 10, 2018. The State is requesting the Company to pay $100,000 as a penalty for violating the stipulation agreement. The Company’s engineering firm estimate the cost to breach the dam structure to be between $1.8 to $2.2 million.
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 Two Rivers 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, the mater is scheduled for trial in October, 2018. 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 DFP farming operation for alleged theft. We are in the process of gathering evidence of the theft and setting a court hearing date. A former employee of DFP has filed a counter claim against the Company, which amount is immaterial. Management believes that claims against former employees are in excess of any counter claims.
On January 19, 2018 Blue & Green, LLC (“Blue Green”) filed a complaint against GrowCo, Inc. claiming a default on payments by GrowCo to Blue Green under the terms of the GrowCo $2,115,000 promissory note held by Blue Green. The complaint is requesting immediate payment of the note, back due interest in excess of $300,000, and attorney fees.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock
Common Stock is traded in the over-the-counter market on the OTC Bulletin Board maintained by the Financial Industry Regulatory Authority, or FINRA. On September 17, 2007, common stock began trading on the over-the-counter bulletin board as Navidec Financial Services, under the symbol “NVDF”. On October 13, 2010, due to a name change the common stock began trading on the over-the-counter QB market under the symbol “TURV”.
The following table sets forth the range of high and low bid quotations for common stock during each quarter of 2017 and 2016. The quotations were obtained from information published by FINRA and reflect inter-dealer prices, without retail mark-up, mark-down or commission and do not necessarily represent actual transactions.
The last sale price of common stock on April 5, 2018 on the OTCQB market was $0.21 per share. As of December 31, 2017, there were 463 holders of record. We estimate that there are approximately 5,130 beneficial shareholders. In many instances, a registered shareholder is a broker or other entity holding shares in street name for one or more customers who beneficially own the shares.
Our transfer agent is Broadridge Financial Solutions, Inc., 1717 Arch St., Suite 1300, Philadelphia, Pennsylvania 19103, phone: (215) 553-5400.
Dividends on Common Stock
We have never declared or paid any cash or stock dividends to holders of common stock. Any future dividends would be declared at the discretion of the board of directors and would depend upon such factors as the board deems relevant, including our ability to generate positive cash flows from operations.
Penny Stock Regulation
Broker-dealer practices in connection with transactions in “penny stocks” are regulated by certain penny stock rules adopted by the SEC. Penny stocks generally are equity securities with a price of less than $5.00. Excluded from the penny stock designation are securities listed on certain national securities exchanges or quoted on NASDAQ, provided that current price and volume information with respect to transactions in such securities is provided by the exchange/system or sold to established customers or accredited investors.
The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in connection with the transaction, and the monthly account statements showing the market value of each penny stock held in the customer’s account. In addition, the penny stock rules generally require that prior to a transaction in a penny stock, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction.
These disclosure requirements may have the effect of reducing the level of trading activity in the secondary market for common stock, and investors therefore may find it more difficult to sell their common stock.
Recent Sales of Unregistered Securities
During the year ended December 31, 2017, Two Rivers had the following common stock transactions:
● In January 2017 we issued 7,500 RSU shares to a director for service in 2016. We also issued 855,385 shares for early warrant exercises.
● In February, 2017 we issued 9,000 shares for investor relations services. We also issued 846,631 shares for early warrant exercises.
● In March, 2017 we issued 10,000 shares to a prior director for 2016 service. We also issued 29,680 shares for early warrant exercises.
● In August, 2017 we issued 16,200 shares for investor relations service. We also issued 339,750 shares for early warrant exercises and 111,000 for a RSU exercise.
● In October, 2017 we issued 49,366 for partial payment of our Black Mountain bridge loan.
● In November, 2017 we issued 13,333 shares to a prior director for 2016 service.
All of the sales of unregistered securities were made in reliance upon Regulation D and Section 4(2) of the Securities Act of 1933. Cash received from the above transactions were used for general administrative purposes.
ITEM 6.
ITEM 6. SELECTED FINANCIAL INFORMATION
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto and the other financial information included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward looking statements as a result of any number of factors, including those set forth under “Risk Factors” and elsewhere in this report.
Overview
In the short-term, our business model is designed to provide us with increased profitability and cash flow that will enable us to acquire and develop additional water rights and infrastructure. We seek to concentrate our acquisitions on water rights and infrastructure that are, in part, owned by municipalities, which can alleviate and expedite the legal and political processes necessary for municipal consumers to obtain excess water.
Since 2009, we have acquired strategic water assets and land in the Huerfano and Cucharas river basins in southeastern Colorado, thus the name Two Rivers. In October 2016 we began to focus on monetizing our assets by investing strategically in assets that we believe offer opportunities for significant future returns for our shareholders and by selling those assets we determine will not yield those returns. As the result of that process, the management of water has become our core business., Our water asset total drainage area spans over 1,500 square miles and drops in elevation from over 14,000 feet to 4,500 feet at the confluence of the Arkansas River, just east of Pueblo, Colorado. We operate in a natural, gravity fed water alluvial, which is is the last undeveloped basin along the front range of Colorado. As our first water-focused project, we plan to develop this basin to properly manage the water contained therein and serve the community while providing returns to our investors. Our water development operations and strategy are described below under “─Our Water Operations.”
Our principal investments since commencing operations in 2009, and the status of those investments following the implementation of our monetization strategy in 2016, are described below:
● HCIC: From 2009 to 2010 we purchased 95% of the outstanding shares of Huerfano-Cucharas Irrigation Company, or HCIC, in a series of transactions for $24.2 million in cash, promissory notes and Two Rivers’ common stock. HCIC is a mutual ditch company formed in 1944, and we have used its water rights and facilities to supply some of our farmland with irrigation water. In the future, we will use these water rights to supply water to farmland we lease to others and to implement our new water strategy.
● Additional Farmland: From 2009 to 2011 we acquired 2,753 acres of farmland served by HCIC’s ditch system for purchase prices totaling $1.4 million in cash and seller carry back financing. In 2012 we acquired 1,584 acres in Butte Valley for $509,000 in cash and seller carry back financing. In 2016, we returned 187 acres of Butte Valley land back to the holder of seller carry back financing in exchange for forgiveness on $187,000 of debt and associated accrued interest.
● Orlando: In 2011 we acquired Orlando Reservoir No. 2 Company, LLC, or Orlando, for $3.45 million in cash, promissory notes and common stock. Our ownership of Orlando increases the reliability of water supplies for our farmland in the Huerfano and Pueblo river basins. We undertook a program to refurbish and restore Orlando’s diversion structure, storage reservoirs and conveyance system. During the period from November 2011 to February 2012, we constructed new outlet works, and in 2012 we reconstructed the diversion structure, which takes water from the Huerfano River for storage in the Orlando reservoir and then conveyance to irrigate our nearby leased farmland. Additional renovation projects will be completed as necessary to provide reliable water supplies for farmland we lease to others and community use.
● DFP (discontinued operations): In 2012 we acquired Dionisio Farms & Produce, Inc., or DFP, for $3.4 million in cash and promissory notes. DFP, which has operated for more than 60 years, produces high-value fruits and vegetables as well as fodder crops. Through this acquisition, we obtained 146 acres of irrigable farmland, 146 shares of the Bessemer Ditch Irrigation Company, a senior water right holder on the main stem of the Arkansas River and 2 supplemental ground water wells. As part of the acquisition, we entered into leases for an additional 279 irrigable acres. In late 2016, based on three years of operational losses, we decided to sell DFP assets and wind down our produce growing and distribution business, and during the first quarter of 2017 we sold the DFP irrigated farmland and the associated DFP produce business that no longer served our strategic vision of water management
● GrowCo: We formed GrowCo, Inc., or GrowCo, in May 2014 for the purpose of constructing state-of-the-art computer controlled greenhouses to be leased to licensed marijuana growers throughout the United States. GrowCo is not a licensed marijuana grower or retailer. GrowCo does not “touch the plant” and only provides growing infrastructure as a landlord for licensed marijuana grower tenants along with support and administrative services. In August 2014 we announced we were reserving 10 million of the GrowCo shares for distribution to holders of common stock as of four record dates (January 1, 2015; April 1, 2015; July 1, 2015 and October 1, 2015) after a registration statement for GrowCo common shares has been filed and declared effective, which has not yet occurred. Currently, GrowCo has 30 million common shares outstanding, of which 6.7 million shares are subject to performance unvesting, which has yet to occur. [UPDATE]
● Water Redev: We formed Water Redevelopment Company, or Water Redev, in February 2017 to separate our water assets from the rest of our business and to enable additional raising of capital solely for the purpose of investing in our water assets. Water Redev is a subsidiary of Two Rivers and focuses on development and redevelopment of infrastructure for water management and delivery, as further described in “─Our Water Operations” below.
Revenue
Water
During fiscal year 2017 we had negligible revenues from our water business as our new initiatives have not yet gained traction. We also anticipate negligible water revenues in 2018 as we begin our reinvestment into our water assets. In 2019, we expect that revenue will be generated from the leasing of water from our storage facilities, the selling of water taps, and the leasing of land and water to agricultural users including marijuana and hemp growers.
Greenhouse Leasing
GCP1 leased the first greenhouse and warehouse to related party Johnny Cannaseed pursuant to a lease agreement dated August 4, 2016, which was subsequently terminated effective January 31, 2018. The lease agreement was classified as an operating lease because it does not meet any of the four criteria which listed in ASC 840-10-25,“Lease Classification Criteria”. Before termination, Johnny Cannaseed subleased the greenhouse and warehouse to two licensed marijuana growers.
Revenue from the first half of the greenhouse (GCP1-1) began accruing on December 1, 2016. For the year ended December 31, 2017, total lease revenue from GCP1-1 was $620,000. The second half of the greenhouse (GCP1-2) began accruing revenue on March 1, 2017. However, due to non-payment, Johnny Cannaseed evicted the GCP1-2 tenant in December, 2017. Concurrently GCP1-2 remains unoccupied.
Effective February 1, 2018, the Johnny Canaseed lease was mutually terminated. This lease was replaced by a lease to Amerijunna LLC, effective February 1, 2018 and expiring August 31, 2020.
Related Party Transactions
Pursuant to ASC 850 “Related Party Disclosure”, during the year ended December 31, 2017, management has evaluated related parties and all transactions associated with those and determined that no transactions exist which would require disclosure, except as disclosed below:
● Wayne Harding, Company Chief Executive Officer provided a short term loan to the Two Rivers of $25,000. The loan is secured by land assets of the Two Rivers and carried an interest rate of 12%. The loan was paid off in the third quarter of 2017.
● Advances totaling $34,400 resulting in a cumulative total of $72,999 for greenhouse expenses to Johnny Cannaseed, LLC which is majority owned by former Company Chief Executive Officer John McKowen.
● Revenue totaled $620,000 has been recorded for leasing income from Johnny Cannaseed.
● Advances totaled $26,957 resulting in a cumulative total of $43,798 for greenhouse expense to McGrow, LLC which is partially owned by our former Company Chief Executive Officer John McKowen.
● Payments totaling $335,531 to MCG Services, LLC which is majority owned by former Company Chief Executive Officer John McKowen for costs associated with a services agreement with GrowCo.
● Advances to MCG Services, LLC totaled $13,295. This amount was written off.
● Payments totaling $11,210 to John McKowen for interest expense on a loan held by Mr. McKowen to GrowCo.
● Existing investors, including the Thomas Prasil Trust who is a greater than 5% investor, have invested approximately $11.0M in GrowCo securities.
● The Chief Executive Officer of Two Rivers serves as the only members of the Sunset Metropolitan District (Sunset). Sunset is a quasi-governmental agency operating under Title 32 of the State of Colorado Constitution. As of December 31, 2017, Two Rivers had advanced $81,000 to Sunset.
● On June 29, 2017, a mediation session was held in Colorado Springs between all parties involved with the Suncanna lawsuit along with each party’s legal counsel. To date, no settlement has been proposed.
● Two Rivers leases its former corporate headquarters office space to McGrow. Total lease payments are $47,000 per year.
● Wayne Harding, Company Chief Executive Officer provided a long-term loan to Two Rivers of $50,000. The loan is secured by land assets of Two Rivers and carries an interest rate of 18%.
● Wayne Harding provided a short-term loan to Two Rivers of $32,500 in the quarter ended December 31, 2017. $17,500 was repaid before the year ended December 31, 2017. The remainder, $15,000 plus interest was paid in February 2018.
Results of Operations
Year ended December 31, 2017 compared to year ended December 31, 2016
For the years ended December 31, 2017 and 2016 our revenues have been predominantly derived from our greenhouse leasing activities. Near the end of 2016 we decided to discontinue our farming operations. Consequently we have classified our farming financial results on our income and balance sheet statements as Discontinued Operations.
During the year ended December 31, 2017, we recognized $620,000 of greenhouse lease income. Due to past problems with our greenhouse tenants and agreements reached with Johnny Cannaseed and its sub-tenant and payment of rent in early 2018, management decided to only recognize actual lease payments received. We also recognized $72,000 of other income which was from both water and land leasing activities. After the direct cost of our leasing activities, we reported a gross margin of $659,000 for the year ended December 31, 2017 compared to $272,000 for the year ended December 31, 2016.
Our first greenhouse began to generate revenue on September 1, 2015 and was partially occupied by Suncanna (our former related party tenant, as described under “Overview”). Suncanna had agreed to pay the full lease payments effective September 1, 2016. At December 31, 2015, we had recorded lease receivables of $904,000 and deferred rent of $43,400 in connection with the Suncanna lease arrangements. On April 14, 2016 we were notified that Suncanna LLC had received a notice of suspension from the Marijuana Enforcement Division of the Colorado Department of Revenue.
Due to the suspension order and Suncanna’s non-payment, Suncanna was in violation of its lease agreement with us. On April 25, 2016, GCP1 terminated Suncanna’s lease and began an eviction process against Suncanna. Consequently, during the quarter ended March 31, 2016, we stopped recognizing lease revenue and wrote off the $700,000 lease receivable and $43,000 deferred rent that had been recorded as of December 31, 2015. We also wrote off advances to Suncanna totaling $587,000.
During the year ended December 31, 2017, expenses from operations were $9,398,000 compared to $3,877,000 for the year ended December 31, 2016. The increase of $5,521,000 was primarily due to recognition of an impairment of our water infrastructure of $6,900,000 offset by lower general and administrative and a lower expense from the write-off of tenant receivables.
During the year ended December 31, 2017, other expenses were $2,914,000 compared to $2,090,000 for the year ended December 31, 2015. The increase in other expenses of $824,000 was the result of an increase in GrowCo interest expense of $879,000 partially offset by a reduction of warrant expense.
These figures produced a net loss from continuing operations of $11,653,000 for the year ended December 31, 2017 compared to a net loss of $5,695,000 for the year ended December 31, 2016.
Loss due to discontinued operations was $2,624,000 for the year ended December 31, 2016. There was a loss from discontinue operations for the year ended December 31, 2017 of $1,045,000.
Net loss attributable to noncontrolling interests was $637,000 for the year ended December 31, 2017 compared to a loss of $200,000 for the year ended December 31, 2016.
Preferred distributions for the year ended December 31, 2017 was $863,000 compared to $2,608,000 for the year ended December 31, 2016. The reduction of $1,745,000 was mostly attributed to the recapture of recorded preferred distributions to GCP1 preferred members due to write off of lease revenue.
The above produced a loss to Two Rivers common shareholders of $12,924,000 for the year ended December 31, 2017 compared to $10,727,000 loss for the year ended December 31, 2016.
Liquidity and Capital Resources
Resources
We have expanded our operations relying on various funding mechanisms, including debt, convertible debt and equity capital. Since inception, we have raised and invested over $82 million to acquire, improve, integrate farm/water assets and launch and expand our GrowCo greenhouse facilities and support operations.
With the discontinuance of our farming operations we no longer require the large capital outlay for crop inputs. We believe our existing cash, cash equivalents, our projected cash flows from greenhouse leasing operating activities and anticipated influx of capital from financing activities will be sufficient to meet our anticipated cash needs for at least the next twelve months. On February 9, 2018 Two Rivers closed a PIPE (private investment in public entity) that provided net funding of $515,000. The proceeds were used to help reduce our accounts payable and provide working capital. It is important for Two Rivers to acquire additional funding. At this time, we have no further definitive agreements to provide the necessary funding.
Our future working capital requirements will depend on many factors, including the expansion of water projects and expansion of our greenhouse development. To the extent our cash, cash equivalents and cash flows from operating activities are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. We also may need to raise additional funds in the event we determine in the future to affect one or more acquisitions of businesses, technologies and products. If additional funding is required, we may not be able to affect an equity or debt financing on terms acceptable to us or at all.
We historically have funded our operations primarily from the following sources:
● equity and debt proceeds through private placements of Parent Company and subsidiaries securities;
● revenue generated from operations; and
● loans and lines of credit.
At the present time we have no available line or letters of credit.
Cash flow from operations has not historically been sufficient to sustain our operations without the above additional sources of capital. As of December 31, 2017, we had cash and cash equivalents of $14,000. Cash flow consumed by our operating activities totaled $2,898,000 for the year ended December 31, 2017 compared to operating activities consuming $2,729,000 for the year ended December 31, 2016.
As of December 31, 2017, we had $70,000 in current assets and $24,777,000 in current liabilities. A large portion of the current liabilities ($6,301,000) is from the HCIC seller carry back notes, some of which were due June 30, 2016. As of December 31, 2017, we are in default on the HCIC note payments. As a result, the entire amount of the notes has been classified as current. Another large portion of the current liabilities is $10,607,000 in GrowCo notes payable. These notes are also in default due to not being current on the interest due on these notes. While there is no assurance, management believes it will be successful in restructuring these notes and bring them current.
Cash provided in investing activities for the year ended December 31, 2017 was $1,215,000, due to a net of $1,721,000 from the sale of property and equipment offset by $506,000 in construction in progress. Cash used in investing activities for the year ended December 31, 2016 was $3,480,000. This was comprised of $2,597,000 for construction in progress, $691,000 for investment in water assets and $192,000 for purchase of equipment.
Cash produced in financing activities was $1,547,000 for the year ended December 31, 2017 compared to a production of cash of $5,838,000 for the year ended December 31, 2016. The decrease of $4,291,000 was due to proceeds from the sale of GCP Super Units LLC preferred member in 2016 of $1,095,000 that was reduced to $345,000 in 2017. Further in 2016 GrowCo issued $5,237,000 in notes which was reduced to $2,456,000 in 2017. For the year ended December 31, 2017, there was a reduction of notes payable of $1,560,000 compared to $950,000 for the year ended December 31, 2016.
Requirements
In January 2015 we renewed a lease with the Colorado Center in Denver, Colorado, for our corporate headquarters. The space is 1,775 square feet and monthly payments of $3,900, with minor escalations and common area maintenance charges. The lease terminates on August 31, 2018. On March 1, 2017 Two Rivers entered into a sub-lease agreement with related party McGrow for these office facilities. The sub-lease began April 1, 2017. The amounts due at the base rate are as follows:
In February 2017 we entered into a new lease with Parker Road Campus, LLC in Aurora, Colorado, for our corporate headquarters. This space is 1,554 square feet and monthly payments of $2,201. The lease terminates on March 31, 2020. Two Rivers’ previous corporate headquarters has been sub-leased to a related party McGrow, LLC, a related party, for the remainder of that lease term. The amounts due at the base rate for our new offices are as follows:
Below is a table showing our anticipated principal payments due by periods.
Critical Accounting Policies
We have identified the policies below as critical to our business operations and the understanding of our results from operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Conditions and Results of Operations where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 2 in the Notes to the Consolidated Financial Statements beginning on page of this document. Note that our preparation of this document requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.
Revenue Recognition
Lease Revenues - Related Party
During the year ending December 31, 2017, GrowCo Partners 1, LLC, leased its only currently operating greenhouse and warehouse to a related party Johnny Cannaseed pursuant to a lease agreement dated August 4, 2016, which was subsequently terminated effective January 31, 2018. The lease agreement was classified as an operating lease because it does not meet any of the four criteria which listed in ASC 840-10-25,“Lease Classification Criteria”. Before termination, Johnny Cannaseed subleased the greenhouse and warehouse to two licensed marijuana growers.
Revenue from the first half of the greenhouse (GCP1-1) began accruing on December 1, 2016. For the year ended December 31, 2017, total lease revenue from GCP1-1 was $620,000. The second half of the greenhouse (GCP1-2) began accruing revenue on March 1, 2017. However, due to non-payment, Johnny Cannaseed evicted the GCP1-2 tenant in December, 2017. Concurrently GCP1-2 remains unoccupied.
Effective February 1, 2018, the Johnny Cannaseed lease was mutually terminated. This lease was replaced by a lease to Amerijuna LLC, effective February 1, 2018 and expiring August 31, 2020.
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 the Two Rivers to HCIC are eliminated in consolidation of the financial statements.
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.
Debt and Equity
Two Rivers accounts for warrants issued with debt in accordance with Accounting Standards Codification (“ASC”) 470, Debt, and allocates proceeds received to the warrants based on relative fair values.
Two Rivers also evaluates whether the issuance of the convertible instruments generates a beneficial conversion feature (“BCF”), which arises when a debt or equity security is issued with an embedded conversion option that is beneficial to the investor or in the money at inception because the conversion option has an effective strike price that is less than the market price of the underlying stock at the commitment date. Two Rivers would recognize the BCF by allocating the intrinsic value of the conversion option, which is the number of ordinary shares available upon conversion multiplied by the difference between the effective conversion price per share and the fair value of each ordinary share on the commitment date, to additional paid-in capital, resulting in a discount on the convertible preferred shares or debt instruments. No BCF has been recognized in the periods presented.
Stock Based Compensation
We account for share-based payments in accordance with FASB Accounting Standards Codification (“ASC”) 710-10-55. We use the Black-Scholes option valuation model to estimate the fair value of stock options and warrants issued under ASC 710-10-55. For the years ended December 31, 2017 and 2016, equity compensation in the form of stock options, warrants and grants of restricted stock that vested totaled $534,000 (including both Two Rivers and Water Redevelopment Company) and $477,000, respectively.
Impairments
Once per year we assess the value of the water rights held by the Company, comparing our estimated values with recent sales of comparable water rights along with depreciation of the infrastructures. In the event that such assessment indicates that the carrying value is greater than the fair market value of the water rights or the depreciable replacement cost of our infrastructure, an impairment will be recorded. If impairment is necessary, a loss on value of our water rights will be recorded, and the impairment will not be reversed in future periods.
Prior to the year ended December 31, 2017, the Company recognized a $30,000 impairment on the Company’s land and water shares.
For the year ended December 31, 2017, the Company examined the depreciable replacement cost of its water infrastructure. This analysis caused the recognition of $6,900,000 impairment to the water infrastructure.
Recently Issued Accounting Pronouncements
In July 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) “Income Statement - Reporting Comprehensive Income (Topic 220)”. This ASU deals with the reclassification of certain tax effects from Accumulated Other Comprehensive Income. We do not believe that there will be any significant financial impact due to prior taxable losses and our net operating loss carry forward.
In July 2017, FASB issued ASU “Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815)”: (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. Management believes that Topics 260 and 480 pertains to the Company and the impact will be immaterial.
In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows”. The new guidance will require that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents is required to be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new guidance is effective for interim and annual periods beginning after December 15, 2017 and early adoption is permitted. The amendment should be adopted retrospectively. We plan to adopt this new guidance in the first quarter of fiscal year 2018 and does not expect the adoption to have a material impact on our financial statements.
In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Compensation Accounting”, which requires that excess tax benefits are recorded on the income statement as opposed to additional paid-in-capital, and treated as an operating activity on the statement of cash flows. ASU 2016-09 also allows companies to make an accounting policy election to either estimate the number of awards that are expected to vest (current U.S. GAAP) or account for forfeitures when they occur. ASU 2016-09 further requires cash paid by an employer when directly withholding shares for tax-withholding purposes to be classified as a financing activity on the statement of cash flows. The ASU 2016-09 was subsequently updated with ASU 2017-09, issued in May 2017. These standards will become effective for us in fiscal 2018. We do not believe that there will be any significant financial impact due to prior taxable losses and our net operating loss carry forward.
In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern, or ASU 2014-15. ASU 2014-15 amends FASB ASC 205-40 Presentation of Financial Statements - Going Concern”, by providing guidance on determining when and how reporting entities must disclose going-concern uncertainties in their financial statements, including requiring management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date of issuance of the entity’s financial statements and providing certain disclosures if there is substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 will be effective after December 15, 2016, and early adoption is permitted.
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.
Off Balance Sheet Arrangements
We have no significant off balance sheet transactions, arrangements or obligations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of interest rate changes and change in the market values of our real estate properties. We do not enter into derivatives or other financial instruments for trading or speculative purposes.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial statements specified by this Item, together with the reports thereon of Eide Bailly LLP, are presented following Item 15 of this Form 10-K:b
● Report of Independent Registered Public Accounting Firm.
● Consolidated Balance Sheets as of December 31, 2016 and 2017.
● Consolidated Statements of Operations for the years ended December 31, 2016 and 2017.
● Consolidated Statements of Cash Flows for the years ended December 31, 2016 and 2017.
● Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 2016 and 2017.
● Notes to Consolidated Financial Statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On November 28, 2017, we were notified by Eide Bailly LLP, or Eide Bailly, of its decision to resign as our independent registered public accounting firm.
The reports of Eide Bailly on our consolidated financial statements for the fiscal years ended December 31, 2016 and 2015 did not contain an adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.
During the fiscal years ended December 31, 2016 and 2015, and in the subsequent interim period through November 28, 2017, there were (a) no disagreements with Eide Bailly on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure which disagreements, if not resolved to the satisfaction of Eide Bailly, would have caused Eide Bailly to make reference to the matter in their reports on the consolidated financial statements for such years and (b) no reportable events, as defined in Item 304(a)(1)(v) of Regulation S-K.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Management’s Evaluation of Disclosures Controls and Procedures
We have adopted and maintain disclosure controls and procedures (as such term is defined in Rules 13a-13e and 15d-15f under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act, is recorded, processed, summarized and reported within the time periods required under the ‘SEC’s rules and forms and that the information is gathered and communicated to our management, including our Chief Executive Officer (principal executive officer) who is also our Chief Financial Officer (principal financial and accounting officer), as appropriate, to allow for timely decisions regarding required disclosure.
Pursuant to Rule 13a-15b under the Exchange Act, we carried out an evaluation, with the participation of the our staff, including our Chief Executive Officer who is also our Chief Financial Officer of the effectiveness of the Company’s disclosure controls and procedures (as defined under Rule 13a-15e under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, and taking the matters described below into account, the Company’s CEO/CFO has concluded that our disclosure controls and procedures over financial reporting were not effective during reporting period ended December 31, 2017, as discussed below.
This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting due to an exemption provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, enacted into law in July 2010. The Dodd-Frank Act provides smaller public companies and debt-only issuers with a permanent exemption from the requirement to obtain an external audit on the effectiveness of internal financial reporting controls provided in Section 404(b) of the Sarbanes-Oxley Act. We are a smaller reporting company and are eligible for this exemption under the Dodd-Frank Act.Management’s Annual Report on Internal Control Over Financial Reporting
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company in accordance with as defined in Rules 13a-13e and 15d-15f under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
● pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
● provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made in accordance with authorizations of our management and directors, and
● provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
As of December 31, 2017, the Company did not establish a formal written policy for the approval, identification and authorization of related party transactions.
A material weakness is a control deficiency, or combination of control deficiencies, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
Our internal control system is designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations which may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2017. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated 2013 Framework. Based on this assessment and testing, management concluded that, as of December 31, 2017, our internal control over financial reporting was not effective based on those criteria.
Management’s assessment and testing of the effectiveness of the smaller reporting company’s internal control over financial reporting as of the year ended December 31, 2017 the Company did not maintain effective internal control over financial reporting.
Based upon our evaluation of internal controls, the Company’s management determined that the Company’s controls over financial reporting were not adequate to ensure these calculations were performed correctly. As such, the Company’s Chief Executive Officer/Chief Financial Officer has concluded that the Company’s disclosure controls and procedures contain a material weakness as of the end of the period covered by this Report. Because of the material weaknesses identified, a reasonable possibility exists that a material misstatement in our consolidated financial statements will not be prevented or detected on a timely basis. While our internal controls are established and followed, it is clear by the identified weaknesses that they were not operating as they should be. Management believes that this was the case due to our limited staff along with time constraints and staff turnover. However, our Chief Executive Officer, who is also our acting Chief Financial Officer, believes that the financial statements included in this annual report on Form 10-K present, in all material respects, our financial position, results of operations and cash flows for the periods presented, in conformity with U.S. GAAP.
Changes in Internal Control over Financial Reporting
Effective February 1, 2018, William Gregorak, our Chief Financial Officer, resigned with no disputes with our company. As the result of Mr. Gregorak’s resignation, we have employed an external accountant to assist with preparation of our consolidated financial statements commencing with the quarter and year ended December 31, 2017.
We will continue to monitor the effectiveness of our internal control over financial reporting in the areas affected by the facts described above and employ any additional tools and resources deemed necessary to ensure that our financial statements are fairly stated in all material respects.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS AND CORPORATE GOVERNANCE, COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
At December 31, 2017, our officers and directors were the individuals listed below:
Name
Age
Position
Wayne Harding
Chief Executive Officer and Chairman of the Board of Directors
Bill Gregorak
Chief Financial Officer and Secretary (resigned February 2018)
Samuel Morris
Director, Chairman of Compensation Committee
Michael Harnish
Director, Chairman of Audit Committee
James Cochran
Director
T. Keith Wiggins
Director
Christopher Bragg
Director
Our officers are elected by the board of directors at the first meeting after each annual meeting of our shareholders and they hold office until their successors are duly elected and qualified under our bylaws.
The directors named above, other than Mr. Gregorak, who resigned in February 2018, will serve until the next annual meeting of our shareholders, which is expected to be held in September, 2018. Mr. Harding holds his positions at the pleasure of the board of directors subject to the terms of his employment agreement described below in “Item 11.
ITEM 11. EXECUTIVE COMPENSATION
Executive Compensation
Summary Compensation Table
The following table sets forth certain information concerning compensation paid to each of the individuals who served as executive officers during 2017:
(1) Stock award compensation is based on stock options or RSUs granted, vested and issued during the year. For payroll tax purposes, and as reported here, valuation of the RSU grants that are vested is recorded through payroll at a 25% fair value discount due to large blocks and limitations on selling. This is based on outside executive compensation consultant’s opinion. For financial statement purposes, the full fair value of the grant is recorded, less expected forfeitures.
(2) Other Compensation is the payment of the health insurance benefit by the Company ($2,361) and office allowance ($10,000).
(3) Other Compensation is the payment of the health insurance benefit by the Company ($13,284) and office allowance ($25,000).
(4) Other Compensation is the payment of the health insurance benefit by the Company ($6,050).
(5) Other Compensation is the payment of the health insurance benefit by the Company ($6,800).
(6) Mr. McKowen resigned June 2016
(7) Mr. Harding was named Chief Executive Officer in June 2016 and became Chairman in September 2016.
(8) Mr. Gregorak was named Chief Financial Officer in March of 2017 and resigned on February 1, 2018.
(9) Other Compensation is the payment of the health insurance benefit by the Company ($9,800).
(10) Other Compensation is the payment of the health insurance benefit by the Company ($4,800).
Grants and Issuance of Plan-Based Awards for 2017 and 2016
For the year ended December 31, 2017, the Company issued 225,000 options for common shares to Wayne Harding, with 64,286 shares vesting by December 31, 2017.
Outstanding Equity Awards at Fiscal Year End
The following table sets forth certain information as to unexercised restricted stock units held on December 31, 2017 by the named executive officers.
(1) The closing price of our common stock on OTCQB on December 31, 2017 was $0.52
Employment and Change in Control Agreements
We entered into an employment agreement with Wayne Harding effective as of January 1, 2011. This employment agreement renews automatically for successive one-year terms until either party delivers notice of termination within 30 days of the expiration of the then-current term.
Under each agreement, annual base salary and other compensation is to be reviewed, and may be adjusted upward, no less frequently than quarterly. Mr. Harding’s annual base salary has been $120,000 per year until November 2016, when his salary was increased to $150,000 per year.
On August 22, 2017, Mr. Harding entered into a new compensation agreement. This agreement contains the same terms as the prior agreement with the exception of the expanded definition of “Early Termination: Resignation by the Employee for Good Reason.” This definition has been expanded to include the election or appointment of 50% or more new members of the Company’s board.
The employment agreement provides that Mr. Harding will be entitled, in the event his employment is terminated during the term by us without cause (as defined) or by him for good reason (as defined), to (a) receive an amount in cash equal to six months’ base salary at the highest base salary in effect during the twelve months prior to termination plus the amount of the annual bonus, if any, paid to him for the preceding fiscal year, prorated to the termination date and (b) immediate vesting of all non-vested stock options. The agreement also provides for immediate vesting of all non-vested stock options in the event of a change in control, which generally is defined to be a sale or other disposition to a person, entity or group of 50% or more of our consolidated assets. The following table sets forth estimated compensation that would have been payable to Mr. Harding upon termination of employment, assuming termination took place on December 31, 2017, whether in connection with a change in control or otherwise. Mr. Harding held unvested options as of December 31, 2017, and therefore would have been entitled to additional compensation had a change in control occurred as of December 31, 2017.
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL TABLE
Director Compensation
The following table sets forth information concerning compensation paid to our outside directors for services during 2017:
From September 30, 2016 to August 31, 2017, each outside director receives $1,000 for each meeting attended in person. Directors were also paid $4,000 per calendar quarter. At the annual meeting of the board of directors on September 7, 2017, the board voted to award each outside director options for 150,000 shares of common stock. These stock option shares vested 1/8 on the date granted with the balance equally over seven quarters commencing December 31, 2017. The chair of the audit committee received an additional 20,000 stock options per year. The chair of the compensation committee received an additional 10,000 stock options per year. Committee chair options vest half immediately, half in six months.
At the September 7, 2017 board meeting, the Compensation Committee recommended, and the Board approved, to increase each indepndent director’s quarterly cash compensation from $4,000 per calendar quarter to $5,000 per calendar quarter.
In 2017, we expensed $34,843 in stock option expense for each of the independent directors listed above.
Corporate Governance
Code of Conduct
We have adopted a written code of ethics that applies to directors, officers and employees, including the principal executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. You can access our code of conduct for our board in the “Investor” section of our website located at www.2riverswater.com/investors. Employees’ (including officers and management) code of conduct is detailed in our employee handbook, which all employees must sign. We post on our website all disclosures required by law concerning any amendments to, or waivers from, any provision of the code. Our website and its contents are not incorporated into this report.
Board Leadership Structure
The chair of the board of directors is responsible for approving the agenda for each board meeting and for determining, in consultation with the other directors, the frequency and length of board meetings. The board of directors does not have a policy on whether or not the roles of Chief Executive Officer and board chair should be separate and, if they are to be separate, whether the board chair should be selected from the non-employee directors or be an employee. The board believes that it is preferable to evaluate the appropriateness of separating these roles from time to time in light of the best interests of our company and our stockholders. Wayne Harding, our Chief Executive Officer, currently serves as the board chair.
Director Nomination Process
The process followed by the compensation, governance and nominating committee to identify and evaluate director candidates includes requests to directors and others for recommendations, meetings from time to time to evaluate biographical information and background material relating to potential candidates, and interviews of selected candidates by members of the compensation, governance and nominating committee and the board of directors.
In considering whether to recommend any particular candidate for inclusion in the board’s slate of recommended director nominees, the compensation, governance and nominating committee applies the criteria set forth in our corporate governance guidelines. These criteria include the candidate’s integrity, business acumen, knowledge of our business and industry, experience, diligence, conflicts of interest and the ability to act in the interests of all stockholders. The board’s corporate governance guidelines specify that the value of diversity on the board should be considered by the compensation, governance and nominating committee in the director identification and nomination process. The compensation, governance and nominating committee seeks nominees with a broad diversity of experience, professions, skills, geographic representation and backgrounds. The compensation, governance and nominating committee does not assign specific weights to particular criteria and no particular criterion is a prerequisite for each prospective nominee. The board believes that the backgrounds and qualifications of its directors, considered as a group, should provide a composite mix of experience, knowledge and abilities that will allow it to fulfill its responsibilities. Nominees are not discriminated against on the basis of race, religion, national origin, sexual orientation, disability or any other basis proscribed by law.
Stockholders may recommend individuals to the compensation, governance and nominating committee for consideration as potential director candidates by submitting their names, together with appropriate biographical information and background materials and a statement as to whether the stockholder or group of stockholders making the recommendation has beneficially owned more than five percent of the common stock for at least a year as of the date such recommendation is made, to the compensation, governance and nominating committee in care of Two Rivers Water & Farming Company, 3025 S Parker Rd, #140, Aurora, Colorado 80014, Attention: Secretary. Assuming that appropriate biographical and background material has been provided on a timely basis, the compensation, governance and nominating committee will evaluate stockholder-recommended candidates by following substantially the same process, and applying substantially the same criteria, as it follows for candidates submitted by others.
Communicating with Independent Directors
The board of directors will give appropriate attention to written communications that are submitted by stockholders, and will respond if and as appropriate. The director serving as chair of the compensation, governance and nominating committee, with the assistance of our Chief Financial Officer, is primarily responsible for monitoring communications from stockholders and for providing copies or summaries to the other directors as such director considers appropriate.
Under procedures approved by a majority of our independent directors, communications are forwarded to all directors if they relate to important substantive matters and include suggestions or comments that the Chief Financial Officer considers to be important for the directors to know. In general, communications relating to corporate governance and corporate strategy are more likely to be forwarded than communications relating to ordinary business affairs, personal grievances and matters as to which we receive repetitive or duplicative communications.
Stockholders who wish to send communications on any topic to the board should address such communications to the board in care of Two Rivers Water & Farming Company, 3025 S Parker Rd, #140, Aurora, Colorado 80014, Attention: Secretary.
Compensation Committee Interlocks and Insider Participation
The members of the compensation committee are Samuel Morris, James Cochran and Michael Harnish. Neither Mr. Morris, Mr. Cochran nor Mr. Harnish has ever been an officer or employee of our company or any subsidiary of ours or had any relationship with us during 2017 requiring disclosure under Item 404 of Regulation S-K of the SEC.
Our executive officer has not served as a director or member of the compensation committee (or other committee serving an equivalent function) of any other entity, one of whose executive officers served as a member of our board of directors or our compensation committee.
Director Attendance at Board and Shareholder Meetings
The board of directors met formally multiple times during 2017, either in person or by teleconference. The board conducted numerous special board meetings during 2017. Each director attended at least 90% of the meetings of the board held in 2017 during the period in which such person was a director.
We do not have a policy regarding director attendance at our annual meetings of shareholders. Messrs. Morris, Harnish, Cochran, Wiggins and Bragg all attended our annual meeting of shareholders held on September 7, 2017.
Board Committees
The board of directors has established an audit committee, a compensation, and a governance and nominating committee.
Audit Committee
Members of the audit committee are Michael Harnish, Chris Bragg, and Samuel Morris, each of whom is an independent director. Mr. Harnish chairs the audit committee and serves as the audit committee financial expert.
The committee’s responsibilities include:
●appointing, approving the compensation of, and assessing the independence of our registered public accounting firm;
●overseeing the work of the registered public accounting firm, including through the receipt and consideration of certain reports from such firm;
●reviewing and discussing our annual and quarterly financial statements and related disclosures with management and the registered public accounting firm;
●monitoring our internal control over financial reporting, disclosure controls and procedures, and code of ethics, and overseeing risk management;
●establishing policies regarding hiring employees from the registered public accounting firm and procedures for the receipt and retention of accounting related complaints and concerns;
●meeting independently with our registered public accounting firm and management; and
●reviewing and approving or ratifying any related-person transactions.
The audit committee met four times during 2017, either in person or by teleconference. During 2017, each member of the audit committee attended all of the meetings of the committee held during the year. The audit committee charter is available at http://www.2riverswater.com/governance-documents/.
Compensation Committee
Members of the compensation nominating committee are Michael Harnish, James Cochran and Samuel Morris. Mr. Morris chairs the compensation committee.
The compensation has the final determination in compensation for our executives. The compensation committee is responsible for considering and approving the payment of bonuses to executives. There is no set schedule for the payment of bonuses. Bonuses are considered upon achievement of specified benchmarks, which in the past have included capital and debt raises, operational performance, acquisitions of significant assets, and entry into agreements accretive to our business. The benchmarks and the amount and type of bonuses are determined by the committee.
The compensation committee also is responsible for approving employment agreements with executives.
The Compensation Committee met twice during 2017.
Nominating and Governance Committee
Members of the governance and nominating committee are Samuel Morris and Keith Wiggins. Mr. Morris chairs the committee.
The governance and nominating committee is responsible for identifying individuals whom the Committee believes are qualified to become Board members in accordance with the nominating criteria set forth below (the “Nominating Criteria”), and recommend that the Board select such individuals as nominees to stand for election at each Annual Meeting of Shareholders. In addition, the committee will annually evaluate the qualifications and performance of incumbent directors and determine whether to recommend them for re-election to the Board. In the case of a Board vacancy (including a vacancy created by an increase in the size of the Board), the committee is responsible for recommending to the Board in accordance with the nominating criteria an individual to fill such vacancy either through election by the Board or through election by shareholders. The Governance and Nominating Committee met once during 2017.
Summary of Committee Service
The following is a table showing board members involvement in each committee:
M = Member C = Chair
Audit Committee Report
The audit committee has reviewed and discussed the audited consolidated financial statements of the Two Rivers and its subsidiaries for fiscal 2017, and has discussed these financial statements with the Twor Rivers’ management and independent registered public accounting firm for fiscal 2017, M&K CPAs, LLP.
The audit committee has also received from, and discussed with, M&K CPAs, LLP various communications that the independent registered public accounting firm is required to provide to the audit committee, including the matters required to be discussed by Statement on Auditing Standards No. 61, as amended (AICPA, Professional Standards, Vol. 1. AU section 380) as adopted by the Public Company Accounting Oversight Board in Rule 3200T.
M&K CPAs, LLP also provided the audit committee with the written communications required under regulations of the Public Company Accounting Oversight Board, including communications regarding the independence of the registered public accounting firm. The audit committee has discussed with M&K CPAs, LLP its independence from Two Rivers. The audit committee also considered whether the provision of other, non-audit related services referred to under the heading "Independent Registered Public Accounting Firm Fees and Other Matters" is compatible with maintaining the independence of the registered public accounting firm.
Based on its discussions with management and the independent registered public accounting firm, and its review of the representations and information provided by management and M&K CPAs, LLP, the audit committee recommended to the board of directors that the audited consolidated financial statements be included in the Two Rivers’ Annual Report on Form 10-K for the fiscal year ended December 31, 2017.
AUDIT COMMITTEE
Michael Harnish
Christopher Bragg
Samuel Morris
The material in this audit committee report is not "soliciting material," is not deemed "filed" with the SEC, and is not to be incorporated by reference in any filing by Two Rivers under the Securities Act or the Securities Exchange Act, whether made before or after the date hereof, and irrespective of any general incorporation language in any such filing.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth information regarding the beneficial ownership of common stock as of March 30, 2017, by:
●each person, or group of affiliated persons, who is known by us to own beneficially more than five percent of the outstanding shares of common stock;
●each of our directors and executive officers; and
●all of our current directors and executive officers as a group.
The following table lists the percentage of shares beneficially owned based on 32,749,920 shares of common stock outstanding as of March 30 , 2018, plus an additional 1,299,643 options issued that can be exercised by May 29, 2018 (60 days after March 30, 2018). Except as otherwise indicated, all of the shares reflected in the table are common stock and all persons listed below have sole voting and investment power with respect to the shares beneficially owned by them, subject to applicable community property laws.
* Less than 1%
(1) Includes 6,666 shares owned by an individual retirement account for the benefit of Mr. Harding’s spouse.
(2) Mr. McKowen was the CEO and Chair of the Board of the Company until his resignation in May, 2016. He is still considered an affiliate due to the size of his holdings and being on GrowCo’s board of directors and serving as GrowCo’s CEO.
For purposes of the table above, the address of each of our directors and executive officers is in care of Two Rivers Water & Farming Company, 3025 S Parker Rd, Suite 140, Aurora CO 80014. Two Rivers has 200,000,000 authorized common shares. There are a total of 10,000,000 common shares under Two Rivers’ 2011 Option Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The following discussion relates to certain transactions that involve both our company and one of our executive officers, directors or five-percent shareholders, each of whom we refer to as a “related party.” For purposes of this discussion, a “related-party transaction” is a transaction, arrangement or relationship in which we participate and in which a related party has a direct or indirect material interest.
Since January 1, 2017 there have been the following related-party transactions, except for the compensation arrangements described under “Executive Compensation” and “Director Compensation”:
● Wayne Harding CEO
o Short-term loan to the Company of $5,000.
o Short-term loan to the Company of $27,000.
o Short-term loan to the Company of $32,500.
● Board Members
o Samuel Morris $5,000 short-term loan to the Company.
o Michael Harnish invested $35,000 in the GrowCo $6M Exchange Note, $100,000 in GrowCo $4,000,000, and $25,000 in GCP Super Units prior to becoming a board member.
● Thomas Prasil greater than five percent shareholder had the following transactions with the Company:
o Invested $400,000 in the GrowCo $6M Exchange Note.
Since January 1, 2017 the following related party transactions have taken place with John McKowen our prior Chief Executive Officer, who resigned in May, 2016:
● In August 2016 TR Capital Partners, LLC’s subsidiary GCP1 signed a lease agreement for greenhouse 1 with Johnny Cannaseed, a company formed and operated by John McKowen. This lease was subsequently cancelled by mutual agreement on January 31, 2018.
● In August 2016, GrowCo’s subsidiary GCP2 signed a lease agreement for greenhouse 2 with Johnny Cannaseed.
● In July 2016 the Company’s subsidiary GrowCo signed a series of agreements with McGrow, LLC, a Colorado limited liability company that is headed and partially owned by John McKowen. The agreements included a Master Agreement, and Advisory Services agreement, a Construction Services agreement, a Financing Services agreement, a Non-Compete and Exclusivity agreement, and a Stock Purchase Agreement. Collectively these are known as the “McGrow Agreements”. As a result of these agreements GrowCo paid McGrow for services provided primarily for the construction of greenhouses and fees associated with the raising of capital. These agreements were fulfilled or cancelled by the end of March 31, 2017.
The following is a list of all related party transactions with John McKowen during the year ended December 31, 2017:
● Advances totaling $34,400 resulting in a cumulative total of $72,999 for greenhouse expenses to Johnny Cannaseed, LLC which is majority owned by former Company Chief Executive Officer John McKowen.
● Revenue totaled $620,000 has been recorded for leasing income from Johnny Cannaseed.
● Advances totaled $26,957 resulting in a cumulative total of $43,798 for greenhouse expense to McGrow, LLC which is partially owned by former Company Chief Executive Officer John McKowen.
● Payments totaling $335,531 to MCG Services, LLC which is majority owned by former Company Chief Executive Officer John McKowen for costs associated with a services agreement with GrowCo.
● Advances to MCG Services, LLC totaled $13,295. This amount was written off.
● Payments totaling $11,210 to John McKowen for interest expense on a loan held by Mr. McKowen to GrowCo.
Our board contains six people, of which all are classified as independent members, except for Wayne Harding.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Eide Bailly LLP (“Eide Bailly”) was the principal audit accounting firm and has performed the audit beginning with the year ended December 31, 2011 through December 31, 2016 and performed reviews for the periods ending March 31, 2017, June 30, 2017 and September 30, 2017.
On November 28, 2017 we were notified by Eide Bailly of its decision to resign as our independent registered public accounting firm. The reports of Eide Bailly on our consolidated financial statements for the fiscal years ended December 31, 2016 and 2015 did not contain an adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles. During the fiscal years ended December 31, 2016 and 2015, and in the subsequent interim period through November 28, 2017, there were (a) no disagreements with Eide Bailly on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure which disagreements, if not resolved to the satisfaction of Eide Bailly, would have caused Eide Bailly to make reference to the matter in their reports on the consolidated financial statements for such years and (b) no reportable events, as defined in Item 304(a)(1)(v) of Regulation S-K.
On December the audit committee of the Company’s board of directors appointed M&K CPAs, PLLC (“M&K”) as its independent registerd public accounting firm for the year ending December 31, 2017. The company signed an engagement letter with M&K on December 4, 2017. The Company has considered whether the provisions of audit services are compatible with maintaining M&K’s independence and concluded that M&K is independent. The audit committee has approved all of Eide Bailly’s and M&K’s fees.
The following table represents aggregate fees billed to us by Eide Bailly during 2017 and 2016.
The following table represents aggregate fees billed to us by M&K CPAs LLP during 2017 and 2016.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following is a complete list of exhibits filed as part of this Form 10-K. Exhibit number corresponds to the numbers in the Exhibit table of Item 601 of Regulation S-K.
† Management contract or compensatory plan or arrangement.
* The certification attached as Exhibit 32.1 that accompanies this Annual Report on Form 10-K is not deemed filed with the SEC and is not to be incorporated by reference into any filing of Two Rivers Water & Farming Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the filing date of this Form 10-K, irrespective of any general incorporation language contained in such filing.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: April 6, 2018 Two Rivers Water & Farming Company
/s/Wayne Harding
Chief Executive Officer (Principal Executive Officer) & Chief Financial Officer (Principle Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Dated: April 6, 2018
/s/Wayne Harding
Wayne Harding
President, Chief Executive Officer, Chief Financial Officer and Chairman of the Board
/s/ Samuel Morris
Samuel Morris
Director
/s/Michael Harnish
Michael Harnish
Director
/s/ Christopher Bragg
Christopher Bragg
Director
/s/ Jim Cochran
Jim Cochran
Director
FINANCIAL STATEMENTS
Two Rivers Water & Farming Company2017 FinancialsPage
TWO RIVERS WATER & FARMING COMPANY AND SUBSIDIARIES
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Two Rivers Water & Farming Company
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Two Rivers Water & Farming Company (the Company) as of December 31, 2017, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year ended December 31, 2017, and the related notes and schedules (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017, and the results of its operations and its cash flows for the year ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements of Two Rivers Water & Farming Company as of December 31, 2016, were audited by other auditors whose report dated March 29, 2017 expressed an unqualified opinion on those consolidated statements.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 10 to the consolidated financial statements, the Company suffered a net loss from operations and has a net capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters are described in Note 10. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ M&K CPAS, PLLC
We have served as the Company’s auditor since 2017.
Houston, TX
April 9, 2018
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TWO RIVERS WATER & FARMING COMPANY AND SUBSIDIARIES
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Two Rivers Water & Farming Company
Denver, Colorado
We have audited the accompanying consolidated balance sheet of Two Rivers Water & Farming Company (the “Company”) as of December 31, 2016, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the year then ended. Two Rivers Water & Farming Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Two Rivers Water & Farming Company as of December 31, 2016, and the results of its operations and its cash flows for the year ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 3 to the consolidated financial statements, the Company has made plans to discontinue its farming operations as of December 31, 2016. Our opinion is not modified with respect to this matter.
As discussed in Note 9 to the consolidated financial statements, the Company made immaterial error corrections to restate the previously filed balance sheet for the year ended December 31, 2016. Accordingly, amounts reported for long term assets for land and water, and the liabilities for discontinued operations and notes payable, net of current portion have been restated in the December 31, 2016 financial statements now presented. Our opinion is not modified with respect to this matter.
/s/ Eide Bailly, LLP
Denver, Colorado
March 29, 2017
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TWO RIVERS WATER & FARMING COMPANY AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except for number of shares)
The accompanying notes to consolidated financial statements are an integral part of these statements.
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TWO RIVERS WATER & FARMING COMPANY AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except for Loss per Share)
The accompanying notes to consolidated financial statements are an integral part of these statements.
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TWO RIVERS WATER & FARMING COMPANY AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
Continued on next page
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Continued from previous page
The accompanying notes to consolidated financial statements are an integral part of these statements
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TWO RIVERS WATER & FARMING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2017 and 2016
(In thousands)
Continued on next page
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The accompanying notes to consolidated financial statements are an integral part of these statements.
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TWO RIVERS WATER & FARMING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2017 and 2016
NOTE 1 - ORGANIZATION AND BUSINESS
The following is a summary of some of the information contained in this document. Unless the context requires otherwise, references in this document to “Two Rivers,” or the “Company” is to Two Rivers Water & Farming Company and its subsidiaries.
Corporate Evolution
Prior to 2009, the Company was named Navidec Financial Services, Inc. (“Navidec”) and had been engaged in mortgage lending and other enterprises unrelated to its current lines of business. Navidec was incorporated in the state of Colorado on December 20, 2002. On July 28, 2009, Navidec formed a wholly-owned Colorado corporation for the purpose of acquiring farm and water assets in the Colorado Huerfano/Cucharas watershed. On November 19, 2009, with shareholder approval, Navidec changed its name to Two Rivers Water Company. On December 11, 2012, with shareholder approval, the Company changed its name to Two Rivers Water & Farming Company.
On January 29, 2014, the board of directors approved a plan to reorganize our subsidiaries in a more integrated manner based on functional operations. We formed a new company, TR Capital Partners, LLC or TR Capital, which issued all of its common units to Two Rivers Water & Farming Capital. TR Capital then initiated the transactions described below under “Placement of Preferred Units”. Following the completion of those transactions in September 2014, TR Capital and our other direct and indirect subsidiaries (excluding HCIC Holdings, LLC and Huerfano-Cucharas Irrigation Company) entered into a series of related transactions as the result of which assets and operations of such other subsidiaries transferred to TR Capital. As a result of those transactions, TR Capital operates all of the operations formerly conducted by those subsidiaries. The following chart shows a high-level view of our corporate organization as of March 21, 2017. For a more detailed accounting of ownership structure please refer to exhibit 21.1 filed herewith.
The above organizational charts shows GrowCo as a subsidiary of Two Rivers. Two Rivers owns 10,000,000 GrowCo common shares out of approximately 35,000,000 GrowCo common shares outstanding. Ordinarily, this ownership percentage would not allow consolidation. However, under Accounting Standards Codification 810-10-05 “Variable Entities” if there are material obligations between the parent (Two Rivers) and the subsidiary (GrowCo) consolidation is required. Certain GrowCo investors have a secondary collateral position in the Orlando/Butte Valley assets of Two Rivers. Two Rivers is viewed as the primary beneficiary since it holds the majority of the variable interests.
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Overview
In 2009, we began acquiring and developing irrigated farmland and associated water rights and infrastructure. As of December 31, 2017, we own 6,538 gross acres. Gross acres owned decreased from 7,376 gross acres at December 31, 2016 due to the sale of 838 acres.
We are focused on water assets we have acquired and will acquire in the future. Since 2009, we have acquired strategic water assets and land in the Huerfano and Cucharas river basins in southeastern Colorado, thus the name Two Rivers. Our water asset area spans over 1,900 square miles and drops in elevation from over 14,000 feet down to the confluence of the Arkansas River, just east of Pueblo Colorado at 4,500 feet. We operate in a natural, gravity fed water alluvial. This basin is the last undeveloped basin along the front range of Colorado. As our first water-focused project, we plan to fully develop this basin to properly manage the water contained therein and serve the community while providing returns to our investors.
Since October 2016 we have refocused on monetizing our assets. Monetization occurs in two different ways: sell or additionally invest. We have determined to sell assets that we have determined will not yield significant future returns to our shareholders and invest strategically in the assets that will. Specifically, we are selling our irrigated farmland currently used for the production of produce, the associated Dionisio produce business along with land that no longer serves our strategic vision of water management. We will take net proceeds, if any, from these sales and continue to invest in our water and water infrastructure.
In May 2014, we formed GrowCo, Inc., a wholly owned subsidiary of Two Rivers through the issuance of 20,000,000 shares of common stock. On August 1, 2014, we announced that we were placing 10,000,000 GrowCo shares in a trust to be distributed to Two Rivers’ common shareholders based on four record dates (January 1, 2015; April 1, 2015; July 1, 2015, and October 1, 2015) after an effective registration statement is filed, which has not yet occurred. Each record date will distribute 2,500,000 GrowCo common shares on a prorata basis of shares owned of Two Rivers’ common shares.
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.
During the third quarter of 2015, GrowCo completed a $4.0 million private placement of GrowCo debt, with proceeds to be used to partially fund the second greenhouse and provide working capital.
In March 2016, GrowCo completed a $5.5 million private placement of equity interests of GCP Super Units, LLC, which will invest directly in various assets of GCP1 and GCP2, with proceeds to be used to complete the construction of the first greenhouse, partially fund the second greenhouse and provide working capital. The outside investment in GCP Super Units, LLC is reflected on our balance sheet as a non-controlling equity interest.
GCP1’s greenhouse was partially occupied in September, 2015 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 three months ended March 31, 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.
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Pending the eviction of Suncanna, on August 4, 2016 GCP1 entered into a lease agreement with a related party Johnny Cannaseed, LLC, a related party (“Johnny Cannaseed”) which is owned predominantly by our former CEO John McKowen who is the majority shareholder in the Company. Under the terms of the lease, one half of the GCP1 greenhouse was sublet to a licensed marijuana grower on December 1, 2016. The second half of the greenhouse was leased to a second licensed marijuana grower on March 1, 2017. At December 31, 2016 we had recorded lease receivables of $240,000 from Johnny Cannaseed.
Johnny Cannaseed was not able to receive a license to grow marijuana. Therefore, Johnny Cannaseed subleased, with the approval of GCP1’s board, to two tenants. In 2017, GCP1 expended $308,000 to divide the greenhouse into two, mostly equal, parts, referred to as GCP1-1 and GCP1-2. As reported by Johnny Cannaseed, for the year ended December 31, 2017, the GCP1 tenant paid to Johhny Cannaseed $620,000 which was paid to GCP1. The GCP1-2 tenant did not pay any rent and was subsequently evicted by Johnny Cannaseed. Johnny Cannaseed is proceeding to collect back due rent from the GCP1-2 tenant. For the year ended December 31, 2017, the Company’s consolidated income only recognizes the actual rent received of $620,000. Effective February 1, 2018, GCP1 released Johnny Cannaseed from its lease. At that time, GCP1 signed a lease with the then current sub-lessee of GCP1-1.
GrowCo’s 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 GCP2. GCP2’s greenhouse structure was ordered in 2016. Construction on this greenhouse began in early January 2016 with an unkown completion date. It is necessary to raise additional capital to complete GCP2.
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, .25 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.
A new $2M offering was subsequently initiated in March 2017 with substantially the same terms of prior GrowCo notes for the purposes of supporting operations and finishing the second greenhouse. As of December 31, 2017, $1,520,000 was raised for this offering along with an additional $386,000 under the $7 million exchange note.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Two Rivers, Huerfano-Cucharas Irrigation Company and TR Capital and its subsidiaries, Two Rivers Farms, Two Rivers Water and GrowCo. All significant inter-company balances and transactions have been eliminated in consolidation.
Non-controlling Interest
Below is the detail of non-controlling interest shown on the balance sheet.
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During the year ended December 31, 2014, investors in Two Rivers Farms (convertible notes and preferred shares), Two Rivers Farms (convertible notes and preferred shares), the Company’s preferred shares, ASF convertible notes, DFP preferred shares, Ellicott second mortgage, and the new cash investments of $6,000,000 were given the opportunity to convert into TR Capital Partners, LLC and were issued 30,159,000 TR Capital Preferred Membership units, with a NCI value of $20,740,000.
The 30,159,000 TR Capital Preferred Membership units issued during the year ended December 31, 2014 are convertible into 1 common stock share of the Company and one-half warrant to purchase a share of stock of the Company. In accordance with ASC Topic 470-20, Debt (and other convertible instruments with beneficial convertible features (“BCF”), the Company determined that a BCF amounting to approximately $12,337,000 and a relative fair value attached to the warrants of approximately $3,641,000 were recorded for the year ended December 31, 2014.
Two Rivers also formed three LLC special entities (TR Cap 20150630, Distribution, TR Cap 20150930 Distribution and TR Cap 20151231) to provide in-kind distributions totaling $1,452,000 to holders of TR Capital Preferred Membership units.
Below is the breakdown of the non-controlling interest share of gains (losses):
Notes:
(1) The Company owns 95% of HCIC.
(2) The terms of the preferred shares in each subsidiary allows for a participatory additional preferred share dividend of 25% of the profits derived from the assets held by the subsidiary. This participatory dividend, if any, will be recorded as a non-controlling share of the income.
Reclassification
Certain amounts previously reported have been reclassified to conform to current presentation. Certain labels of accounts/classifications have been changed.
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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 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 Water & Farming Company 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.
Concentration of Credit Risk
Financial instruments that potentially subject Two Rivers to significant concentrations of credit risk include cash equivalents, marketable investments, advances and accounts receivable. The Company maintains its cash balances in the form of bank demand deposits, money market accounts that management believes to be of high credit quality. Accounts receivable are typically uncollateralized and are derived from transactions with and from customers primarily located in the United States.
Fair Value of Measurements and Disclosures
Fair Value of Assets and Liabilities Acquired
Fair value is the price that would be received from the sale of an asset or paid to transfer a liability (i.e., an exit price) in the principal or most advantageous market in an orderly transaction between market participants. In determining fair value, the accounting standards established a three-level hierarchy that distinguishes between (i) market data obtained or developed from independent sources (i.e., observable data inputs) and (ii) a reporting entity’s own data and assumptions that market participants would use in pricing an asset or liability (i.e., unobservable data inputs). Financial assets and financial liabilities measured and reported at fair value are classified in one of the following categories, in order of priority of observability and objectivity of pricing inputs:
● Level 1 - Fair value based on quoted prices in active markets for identical assets or liabilities.
● Level 2 - Fair value based on significant directly observable data (other than Level 1 quoted prices) or significant indirectly observable data through corroboration with observable market data. Inputs would normally be (i) quoted prices in active markets for similar assets or liabilities, (ii) quoted prices in inactive markets for identical or similar assets or liabilities or (iii) information derived from or corroborated by observable market data.
● Level 3 - Fair value based on prices or valuation techniques that require significant unobservable data inputs. Inputs would normally be a reporting entity’s own data and judgments about assumptions that market participants would use in pricing the asset or liability.
The fair value measurement level for an asset or liability is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques should maximize the use of observable inputs and minimize the use of unobservable inputs.
Recurring Fair Value Measurements
The carrying value of the Company’s financial assets and financial liabilities is their cost, which may differ from fair value. The carrying value of cash held as demand deposits, money market and certificates of deposit, marketable investments, accounts receivable, short-term borrowings, accounts payable and accrued liabilities approximated their fair value. Marketable investments are valued at Level 1 due to readily available market quotes. The fair value of the Company’s long-term debt, including the current portion approximated its carrying value. Fair value for long-term debt was estimated based on quoted market prices of the identical debt instruments or values of comparable borrowings.
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Accounts Receivable, Related Party
The Company carries its accounts receivable, net at management’s expectation of collection and past experience. As of December 31, 2017, and 2016, the Company did not have an allowance for doubtful accounts receivable based on past payment performance. See Note 11 for transactions with this related party.
Capitalization of Interest
As of December 31, 2017, $897,000 in notes payable interest has been capitalized in the construction of greenhouse 1 and 2.
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 is recorded at cost. Some of the land acquired has not been farmed for many years, if not decades. Therefore, additional expenditures are required to make the land ready for efficient farming. 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, 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
Subsequent to purchase of water rights and water infrastructure, 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. No amortization or depreciation is taken on the water rights. See the discussion below concerning Impairments - Water rights and infrastructure.
Intangibles
Two Rivers recognizes the estimated fair value of water rights acquired by the Company’s purchase of stock in HCIC and 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.
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Impairments
Property and Equipment
Once per year we review all property, equipment and software owned by the Company and compared the net book value of such assets with the fair market value of each piece of equipment having a net book value greater than $5,000. If it is determined that the net book value is greater than the fair market value, an impairment will be recorded. If impairment is necessary, a loss on the value of the affected asset will be recorded, and the impairment will not be reversed in future periods.
Land
Once per year we review each parcel of land owned by the Company together with improvements to each parcel and compare the carrying cost with the fair market value. If it appears that our carrying value may be greater than the fair market value, an independent appraisal will be ordered. If the appraised value is less than our carrying value, an impairment will be recorded. If impairment is necessary, a loss on the value of our land will be recorded, and the impairment will not be reversed in future periods.
Water rights and infrastructure
Once per year we assess the value of the water rights held by the Company, comparing our estimated values with recent sales of comparable water rights along with depreciation of the infrastructures. In the event that such assessment indicates that the carrying value is greater than the fair market value of the water rights or the depreciable replacement cost of our infrastructure, an impairment will be recorded. If impairment is necessary, a loss on value of our water rights will be recorded, and the impairment will not be reversed in future periods.
Prior to the year ended December 31, 2017, the Company recognized a $30,000 impairment on the Company’s land and water shares.
For the year ended December 31, 2017, the Company examined the depreciable replacement cost of its water infrastructure. This analysis caused the recognition of $6,900,000 impairment to the water infrastructure.
Impairment of DFP Intangibles
In 2016, due to the discontinuance of DFP operations, we wrote off the full value of DFP intangibles (see Note 4).
Revenue Recognition
Leasing Greenhouse
The lease between GrowCo Partners 1, LLC and its lessee is classified as an operating lease under ASC 840. However, due to the uncertainity of lease payments, for the year ended December 31, 2017, only the actual lease revenues received were recognized.
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 financial statements.
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.
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All options granted prior to the adoption of ASC 718 and outstanding during the periods presented were fully vested at the date of adoption.
Debt and Equity
The Company accounts for warrants issued with debt in accordance with Accounting Standards Codification (“ASC”) 470, Debt, and allocates proceeds received to the warrants based on relative fair values.
The Company also evaluates whether the issuance of the convertible instruments generates a beneficial conversion feature (“BCF”), which arises when a debt or equity security is issued with an embedded conversion option that is beneficial to the investor or in the money at inception because the conversion option has an effective strike price that is less than the market price of the underlying stock at the commitment date. The Company would recognize the BCF by allocating the intrinsic value of the conversion option, which is the number of ordinary shares available upon conversion multiplied by the difference between the effective conversion price per share and the fair value of each ordinary share on the commitment date, to additional paid-in capital, resulting in a discount on the convertible preferred shares or debt instruments. No BCF has been recognized in the periods presented.
Income Taxes
Provision for income taxes represents actual or estimated amounts payable on tax return filings each year. Deferred tax assets and liabilities are recorded for the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the accompanying balance sheets, and for operating loss and tax credit carry forwards. The change in deferred tax assets and liabilities for the period measures the deferred tax provision or benefit for the period. Effects of changes in enacted tax laws on deferred tax assets and liabilities are reflected as adjustment to the tax provision or benefit in the period of enactment.
The Company uses a two-step process to evaluate a tax position. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.
Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met. The Company reports tax-related interest and penalties as a component of income tax expense.
Based on all known facts and circumstances and current tax law, the Company believes that the total amount of unrecognized tax benefits as of December 31, 2017, is not material to its results of operations, financial condition, or cash flows. The Company also believes that the total amount of unrecognized tax benefits as of December 31, 2017, if recognized, would not have a material effect on its effective tax rate. The Company further believes that there are no tax positions for which it is reasonably possible, based on current tax law and policy that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the Company’s results of operations, financial condition or cash flows.
The amount of income taxes the Company pays is subject to ongoing examinations by federal and state tax authorities. To date, there have been no reviews performed by federal or state tax authorities on any of the Company’s previously filed returns. The Company’s 2013 and later tax returns are still subject to examination.
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Net Income (Loss) per Share
Basic net income 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, 3,847,500 options, and 16,469,328 warrants at December 31, 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 July 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) “Income Statement - Reporting Comprehensive Income (Topic 220)”. This ASU deals with the reclassification of certain tax effects from Accumulated Other Comprehensive Income. We do not believe that there will be any significant financial impact due to prior taxable losses and our net operating loss carry forward.
In July 2017, FASB issued ASU “Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815)”: (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. Management believes that Topics 260 and 480 pertains to the Company and the impact will be immaterial.
In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows”. The new guidance will require that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents is required to be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new guidance is effective for interim and annual periods beginning after December 15, 2017 and early adoption is permitted. The amendment should be adopted retrospectively. The Company plans to adopt this new guidance in the first quarter of fiscal year 2018 and does not expect the adoption to have a material impact on our financial statements.
In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Compensation Accounting”, which requires that excess tax benefits are recorded on the income statement as opposed to additional paid-in-capital, and treated as an operating activity on the statement of cash flows. ASU 2016-09 also allows companies to make an accounting policy election to either estimate the number of awards that are expected to vest (current U.S. GAAP) or account for forfeitures when they occur. ASU 2016-09 further requires cash paid by an employer when directly withholding shares for tax-withholding purposes to be classified as a financing activity on the statement of cash flows. The ASU 2016-09 was subsequently updated with ASU 2017-09, issued in May 2017. These standards will become effective for us in fiscal 2018. We do not believe that there will be any significant financial impact due to prior taxable losses and our net operating loss carry forward.
In February 2016, the FASB issued 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 November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes”, which requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position to simplify the presentation of deferred income taxes. The standard is effective prospectively for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The Company does not expect the adoption of this update to have a material impact on its financial statements.
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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.
In April 2015, FASB issued ASU 2015-03, “Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs”. The guidance in the ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is allowed for financial statements that have not been previously issued. Debt issuance costs related to a recognized debt liability will be presented on the balance sheet as a direct deduction from the debt liability, similar to the presentation of debt discounts. The Company has elected to adopt this ASU early and is presented in these financial statements.
In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory”. Under this ASU, inventory will be measured at the “lower of cost and net realizable value” and options that currently exist for “market value” will be eliminated. The ASU defines net realizable value as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” No other changes were made to the current guidance on inventory measurement. ASU 2015-11 is effective for interim and annual periods beginning after December 15, 2016. Early application is permitted and should be applied prospectively. Management has early adopted ASU 2015-11 and notes no material impact on the Company’s financial position or results of operations.
In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern, or ASU 2014-15. ASU 2014-15 amends FASB ASC 205-40 Presentation of Financial Statements - Going Concern”, by providing guidance on determining when and how reporting entities must disclose going-concern uncertainties in their financial statements, including requiring management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date of issuance of the entity’s financial statements and providing certain disclosures if there is substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 will be effective after December 15, 2016, and early adoption is permitted.
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 - 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 December 31, 2017 and December 31, 2016 consist of the following:
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The income from discontinued operations presented in the statements of operations consist of the following for the year ended December 31, 2017 and December 31, 2016:
On March 3, 2017, the Company’s land and water assets associated with farming operations were auctioned off. Gross proceeds fom the auction were $1,740,000 with net proceeds estimated to be $1,583,000. Proceeds were used to pay off secured debt first with any residual proceeds used to pay unsecured debt.
NOTE 4 - INVESTMENTS AND LONG-LIVED ASSETS
Land
Upon purchasing land, the value is recorded at the purchase price or fair value, whichever is more accurate. Costs incurred to prepare the land for the intended purpose, which is efficient irrigated farming, is 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. We have obtained water rights through the purchase of shares in a mutual ditch company, which we did with our purchase of shares in HCIC, or through the purchase of an entity holding water rights, which we did with our purchase of the 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.
Upon purchasing water rights, the value is recorded at our purchase price. If a majority interest is acquired in a company holding water assets (potentially with other assets including water delivery infrastructure, right of ways, and land), the Company determines the fair value of the assets. To assist with the valuation, the Company may consider reports from a third-party valuation firm. If the value of the water rights is greater than what the Company paid then a bargain purchase gain is recognized. If the value of the water assets are less than what the Company paid then goodwill is recognized.
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 $6,930,000 in impairments on the Company’s land and water rights. No amortization or depreciation is taken on the water rights.
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Construction in progress
During the year ended December 31, 2016, the Company transferred, as a partial completion, $3,315,000 into the first greenhouse. The Company has expended $8,922,000 on greenhouses 1 and 2. Management’s current plan is to complete greenhouse 2 to be 90,000 square feet with an associated 15,000 square foot warehouse.
NOTE 5 - NOTES PAYABLE
HCIC Seller Carry Back Notes
Beginning on September 17, 2009, Two Rivers began acquiring shares in HCIC and related land from a HCIC shareholder. As part of these acquisitions, many of the sellers financed notes payable with Two Rivers and HCIC. As of December 31, 2012, these loans totaled $7,364,000. The notes carry interest at 6% per annum, interest payable monthly, the principal amounts were due at various dates from March 31, 2013 through September 30, 2016, and are collateralized by HCIC share.
In June 2013, the Company negotiated an extension on holders representing $6,164,000 of the seller carry back notes. Previously these amounts were due either August or September 2013. The holders of the notes agreed to extend the due date to June 30, 2016. In exchange for this extension, the Company increased the principal balance by 20% from $6,164,000 to $7,397,000, paid 5.43% against the principal and agreed to begin paying monthly interest and principal at a 20-year amortization rate.
In May 2016, the Company negotiated another extension on holders representing $5,214,000 to extend the due date from June 30, 2016 to June 30, 2019. The extension reset the amortization period to 12 years, kept interest at 6% per year, and called for a 5% principal reduction in February, 2017. Payments to all of the HCIC note holders are behind. The Company is in technical default on $6,371,000 of the HCIC carry back notes due to non-payment of interest and principle. Consequently, the entire amount of the notes has been classified as current.
For the year ended December 31, 2017, holders representing $3,181,000 of the notes held conversion rights into the Company’s common shares at $1.00 to $1.25. These conversions were cancelled and replaced by 5-year warrants at $3.00 per share. A total of 1,367,000 warrants were issued. The warrants issued had a fair value of $277,000 using the Black Scholes method of fair value determination.
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Colorado Water Conservation Loan (“CWCB”)
On March 5, 2012, the Company closed long-term financing with the Colorado Department of Natural Resources, Colorado Water Conservation Board in the amount of $1,185,000 (the “CWCB Loan”). This loan partially financed the rehabilitation of the Cucharas Reservoir to temporarily bring it into safety compliance with the Colorado State Engineers office. Further, the CWCB Loan assisted with the rehabilitation of the Orlando facilities through the installation of a new outlet gate/pipe. There was a $12,000 service fee due upon closing. This amount is being amortized over the expected life of the CWCB Loan, which is 20 years with interest fixed at 2.5% per annum. During the year ended December 31, 2016, the Company paid an additional $210,000 toward the CWCB Loan principal in order to release CWCB’s lien on 157 acres being used to build GrowCo greenhouses. As of December 31, 2017, and 2016, the amounts outstanding under the CWCB Loan totaled $748,000 and $798,000, respectively.
FirstOak Bank - Dionisio Purchase
The Company purchased Dionisio assets in 2012. The cost of the Dionisio land/water acquisition was $1,500,000, of which $900,000 was financed by FirstOak Bank and $600,000 was paid in cash.
The terms of the FirstOak loan is at 1% above the base rate on corporate loans posted by at least 75% of the nation’s 30 largest banks known as the Wall Street Journal Prime Rate (3.50% as of December 31, 2016 and 3.25% as of December 31, 2015), subject to a minimum of 6% per annum. The FirstOak loan is secured by the Dionisio assets, which include 146 shares of the Bessemer Irrigation Ditch Company (“BIDC”). There are five annual payments of $76,000 due each December 15 commencing December 15, 2012. A balloon payment of all accrued interest and outstanding principal was due June 15, 2017. As of December 31, 2016 the amounts outstanding under the FirstOak loan totaled $771,000. In March, 2017 this debt was settled through the liquidation of Dionisio Farms and Produce (“DFP”).
In May 2014, the Company also borrowed $176,000 to purchase additional farmland. The loan is at 1.5% above the base rate on corporate loans posted by at least 75% of the nation’s 30 largest banks known as the Wall Street Journal Prime Rate, subject to a minimum of 6% per annum. The FirstOak loan is secured by 9 BIDC shares, well permits and water leases. There are five annual payments of $15,000 due each December 15 commencing December 15, 2014. A balloon payment of all accrued interest and outstanding principal was due December 5, 2018 of $160,000. As of December 31, 2016 the amounts outstanding under the FirstOak loan totaled $118,000, respectively. In March, 2017 this debt was settled through the liquidation of DFP.
Seller Carry Back - Dionisio
On November 2, 2012, the Company acquired the Dionisio produce business and related equipment for $1,500,000. The seller carried back $600,000 (which was subsequently reduced to $590,000 due to the Company assuming additional debt owed by seller) of this purchase price. The note is paid quarterly, interest only at 6% per annum. The note is due November 2, 2017. Certain assets of Dionisio secure the note. In March, 2017 this debt was settled through the liquidation of DFP.
FirstOak Bank - Mater Purchase
The cost of the Mater land/water acquisition was $325,000, of which $169,000 was financed by FirstOak, $25,000 seller carry back and $131,000 was paid in cash. The purchase price has been allocated to land for $106,000 and $219,000 to water rights representing the purchase of BIDC shares.
The terms of the First Oak loan is at 1% above the base rate on corporate loans posted by at least 75% of the nation’s 30 largest banks known as the Wall Street Journal Prime Rate, subject to a minimum of 6% per annum. The FirstOak loan is secured by the Mater assets. There are four annual payments of $15,000 due each December 5 commencing December 15, 2013. A balloon payment of all accrued interest and outstanding principal is due December 5, 2017 for $159,000.
As of December 31, 2016, the amounts outstanding under the FirstOak loan totaled $156,000. In March, 2017 this debt was settled through the liquidation of DFP.
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McFinney Agri-Finance LLC (McFinney) and Ellicot second mortgage (Ellicot)
On March 15, 2013, the Company purchased unimproved land in El Paso county, Colorado for a purchase price of $1,250,000. The company paid $620,000 (including closing costs and allocations) and financed $650,000 McFinney and $400,000 Ellicot, through private investors.
The terms of the McFinney financing is for monthly payments of principal and interest of $4,238 per month, a fixed interest rate of 6.8% per annum, with the remaining principal due on April 1, 2018. The note is secured by a deed of trust on the 2,579 acres of land purchased and a guaranty of payment by the Company. The Company has been in contact with the lender and has reached a verbal agreement to extend the loan another 12 months. However, since the agreement is not in writing, the Company has classified this debt as current.
As of December 31, 2017 and 2016, the amounts outstanding under the McFinney loan totaled $441,000 and $625,000, respectively. The paydown of principal occurred through land sales secured by the loan and the payment of 75% of the land sale proceeds to pay down the principal in return for parital land releases from the bank.
GrowCo $4M Notes
During the ended December 31, 2015, the Company, through its subsidiary GrowCo, issued $4,000,000 in promissory notes to 17 individual investors. The notes have a security interest in the land, water and improvements to the 157 acres where GrowCo Partners 1 and GrowCo Partners 2 are developing the greenhouses. The notes pay 22.5% in annual interest, with interested paid monthly, and are due April 1, 2020. The Company cannot prepay the notes; however, noteholders have the right to call the notes at the first anniversary, or thereafter, of each note with a 60-day notice to the Company. Due to this call provision, the net amount of the GrowCo note balance of $4,000,000 is presented as a current portion of long term debt on the financials.
The GrowCo notes investors also received one GrowCo common stock $1 warrant for each $1 invested. These warrants expire on April 30, 2020.
On January 19, 2018 Blue & Green, LLC (“Blue Green”) filed a complaint against GrowCo, Inc. claiming a default on payments by GrowCo to Blue Green under the terms of the $4 million GrowCo $2,115,000 promissory note held by Blue Green. The complaint is requesting immediate payment of the note, back due interest in excess of $300,000, and attorney fees.
GrowCo Exchange Notes
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, .25 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 December 31, 2017.
During the year ended December 31, 2017, GrowCo raised an additional $1,906,000 under the GrowCo Exchange Notes offering.
During the year ended December 31, 2017, the Company incurred $302,000 in debt issuance costs related to its GrowCo Exchange Notes offering. The debt issuance costs are being amortized via the effective interest method, using 22.5%, over the life of the notes.
Hemp Crop Participation Loan
For the twelve months ended December 31, 2016, DFP issued short term notes, due March 31, 2017, to assist with the payment of crop inputs. These notes are secured by the Company’s live agriculture products planted during the 2016 calendar year. On August 10, 2016, Wayne Harding, our Chief Executive Officer, invested $7,000 in the DFP Hemp Crop Participation Loan (see Note 11). These notes were paid in full in 2017.
El Paso Land Loan
In August, 2017, the Company borrowed $275,000 pledging a second lien on property the Company owns in El Paso County Colorado. This loan pays 18%/annum interest and is to be repaid through the sale of 35 to 40 acre lots. The repayment is based on 25% of the net proceeds from sales. The stated maturity date is August 1, 2019.
WRC Convertible Note
For the year ended December 31, 2017, Water Redevelopment Company (WRC) issued convertible notes which are due note April 1, 2020. It carries interest at 12% per annum and is secured by a security interest in the water supply agreement between the Company and a real estate developer in the area of the Orlando/Butte Valley facilities. This note, at the option of the holder, can be converted into one share of WRC preferred shares for each $4.23 of principal balance and accrued interest. At December 31, 2017, the balance was $300,000.
OID Black Mountain Note
This note was entered into on April 26, 2017. It is an orginal issuance discount note with the face principal amount of $330,000 and gross cash paid at closing of $300,000. It was due on October 26, 2017, but has been extended to now being due on April 1, 2018.
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Below is a summary of the Company’s long term debt:
Notes:
(1) Prime rate + 1%, but not less than 6%
(2) Prime rate + 1.5%, but not less than 6%
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Schedule of principal payment due by year:
NOTE 6 - 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.
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Operating results for each of the segments of the Company are as follows (in thousands):
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NOTE 7 - EQUITY TRANSACTIONS
Common Stock
The Company has authorized 100,000,000 shares of common stock with a par value of $0.001. The total issued common stock as of December 31, 2017, was 32,749,920 common shares.
During the year ended December 31, 2017, the Company had the following common stock transactions:
● issued 1,417,000 shares for early warrant exercises;
● issued 52,260 shares for conversions by TR Capital preferred units;
● issued 25,200 shares for investor relations services;
● issued 139,000 from an RSU exercise, and
● issued 665,000 shares in exchange for debt.
During the year ended December 31, 2016, Two Rivers had the following common stock transactions:
● issued 1,880,948 shares to its former CEO for RSU’s previously awarded;
● returned 35,000 from a former independent board member;
● issued 127,500 shares to its independent board members for 2015 service;
● issued 85,000 shares to a former director for RSU’s previously awarded;
● issued 727,500 shares to an HCIC debt holders in return for reduction in debt;
● issued 649,700 shares for warrant exercises, and
● issued 35,616 shares to holders of TR Capital for conversion into the Company’s shares.
Stock Incentive Plans
The Company previously had a 2005 Stock Option Plan (“2005 Plan”) that was superseded by the Two Rivers 2011 Long-Term Stock Incentive Plan (“2011 Plan”). Upon the Company’s shareholder adoption of the 2011 Plan, the 2005 Plan stopped issuance of any further grants, except for grants previously committed by agreement.
Under the 2005 Plan, we have the following stock options issued and outstanding:
There were no options issued under the 2005 Plan for the years ending December 31, 2017 and 2016.
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A summary of the Two Rivers 2005 Option Plan (“2005 Plan”) is as follows:
Note 1: 600,000 options were extended and repriced from $1.25/share to $0.70/share
For the year ended December 31, 2017, the Company extended 600,000 options that were due to expire in 2016 and 2017 to an expiration dates in 2018 and 2019. This extension resulted in $52,000 of expense being recorded in 2017.
For the yeard ended December 31, 2017, the Company extended the same 600,000 options and reset the strike price from $1.25/share to $0.70/share and extended the expiration to occur in 2021 and 2022. This extension resulted in $85,000 of expense being recorded in 2017.
Under the 2011 Plan, we have the following stock options issued and outstanding:
Option Valuation Process
The fair value of each option award is estimated on the date of grant. To calculate the fair value of options, the Company uses the Black-Scholes model employing the following variables:
The Company arrived at the foregoing estimate of volatility of the Company’s common stock based on the Company’s stock closing price on a weekly basis and averaged over the prior five years. The risk-free rate for periods within the expected term of the options is based on the U.S. Treasury yield curve in effect at the time of grant. The Company believes these estimates and assumptions are reasonable. However, these estimates and assumptions may change in the future based on actual experience as well as market conditions.
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A summary of the Two Rivers 2011 Long-Term Stock Incentive Plan (“2011 Plan”) is as follows:
The option expense from both the 2011 and 2005 Plans were $534,000 and $180,000 for the years ended December 31, 2017 and 2016, respectively.
Under the 2011 Plan, we have issued the following Restricted Stock Units (RSUs):
The Company can issue stock awards and options for nonemployee services. If stock is granted, the Company values the stock using an average of the closing price of the Company’s stock over the period that the service was rendered. If options are granted, the Company uses the Black-Scholes model for determining fair value (see above).
Warrants
As of December 31, 2017, the Company has outstanding the following warrants to purchase common stock:
(1) These warrants are priced at the same price per share as the expected equity offering and expire one year after the completion of the expected equity offering.
For the years ended December 31, 2017 and 2016, warrant expense totaled $92,000 and $327,000, respectively.
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TR Capital Preferred Membership Units
The 30,159,000 TR Capital Preferred Membership units issued during the year ended December 31, 2014 are convertible into 1 common stock share of the Company and one-half warrant to purchase a share of stock of the Company. In accordance with ASC Topic 470-20, Debt (and other convertible instruments with beneficial convertible features (“BCF”), the Company determined that a BCF amounting to approximately $12,337,000 and a relative fair value attached to the warrants of approximately $3,641,000 were recorded for the year ended December 31, 2014. On the balance sheet as of December 31, 2014, these amounts were recorded as retained earnings and as additional paid in capital, respectively, and are representative of preferred share dividends available to non-controlling interest holders in the entity.
NOTE 8 - INCOME TAXES
The Company accounts for income taxes in accordance with ASC 740, Income Taxes (formerly Statement of Financial Accounting Standard No., 109, Accounting for Income Taxes). Under the provisions of ASC 740, a deferred tax asset or liability (net of a valuation allowance) is provided in the financial statements by applying the provisions of applicable laws to measure the deferred tax consequences of temporary differences that will result in taxable or deductible amounts in future years as a result of events recognized in the financial statements in the current or proceeding years.
The items accounting for the difference between income taxes computed at the federal statutory rate and the provision for income taxes consists of the following:
Book loss reconciliation to estimated taxable income is as follows (in thousands):
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Income tax provision is summarized below (in thousands):
We will recognize future accrued interest and penalties related to unrecognized tax benefits in income tax expense if incurred. At December 31, 2017 we had no unrecognized tax benefits in income tax expense, and do not expect any in 2018. Our income tax returns are no longer subject to Federal tax examinations by tax authorities for years before 2014 and state examinations for years before 2014.
The components of the deferred tax asset are as follows (in thousands):
For the years ended December 31, 2017 and December 31, 2016, the deferred tax asset of $18,384,000 and $17,889,000, respectively, has a valuation allowance of $18,384,000 and $17,899,000, respectively, since management has determined the tax benefit cannot be reasonably assured of being used in the near future. The net operating loss carryforward, if not used, will begin to expire in 2029, and is severely restricted as per the Internal Revenue Code if there is a change in ownership. The following is a summary of the combined net operating loss carryforward (in thousands):
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NOTE 9 - IMMATERIAL ERROR CORRECTIONS
This 10-K of the Company for the twelve months ended December 31, 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 10 - 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 $12,924,000 and $10,727,000 during the years ended December 31, 2017 and 2016, respectively. At December 31, 2017, the Company has a working capital deficit and an accumulated deficit of approximately $24,700,000 and $90,000,000, respectively. The HCIC seller carry back debt and the GrowCo notes are in technical default. The $4M GrowCo Note is classified as current due to the holders’ right to call the note upon 60-day’s notice. GrowCo has received notification of an entity holding $2,115,000 of this debt of its intent to collect the amount of the note, plus back due interest and attorney fees.
These factors raise 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. The following paragraphs describe management’s plans to mitigate.
Since December 31, 2017 to March 21, 2018 the Company has collected $535,000 under its financing arrangement with Powerdorn LLC under debt/equity financing. Currently GrowCo, through GCP1 is receiving rent payments on one-half of the first greenhouse. The first use of these funds will be to pay GCP1 accounts payable including GCP1’s obligation to GrowCo. In addition, the Company has received $252,000 in preferred investment into its Water Redevelopment subsidiary. We are in the process of securing additional debt financing on the land and water assets that we own that are unencumbered.
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Additionally, we continue to reduced our general and administrative and cash required for our operations.
Management Plans
The Company has implemented a new strategy involving focusing on its water assets along with associated capital raises through the formation of Water Redevelopment Company (“WRC”). It is planned that WRC will provide the asset value necessary to obtain additional financing.
We believe that the actions discussed above are probable of occurring and mitigating the substantial doubt raised by our historical operating results. We believe the actions will 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 11 - COMMITMENTS AND CONTINGENCIES
Operating Leases
In January 2016, the Company entered into a new lease with the Colorado Center in Denver Colorado for the corporate headquarters. The space is 1,775 square feet and monthly payments of $3,900, with minor escalations and common area maintenance charges. The lease terminates on June 30, 2018. On March 1, 2017 the Company entered into a sub-lease agreement with our related party McGrow for these office facilities.
The amounts due at the base rate are as follows:
In February 2017 we entered into a new lease with Parker Road Campus, LLC in Aurora, Colorado, for our corporate headquarters. This space is 1,554 square feet and monthly payments of $2,201 which began on April 1, 2017. The lease terminates on March 31, 2020. The amounts due at the base rate are as follows:
Defined Contribution Plan
Two Rivers does not have a defined contribution plan.
Employment Agreements
Effective January 1, 2011, the Company entered into an employment agreement with Wayne Harding, as CFO. The initial term of the contract was one year, which renews automatically for successive one-year terms unless and until either party delivers notice of termination within 30 days of the expiration of the then current term. The original employment agreement was modified in 2017.
The Board determines annual incentive compensation at the Board’s sole discretion. If there is a change of control, each is entitled to an accelerated option vesting.
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GCP 2 Construction
The GCP 2 greenhouse is partially completed. We estimate that the cost to complete the second greenhouse is approximately $3,000,000. At this time we do not have the necessary funds to complete GCP2 construction.
Suncanna Litigation
In 2016, the Suncanna lease arrangement was the subject of administrative and judicial proceedings:
● On April 14, 2016, we were notified that Suncanna LLC had received a notice of suspension from the Marijuana Enforcement Division of the Colorado Department of Revenue. This suspension remains in place until a hearing.
● Due to the suspension order, Suncanna was in violation of its lease agreement with us. On April 25, 2016, GCP1 terminated Suncanna’s lease and began an eviction process against Suncanna. Consequently, during the quarter ended March 31, 2016, we stopped recognizing lease revenue and wrote off the $700,000 lease receivable and $43,000 deferred rent that had been recorded as of December 31, 2015. We also wrote off advances to Suncanna totaling $587,000.
● On July 22, 2016 GCP1 received a Writ of Restitution from the Pueblo County Colorado District Court ordering Suncanna to vacate the 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. We believe that the suit has no merit and will have no material impact on our financial condition.
● On September 6, 2016, in accordance with the Writ of Restitution, Suncanna vacated the greenhouse and GCP1 took possession and began re-conditioning its greenhouse for a new tenant, who began growing operations in the fourth quarter of 2016.
● On October 27, 2016, in a contempt of court hearing, a Pueblo County Colorado District Court judge ruled in favor of plaintiff Aaron Van Wingerden and against GCP1 in a matter regarding the prevention of Suncanna’s access to GCP1’s greenhouse prior to Suncanna vacating the premises on September 6, 2016. We believe that this ruling was in error and are appealing this decision.
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.
Prior board of directors litigation
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, the matter is scheduled for trial in October, 2018. The $139,000 is included in our accounts payable on the balance sheet.
DFP litigation
On October 18, 2017, at the Company filed a lawsuit against former employees of the its DFP farming operation for alleged theft. We are in the process of gathering evidence of the theft and setting a court hearing date. A former employee of DFP has filed a counter claim against the Company, which amount is immaterial. Management believes that claims against former employees are in excess of any counter claims.
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GrowCo - Blue Green litigation
On January 19, 2018 Blue & Green, LLC (“Blue Green”) filed a complaint against GrowCo, Inc. claiming a default on payments by GrowCo to Blue Green under the terms of the GrowCo $2,115,000 promissory note held by Blue Green. The complaint is requesting immediate payment of the note, back due interest in excess of $300,000, and attorney fees.
State of Colorado litigation
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 to have certain water rights demands by the neighboring water rights holders deemed wasteful. In the quarter ending March 31, 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 by March 31, 2018. The Company has been able to empty all the water in the Dam, but it will not be able to meet the requirements of the stipulation agreement by March 31. It anticipates that it will by late 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. Also as part of the litigation, Two Rivers has sought to have certain water rights demands by the neighboring water rights holders deemed wasteful. This part of the litigation awaits a trial setting. The State is requesting the Company to pay $100,000 as a penalty for violating the stipulation agreement. The Company’s engineering firm estimate the cost to breach the dam structure to be between $1.8 to $2.2 million.
NOTE 12 - RELATED PARTY TRANSACTIONS
Pursuant to ASC 850 “Related Party Disclosure”, during the year ended December 31, 2017, management has evaluated related parties and all transactions associated with those and determined that no transactions exist which would require disclosure, except as disclosed below:
● Wayne Harding, Company CEO provided a short term loan to the Company of $25,000. The loan is secured by land assets of the Company and carried an interest rate of 12%. The loan was paid off in the third quarter of 2017.
● Advances totaling $34,400 resulting in a cumulative total of $72,999 for greenhouse expenses to Johnny Cannaseed, LLC which is majority owned by former Company CEO John McKowen.
● Revenue totaled $620,000 has been recorded for leasing income from Johnny Cannaseed.
● Advances totaled $26,957 resulting in a cumulative total of $43,798 for greenhouse expense to McGrow, LLC which is partially owned by former Company CEO John McKowen.
● Payments totaling $335,531 to MCG Services, LLC which is majority owned by former Company CEO John McKowen for costs associated with a services agreement with GrowCo.
● Advances to MCG Services, LLC totaled $13,295. This amount was written off.
● Payments totaling $11,210 to John McKowen for interest expense on a loan held by Mr. McKowen to GrowCo.
● Existing investors, including the Thomas Prasil Trust who is a greater than 5% investor, have invested approximately $11.0M in GrowCo securities.
● The Chief Executive Officer of Two Rivers serve as the only members of the Sunset Metropolitan District (Sunset). Sunset is a quasi-governmental agency operating under Title 32 of the State of Colorado Constitution. As of December 31, 2017, the Company had advanced $81,000 to Sunset.
● On June 29, 2017, a mediation session was held in Colorado Springs between all parties involved with the Suncanna lawsuit along with each party’s legal counsel. To date, no settlement has been proposed.
● The Company leases its former corporate headquarters office space to McGrow. Total lease payments are $47,000 per year.
● Wayne Harding, Company CEO provided a long-term loan to the Company of $50,000. The loan is secured by land assets of the Company and carries an interest rate of 18%.
● Wayne Harding provided a short-term loan to the Company of $32,500 in the quarter ended December 31, 2017. $17,500 was repaid before the year ended December 31, 2017. The remainder, $15,000 plus interest was paid in February 2018.
NOTE 13 - SUBSEQUENT EVENTS
Pursuant to FASB ASC 855, management has evaluated all events and transactions that occurred from December 31, 2017 through the date of issuance of these financial statements. During this period, the Company did not have any significant subsequent events, except as disclosed below.
Effective February 1, 2018, our CFO and Secretary, Bill Gregorak resigned his positions and employment with the Company.
On February 9, 2018, Two Rivers entered into a securities purchase agreement, or the SPA, with Powderhorn, LLC, pursuant to which we issued to Powderhorn a 12.5% original issue discount convertible promissory note, or the Note, in the principal amount of $675,000 in exchange for $600,000 in cash. Under the SPA, we agreed to file a registration statement to register the sale of up to 8,000,000 shares of common stock by Powderhorn and to use our reasonable best efforts to have the registration statement declared effective by the Securities and Exchange Commission by April 11, 2018. On February 9, 2018, we filed a registration statement on Form S-1 with the Securities and Exchange Commission in accordance with the SPA. On April 2, 2018, Powderhorn agreed that, provided the Company makes a specified amortization payment by the close of business on April 9, 2018, Powderhorn will waive any and all obligations of the Company to have an effective Form S-1 until May 8, 2018. Subject to certain permitted exceptions, if the SEC does not declare the registration statement effective by May 8, 2018 or if we fail to keep the registration statement effective, we will be required to pay liquidated damages to Powderhorn.
As described above under “State of Colorado litigastion” in Note 11, 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)). On April 3, 2018, the Company was notified that the State of Colorado had filed a motion for the issuance of a contempt of court citation based upon the Company’s failure to comply with a consent decree to bring the Cucharas #5 reservoir down to silt level by March 31, 2018. The Company was unable to fully comply with the consent decree due to lack of capital. The Company intends to defend against the sanctions sought in the contempt motion, based in part upon those sanctions being unnecessary and unduly punitive. A hearing has been set for the contempt proceedings on May 10, 2018. The State is requesting the Company to pay $100,000 as a penalty for violating the stipulation agreement. The Company’s engineering firm estimate the cost to breach the dam structure to be between $1.8 to $2.2 million.
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