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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2003

 
Commission file number 0-18756

WESTERN WATER COMPANY

102 Washington Avenue, Point Richmond, CA 94801
        (Address of principal executive offices)         (Zip code)

(510) 234-7400
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

As of July 31, 2003, there were 8,069,012 shares of registrant’s common stock outstanding.

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WESTERN WATER COMPANY AND SUBSIDIARIES

INDEX

 
PART I — FINANCIAL INFORMATION

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WESTERN WATER COMPANY AND SUBSIDIARIES
Consolidated Balance Sheets
June 30 and March 31, 2003
(Unaudited)

See accompanying notes to consolidated financial statements.

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WESTERN WATER COMPANY AND SUBSIDIARIES
Consolidated Statements of Operations
Three months ended June 30, 2003 and 2002
(Unaudited)

See accompanying notes to consolidated financial statements.

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WESTERN WATER COMPANY AND SUBSIDIARIES
Statements of Cash Flows
Three months ended June 30, 2003 and 2002
(Unaudited)

     See accompanying notes to consolidated financial statements.

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WESTERN WATER COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2003
(Unaudited)

Note 1. Summary of Significant Accounting Policies and Practices:

Basis of Presentation

The accompanying unaudited consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) relating to interim financial statements. These statements reflect all adjustments, consisting only of normal, recurring adjustments, necessary to present fairly the consolidated balance sheets of Western Water Company and Subsidiaries (the “Company”) as of June 30, 2003 and March 31, 2003, the consolidated statements of operations for the three months ended June 30, 2003 and 2002 and the statements of cash flows for the three months ended June 30, 2003 and 2002. The results of the three months ended June 30, 2003 are not necessarily indicative of the results to be expected for the full year. The consolidated financial statements of Western Water Company include Western Water Service Company, Cherry Creek Water Company and YG Procyon Corporation, the Company’s wholly owned subsidiaries, and Western Agua, L.P. a limited partnership in which the Company is the general partner and owns a 70% interest.

The information included in this Form 10-Q should be read in conjunction with management’s discussion and analysis, and financial statements and notes thereto in the Company’s annual report on Form 10-K for the fiscal year ended March 31, 2003.

Stock Option Plan

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for its outstanding stock options. As such, deferred compensation expense would generally be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Such deferred compensation is expensed pro-rata over the vesting period of the stock option. Re-priced stock options are accounted for using variable plan accounting which requires periodic re-measurement of the intrinsic value of the related stock option until its exercise, forfeiture, or cancellation. During the fiscal quarters ended June 30, 2003 and 2002, compensation expense of $0 and $14,229 was recognized.

Had the Company determined compensation expense based on the fair value at the grant date for its stock options under SFAS No. 123, the Company’s net loss and basic and diluted loss per share applicable to common stockholders would have been adjusted to the pro forma amounts indicated below:

The per share weighted-average fair value of stock options granted during the fiscal quarters ended June 30, 2003 and 2002 was $0.22, and $0.86, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: Quarters ended June 30, 2003 and 2002 — Expected dividend yield of zero, expected volatility of 136.30 and 125.62, risk-free interest rate of 2.93% and 4.84%, and an expected life of 5 years.

Net Income (Loss) Per Share

The weighted average shares used for basic and diluted net income per share were 8,069,012 shares, respectively, for the three months ended June 30, 2003 and 2002.

Stock options to purchase 1,769,166 and 1,763,166 shares of common stock at exercise prices ranging from $0.23 — $18.69 for the three months ended June 30, 2003 and 2002, respectively, were not included in the computation of diluted net income per share as their effect would have been anti-dilutive.

Convertible debentures, Series C redeemable preferred stock and Series F redeemable preferred stock convertible into 524,450, 463,779 and 401,968 shares of common stock, respectively, at conversion prices of $15.86, $16.62 and $5.60 per share, respectively, were not included in the computation of diluted loss per share for the three months ended June 30, 2003 as their effect would have been anti-dilutive.

Convertible debentures, Series C redeemable preferred stock and Series F redeemable preferred stock convertible into 555,976, 463,779 and 357,143 shares of common stock, respectively, at conversion prices of $15.86, $16.62 and $5.60 per share, respectively, were not included in the computation of diluted net loss per share for the three months ended June 30, 2002 as their effect would have been anti-dilutive.

Segment reporting

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For the three months ended June 30, 2003 and 2002, the Company recognized revenue of $321,000 and $332,000, respectively, from sales of water to the City of Inglewood. No other recurring customer accounted for more than 10% of the Company’s revenue.

The results are determined based on the Company’s management accounting process, which assigns balance sheet and income statement items to each operating segment. This process is dynamic and somewhat subjective. Unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting equivalent to generally accepted accounting principles. The management accounting process measures the performance of the operating segments based upon the Company’s management structure and is not necessarily comparable with similar information for other companies. Management uses the same reporting criteria for measurements of the reportable segments’ profits or losses and assets as used for the Company’s consolidated financial statements.

The non-segment amount under operating income (loss) includes general and administrative expenses. The non-segment amount under depreciation and amortization includes depreciation of the non-segment equipment, and amortization of debt issuance costs. The non-segment amount under assets includes cash and cash equivalents, and equipment not otherwise allocated to a segment, and other assets.

New Accounting Pronouncements

In January 2003, the FASB approved for issuance FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The disclosure requirements of FIN 46 are effective for all financial statements initially issued after January 31, 2003. The Company has evaluated the impact of FIN 46 and has concluded that the Company is not involved with any variable interest entities and therefore does not expect FIN 46 to have a material impact on its consolidated financial statements.

On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires issuers to classify as liabilities (or assets in some circumstance) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company expects to adopt the provisions of the Statement on July 1, 2003. The Company did not enter into any financial instruments within the scope of the Statement during June 2003. However, it is reasonably possible that adopting SFAS No. 150 on July 1, 2003 for existing financial instruments entered into before May 31, 2003, could result in reclassification of the Company’s preferred stock as liabilities. The Company is currently evaluating the impact of SFAS No. 150. If adoption of SFAS No. 150 ultimately requires re-classification of the Company’s Series C and Series F Preferred Stock as liabilities, then the Company’s liabilities would increase by the fair value of the Series C and the Series F Preferred Stock and the mezzanine section of the consolidated balance sheet would decrease by $8,164,105, with any remaining balance recorded to accumulated deficit.

Note 2. Going Concern:

The Company believes that recurring revenues will be insufficient for some time into the future to cover general and administrative expenses, interest on outstanding indebtedness and dividends when and if declared on its outstanding preferred stock. The Company also deferred the decision to declare the January 15, 2003 Series C Preferred Stock dividend and actually declared and paid such dividend in June, 2003. Although the Company believes that foreseeable revenues from operations will be insufficient to fund such operating expenses, the Company currently plans to fund itself during the fiscal year ending March 31, 2004 from any new water revenues that it may generate from its Water Delivery Contract Units, from its existing capital resources, and from planned sales of assets. As of June 30, 2003, the Company had working capital of approximately $150,000. In the event that the Company is unable to generate new water revenues from the sale of Water Delivery Contract Units or complete the sale of assets, or if any or all of the revenue or sales proceeds are significantly less than anticipated, the Company may not have sufficient cash available to fund its estimated expenses for the next twelve months. Such shortfall(s) from anticipated proceeds, if material, could impair the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

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Note 3. Income Taxes:

Management does not expect there will be taxable income for the fiscal year ending March 31, 2004. Accordingly, the Company has not recorded a federal income tax liability and has recorded the minimum state income tax provision for the three months ended June 30, 2003.

Note 4. Supplemental Cash Flow Information:

Note 5. Sale of asset:

In June 2003, the Company sold its shares in the Bear Valley Mutual Water Company (BVMWC), California to a California municipality. The sale provided cash proceeds of approximately $723,000 and resulted in a gain of approximately $73,000.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

In addition to historical information contained herein, this Quarterly Report contains forward-looking statements. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof and based on information currently available to management. Western Water Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the year ended March 31, 2003, any Current Reports on Form 8-K filed by the Company and any Registration Statements on Form S-8 or Form S-3 filed by the Company.

Critical Accounting Policy

In response to the SEC’s release No. 33-8040, “Cautionary Advice Regarding Disclosure about Critical Accounting Policies,” the Company has identified its most critical accounting policy as that related to the carrying value of its water rights, which are carried at cost. Any event or circumstance that indicates to the Company that there is an impairment of the fair value of any of its water rights, such impairment is recorded in the period in which such event or circumstance becomes known to the Company. During each of the periods in the three and nine months ended June 30, 2003 and 2002, no such event or circumstance occurred that would, in the opinion of management, signify the need for a material reduction in the carrying value of any of the Company’s water rights.

The critical estimates are those made by the Company in assessing whether an impairment exists that is associated with the fair value of its water rights. When considered necessary, management obtains third-party valuations to assist and support its estimate of fair value. In the case of the Cherry Creek Project, the Company’s estimate of fair value is based upon comparison with water rights sales in the area, upon various third-party valuations performed for the Company within the preceding twelve months, upon actual sales to an unaffiliated third party of water derived from the Project, and upon current negotiations for the sale of Water Delivery Contract Units.

Overview

Until the fiscal year ended March 31, 2000, the Company’s principal activity had been to acquire and develop water assets in California and in the Cherry Creek basin in Colorado. The Company did so because it believed that there was a growing demand for water resources in both of these areas, which demand is expected to exceed the water resources currently available to these areas. During the fiscal years ended March 31, 2001 and 2000, the Company executed a variety of wholesale water supply contracts with a number of retail municipal water agencies. However, the Company encountered significant regulatory obstacles to its attempts to develop and transfer water for delivery to such customers. Accordingly, the Company reduced its overhead expenditures, has deferred development activities, and has concentrated its efforts in California on overcoming the regulatory obstacles to water transfers and on arranging water transfers that do not face such obstacles. However, based on continuing regulatory difficulties and administrative delays in completing water transfers and generating revenue from water sales, the Company has suspended additional water acquisitions. The Company also faced significant financial problems brought on by the expenditure of funds for overhead and asset acquisitions in the face of constrained operating revenue. Therefore, the Company has been exploring various alternatives, including the sale of the Company, the sale of some or all of its assets, the liquidation of the Company, and various restructuring alternatives While the Company has no formal plan to liquidate all or substantially all of its assets, it is continuing to pursue a strategy of selling non-strategic assets to bolster its cash position while concentrating its efforts on the development and monetization of its existing strategic water-related assets. The Company has also been exploring the sale of its Northern California assets, including both its strategic and non-strategic assets.

Results of Operations

The following is a description of the Company’s results of operations for the three and nine months ended June 30, 2003 and 2002.

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CONSOLIDATED

Management does not expect that the Company will generate taxable income for the fiscal year ending March 31, 2004. Accordingly, the Company has not recorded a federal income tax liability and has recorded the minimum state income tax provision for the three months ended June 30, 2003.

CALIFORNIA OPERATIONS

Revenues for each of the three month periods consisted solely of revenues generated by the Company from its water related activities. Water revenue for the three month periods included revenues from the sale of water and from water lease agreements with municipal water districts in California. Cost of revenue for the three month periods includes the cost of water purchased for resale and amortization of other resource acquisition costs.

Revenues during each of the three-month periods were primarily derived from the Company’s five-year water sale agreement with the City of Inglewood, California. For the three months ended June 30, 2003 and 2002, the Company recognized revenue of $321,000, and $332,000, respectively, from the City of Inglewood, or approximately 75% and 79%, respectively, of the revenues derived during those periods from the Company’s California operations. Although revenues and related cost of sales from the City of Inglewood were relatively unchanged, the revenues from other sources for the quarters ended June 30, 2003 and 2002 included minor water sale transactions which were slightly higher in the 2003 period. As a result, revenues from the Company’s California operations increased by approximately 2% for the three-month period ended June 30, 2003 compared to the three-month period ended June 30, 2002. Revenues from the agreement with the City of Inglewood are expected to remain substantially unchanged until the expiration of that agreement in September, 2003. However, the Company’s ability to generate other revenues in California will be dependent upon its ability to successfully complete water sales and other revenues and, therefore, is not currently predictable.

In June 2003, the Company sold its shares in the Bear Valley Mutual Water Company to a California municipality in an all-cash transaction. The sale resulted in a gain of $73,000.

COLORADO OPERATIONS

All of the Company’s Colorado operations involve the Company’s Cherry Creek Project. Since the date that the Company first acquired water assets in the Cherry Creek basin in Colorado in 1992, the Company has been primarily engaged in acquiring and developing the assets that currently constitute the Company’s Cherry Creek Project. Other than the sale of non-strategic real estate owned by the Company in the Cherry Creek basin, the Company to date has not generated material revenues from its Colorado operations. However, the Company has commenced implementing a plan to market and sell Water Delivery Contract Units (“WDCUs”), contractual rights to receive a specified portion of the undivided water production capacity of the Cherry Creek Project, to Colorado water agencies. The Company is currently engaged in negotiations for the sale of initial WDCUs which, in aggregate, would account for 600 acre-feet of annual production. The Company anticipates that such sales, if completed, will be made as isolated, individually negotiated transactions, the timing and terms of which are inherently unpredictable. Thus, there can be no assurance that WDCUs will, in fact, be sold on terms satisfactory to the Company.

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During the three month periods ended June 30, 2003 and 2002, the Company delivered small amounts of water produced from nontributary resources of the Cherry Creek Project. Neither the amount of water nor the revenue to be derived from such sale is material. However, the Company believes that this initial sale of water, entailing perfection of the underlying water rights, completion of physical infrastructure and acquisition of various permits required for the delivery, represents an important milestone in the development of the Cherry Creek Project.

GENERAL AND ADMINISTRATIVE EXPENSES

     General and administrative expenses for the three months ended June 30, 2003 decreased by $4,000 (1%) from the comparable period in 2002, primarily due to lower consulting expenses in the 2003 period.

OTHER INFORMATION

Interest income is comprised of interest earned on the Company’s cash and cash equivalents and interest earned on the secured promissory notes received by the Company in connection with the properties that it has sold. The secured notes bear interest at rates between 8% and 9.5% per annum. Interest income decreased for the three-month period ended June 30, 2003 from the comparable period ended June 30, 2003 due primarily to lower cash balances invested and lower effective interest rates during the 2003 period.

Interest expense for the three-month period ended June 30, 2003 was lower than the comparable period in 2002 due to $500,000 lower balance on 9% convertible subordinated debentures in the 2003 period, and the underlying outstanding debt for all periods was interest expense of $24,000 in the 2002 period in connection with the Company’s then outstanding obligation to purchase water in the San Joaquin Valley under the Norte-Sur water purchase agreement.

Other expense for the three-month period ended June 30, 2003 was higher than the comparable period in 2002 due to an accrual for a retroactive assessment of property taxes in the amount of $124,000 by the County of San Bernardino relating to certain water rights which the Company sold in December 2002.

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Liquidity and Capital Resources

As of June 30, 2003, the Company had working capital and a current ratio of $150,000 and 1.10 to l, as compared to working capital and a current ratio of $1,134,000 and 1.88 to 1, respectively, at March 31, 2003.

For the three months ended June 30, 2003, the Company had a net loss of $759,000 and a net decrease in cash of $226,000.

The Company funded its working capital needs during the quarter ended June 30, 2003 through its existing operating revenue, its existing capital resources, and cash generated by sales of assets. On June 18, 2003 the Company sold the BVMWC shares and recognized a gain of $73,000. The Company intends to continue to sell other non-strategic assets to generate cash and reduce its operating expenses while it continues to develop its principal water assets to generate operating revenues in the future. For example, during the current fiscal year ending March 31, 2004, the Company plans to sell its remaining land in San Bernardino County. These assets have a book value of $553,000, and the Company currently expects to realize more than the book value of these assets from these sales.

The Company will also consider selling or otherwise redeploying its West Basin groundwater pumping rights during the current fiscal year, because the Inglewood agreement to which those rights have been dedicated since 1998 is scheduled to expire on October 1, 2003. The Company is also considering the possible sale of some or all of its water rights and real estate assets in Northern California.

The Company’s recurring revenues will be insufficient to cover general and administrative expenses, interest on outstanding indebtedness and dividends when and if declared on outstanding preferred stock. Therefore, the Company currently plans to fund itself during the fiscal year ending March 31, 2004 from any new water revenues that it may generate from its Water Delivery Contract Units, from its existing capital resources, and from sales of assets. As of June 30, 2003, the Company had working capital of approximately $150,000. In the event that the Company is unable to generate new water revenues from the sale of Water Delivery Contract Units or assets, or if any or all of the revenue on sales proceeds are significantly less than anticipated, the Company may not have sufficient cash available to fund its estimated expenses for the next twelve months. Such shortfall(s) from anticipated proceeds, if material, could impair the Company’s ability to continue as a going concern.

The Company believes that its current resources plus the funds it expects to generate from the sale of non-strategic assets and the sale of Cherry Creek Project WDCUs will be sufficient to fund its planned capital outlays and operating expenses for the fiscal year ending March 31, 2004.

Although the Company has attempted to reduce its future commitments, the Company is still committed to certain material expenditures over the next several years, including the following:

	•		The Company is obligated to make scheduled payments of principal on its remaining secured indebtedness for fiscal years ending March 31, 2004, 2005, 2006, 2007 and 2008 of $0, $28,000,$31,000, $33,000 and $37,000, respectively.
	•		The Company is required to make semi-annual interest payments on March 31 and September 30 of $374,000 on the $8,318,000 principal amount of Debentures through their maturity on September 30, 2005, and to make the payment of the $8,318,000 of principal upon that maturity date.
	•		The holders of the 7,708 outstanding shares of Series C Preferred Stock are entitled to receive, when and if declared, annual dividends in the amount of $72.50 per share, payable semi-annually on January 15 and July 15 of each year (aggregating $558,830 per year). During the quarter ended June 30, 2003, the Company declared and paid cash dividends of $279,000.
	•		The holders of the 2,251.018 outstanding shares of Series F Preferred Stock are entitled to receive, when and if declared, annual dividends in the amount of $60.00 per share, payable semi-annually on January 15, and July 15 of each year (aggregating $129,000 per year). These dividends may be paid in cash or in additional shares of Series F Preferred Stock, at the Company’s sole discretion.

Based on its existing assets and on its projected operating income and expenses, the Company expects that it will be able to fund its foreseeable operating expenses and working capital needs for at least one year from the date of this report from existing cash, proceeds derived from on-going operations and proceeds from the anticipated sale of certain existing assets and the sale of Cherry Creek Project WDCUs. No assurance can be given that the Company will be able to sell its assets as planned or, if the Company elects to do so, that it will be able to raise additional funds.

The Company does not believe that inflation will have a material impact on its results of operations.

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The Company is committed to certain material expenditures over the next several years, including the following:

The Company is not a party to off-balance sheet arrangements, does not engage in trading activities involving non-exchange traded contracts, and is not a party to any transactions with persons or entities that derive benefits from their non-independent relationships with the Company. Other than as described herein, the Company has no financial guarantees, debt or lease agreements or other arrangements that could trigger a requirement for an early payment or that could change the value of the Company’s assets.

The Company does not believe that inflation will have a material impact on its results of operations.

New Accounting Pronouncements

In January 2003, the FASB approved for issuance FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The disclosure requirements of FIN 46 are effective for all financial statements initially issued after January 31, 2003. The Company has evaluated the impact of FIN 46 and has concluded that the Company is not involved with any variable interest entities and therefore does not expect FIN 46 to have a material impact on its consolidated financial statements.

On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No, 150 requires issuers to classify as liabilities (or assets in some circumstance) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company expects to adopt the provisions of the Statement on July 1, 2003. The Company did not enter into any financial instruments within the scope of the Statement during June 2003. However, it is reasonably possible that adopting SFAS No. 150 on July 1, 2003 for existing financial instruments entered into before May 31, 2003, could result in reclassification of the Company’s preferred stock as liabilities. The Company is currently evaluating the impact of SFAS No. 150. If adoption of SFAS No. 150 ultimately requires re-classification of the Company’s Series C and Series F Preferred Stock as liabilities, then the Company’s liabilities would increase by the fair value of the Series C and the Series F Preferred Stock and the mezzanine section of the consolidated balance sheet would decrease by $8,164,105, with any remaining balance recorded to accumulated deficit.

Risk Factors

The ownership of the Company’s common stock involves numerous risks. The following discussion highlights some of the risks the Company faces and some of the risks related to the ownership of the Company’s Common Stock.

History of Losses in Principal Business
To date, the Company’s activities have primarily consisted of managing and developing its various water rights and related assets, attempting to market and sell its water assets, and those of its clients. The Company has generated revenues of $1,529,000, 1,464,000, and $2,127,000 during the fiscal years ended March 31, 2003, 2002 and 2001, respectively, while incurring net losses of $2,146,000, $3,280,000 and $1,315,000 during such years, respectively. Until Fiscal 2001, the Company had believed that the regulatory obstacles that have prevented the development of a water market in California would be lowered and that the Company would be able to monetize its principal California water assets and to substantially increase its revenues and generate profits therefrom. During Fiscal 2002, those obstacles, along with the spike in electric prices, prevented the Company from completing any new water transfer transactions. Although electric prices receded in Fiscal 2003, conveyance capacity constraints, the trend toward direct transactions between water districts (which eliminate the opportunity for the Company to earn compensation for arranging such transactions) and the Company’s limited financial resources prevented the Company from completing significant new water sales. In light of the Company’s current financial condition, if the Company continues its operations, losses from operations may not be sustainable for the period of time required to develop a viable water market, and it is possible that governmental entities will continue to monopolize access to conveyance and storage facilities thus precluding profitable third-party water transfers, particularly across the Sacramento — San Joaquin River Delta (the “Delta’’). The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company is dependent on sales of water delivery contract units or assets, which raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of that uncertainty.

Uncertainty of Future Water Revenue
The Company’s ability to generate material revenues in the future is dependent on (i) the Company’s ability to sell significant quantities of water from its Yuba Property water assets, (ii) the Company’s ability to develop and sell water as part of the Colorado Cherry Creek Project, (iii) the Company’s activities as an independent water wholesaler in California, and (iv) the Company’s ability to resolve regulatory issues restricting its ability to sell and transport water to potential customers in its California operations. The Company has encountered significant regulatory obstacles in its attempts to develop and transfer water for delivery to California customers, which regulatory obstacles the Company does not expect to overcome in the near future. Unless the regulatory impediments are removed or modified, the Company believes that its ability to generate significant revenues from its water assets will be severely limited. No assurance can be given that the regulatory obstacles currently limiting the Company’s ability to protect, develop and monetize its California water assets will be changed, or if changed, that the changes will occur in the near future. Moreover, the Company faces significant competition in arranging independent water transfers from governmental agencies, including

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USBR, DWR and MWD, which have offered direct water purchase transactions to certain irrigation districts. This competition is significant because these agencies also control or influence access to conveyance facilities necessary to completion of water transfers. Finally, in addition to its ability to overcome numerous regulatory impediments, the Company’s ability to become an independent water wholesaler in California is dependent upon the Company’s ability to arrange for the transportation and storage of water and on its ability to finance the foregoing activities. As a result, no assurance can be given if the Company will ever be able to generate significant revenues from its water transfer activities in California. In addition, before the Company can consummate significant water deliveries in its Cherry Creek Project in Colorado, the Company or the purchaser of such water will have to build the infrastructure necessary to utilize the water. The requirement to build the infrastructure will affect the ability of the Company to sell its water, the price at which the water can be sold, and the revenues that the Company can derive from its Colorado water assets.

Limited Financial Resources
As a result of the operating losses sustained by the Company during the last several years, which have been partially offset in Fiscal 2003, Fiscal 2002 and Fiscal 2001 by sales of certain assets, the Company may not have sufficient available cash to carry out its business plans over the longer term. Regulatory difficulties that the Company has encountered in California will continue to impact the Company’s ability to protect, develop and monetize its California water assets. The time period in which a return could be realized on the investment represented by these assets is unknown. These uncertainties will make it difficult for the Company to obtain new financing, if necessary, to pursue its business plans.

Commitments for Purchase and Sale of Water
In May 1999, the Company entered into an agreement for the purchase of 14,000 acre-feet of water from an unaffiliated company. In accordance with the agreement, the Company paid the seller a deposit of 50% of the total purchase price and agreed to pay the remainder upon periodic delivery of the water. During the year ended March 31, 2001 the Company took delivery of 2,000 acre-feet of this water and redelivered the water to an unaffiliated customer. In accordance with the terms of the purchase agreement, the Company paid the seller the remaining 50% of the purchase price for the 2,000 acre-feet delivered. During Fiscal 2003, the Company paid the seller for the remaining 12,000 acre-feet of water available under the purchase contract. In December 1999, the Company entered into an agreement to sell the aforementioned 14,000 acre-feet of water to a third-party buyer at a price that includes a profit to the Company. As noted above, during the year ended March 31, 2001 the Company delivered 2,000 acre-feet of water to this third party buyer. The remaining 12,000 acre-feet of water cannot currently be delivered to the buyer due to a dispute between the buyer and certain other water agencies who control the means of conveying such water to the buyer. The buyer and the Company have mutually acknowledged that the dispute (which is not material to the Company) represents a force majeure event preventing current delivery. Although the buyer has not been able to accept delivery of the water, the buyer has paid the Company the entire re-sale purchase price for the full 14,000 acre-feet, as required in the re-sale contract. The balance of this prepayment against the Company’s delivery obligation is accounted for as current deferred revenue of $824,120 ($900,000, less deferred interest income of $75,880). The Company continues to be willing to deliver the remaining 12,000 acre-feet of water to the contracted buyer if and when the force majeure issues are resolved. Because near-term resolution of these issues is doubtful, the Company and the buyer are exploring alternatives. Currently, there can be no assurance that viable and mutually attractive alternatives will be identified and/or implemented.

Item 3. Quantitative and Qualitative Market Risk Disclosures

Prior to June 30, 2003, the Company was exposed to market risk primarily due to fluctuations in interest rates on its variable rate debt. The Company had utilized both fixed and variable rate debt. As of June 30, 2003, all variable rate debt had been retired. The Company does not enter into any financial transactions for speculative or trading purposes. The following table presents principal cash flows and related interest rates of the Company’s long-term fixed rate debt for the fiscal periods indicated:

The carrying amount of long-term debt is a reasonable estimate of fair value as management believes the terms of the debt approximates the interest rate and other terms currently available to the Company.

The carrying amount of the debentures is based on the principal amount owed, and does not represent management’s opinion with respect to the interest rates and terms of the debt as compared to those commercially available to the Company in the marketplace for similar instruments. Over the past three fiscal years the Company has repurchased debentures in an unrelated series of voluntary transactions between the Company and individual debenture holders at 55 cents per dollar of the face amount. At the times consummated, each of these repurchase transactions represented the fair value of the debentures. During the fiscal year ended March 31, 2003, the Company repurchased debentures at the price of 55 cents per dollar, which is management’s best estimate of fair value. There were no repurchases during the quarter ended June 30, 2003. Because there is no quoted market for the debentures, estimating fair value is uncertain, and the Company is uncertain as to whether the Company could repurchase further debentures at this price. Through voluntary, arm’s length, negotiated transactions, the Company has repurchased more than $6.6 million of its Debentures over the last four fiscal years at prices which, in aggregate, represent 36% of the face value of Debentures so repurchased.

Item 4. Controls and Procedures.

The Company’s management, with the participation of the President and Chief Executive Officer and Senior Vice President and Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this quarterly report. Based upon this evaluation, the Company’s President and Chief Executive

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Officer, along with the Company’s Senior Vice President and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures are effective in ensuring that material information required to be disclosed is included in the reports that it files with the Securities and Exchange Commission.

There was no change in the Company’s internal control over financial reporting in the most recent fiscal quarter that materially affected, or is reasonably likely to affect, the Company’s internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

     None

Item 5. Other Matters

Annual Meeting of Stockholders. The Company has historically held its annual meeting of stockholders in the second week of September following its fiscal year end. The Company currently plans to defer the annual meeting of stockholders until the third fiscal quarter of the current fiscal year. The date has not yet been established by the Board of Directors.

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits:

               31.1 Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

               32.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)

Reports on Form 8-K: None

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.

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