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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2004.
Commission file number 0-18756 Western Water Company (Exact name of registrant as specified in its charter)
(www.wwtr.com) Delaware(State of incorporation)
    
    33-0085833(I.R.S. Employer Identification No.)102 Washington Avenue,
Point Richmond, California(Address of principal executive offices)
    
    94801(Zip Code)
 Registrants telephone number, including area code: (510) 234-7400
Securities registered pursuant to Section 12(b) of the Act: Name of each exchangeTitle of each class
    
    on which registeredNone
    
    None
 Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Right to Purchase Series E Junior Participating
Preferred Stock, $.001 par value 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
filing requirements for the past 90 days.
Yes  [  ] No  [X] The aggregate market value of the voting stock held by non-affiliates of
the registrant as of September 30, 2003 was approximately $1,166,000 (based on
last reported sale price of $.16 per share of common stock on that date).
Shares of common stock held by each officer and director and by each person who
owns 5% or more of the outstanding common stock have been excluded from this
computation in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes. There were 8,069,012 shares of registrants common stock outstanding as of
October 8, 2004. Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Securities Exchange Act of 1934). Yes  [  ]
No [X] Documents Incorporated By Reference: None




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TABLE OF CONTENTS PagePART IItem 1.
    
    Business
    
    
    1Item 2.
    
    Properties
    
    
    9Item 3.
    
    Legal Proceedings
    
    
    10Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    10PART IIItem 5.
    
    Market for
Registrants Common Equity and Related Stockholder Matters
    
    
    10Item 6.
    
    Selected Financial Data
    
    
    12Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 7A.
    
    Quantitative and Qualitative Market Risk Disclosures
    
    
    26Item 8.
    
    Consolidated Financial Statements and Supplementary Data
    
    
    26Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    26Item 9A
    
    Controls and Procedures
    
    
    26PART III
    
    
    27Item 10.
    
    Directors and
Executive Officers of the CompanyItem 11.
    
    Executive Compensation
    
    
    29Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    34Item 13.
    
    Certain Relationships and Related Transactions
    
    
    35Item 14.
    
    Principal Accountant Fees and Services
    
    
    35PART IVItem 15.
    
    Exhibits, Consolidated Financial Statement Schedules and Reports on Form 8-K
    
    
    36EXHIBIT 21EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 32.1
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Forward-Looking Statements In addition to historical information, this Annual Report contains
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are
subject to the safe harbor created by those sections. 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 sections entitled
Managements Discussion and Analysis of Financial Condition and Results of
Operations and Risk Factors. Readers are cautioned not to place undue
reliance on these forward-looking statements, which reflect managements
analysis only as of the date hereof 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 herein and in other documents the Company files from time to time
with the Securities and Exchange Commission. 
 PART I 
 Item 1.Business Introduction The principal business of Western Water Company has been to manage,
develop, sell and lease water and water rights in the western United States.
Prior to 2000, the Company had been developing this business through the
acquisition of water rights and other interests in water, the purchase of real
estate for the water rights associated with such real estate, and the sale or
lease of water. The Companys principal activity had been to acquire and
develop water assets in California and in the Cherry Creek basin in Colorado
because it believed that there is a growing demand for water resources in both
of these areas and the demand is expected to exceed the water resources
currently available. The Company, directly and indirectly, owns certain water
rights, as well as a limited amount of real estate, in California and Colorado. The Company has, however, encountered significant regulatory obstacles in
its attempts to develop and transfer water for delivery to potential customers
in California. Prior to 2002, these regulatory obstacles were compounded by
the electric energy crisis in California, which rendered many transfers
uneconomic because of the high and unrecoverable cost of pumping water over
long distances. The regulatory and electric cost issues were further
exacerbated by the Companys weakened financial condition. The Company also has faced significant competition in arranging water
transfers from governmental agencies. This competition is significant because
these agencies also control, influence and/or price access to publicly-owned
conveyance, storage and distribution facilities necessary to carry out
California water transfers. During Fiscal Year 2004, these entities announced
that they plan to allocate virtually all water conveyance capacity across the
Delta and virtually all water storage above the Delta among themselves. Because
the Delta is the confluence of the Sacramento and San Joaquin Rivers and also
the location of export facilities serving Southern California, allocation of
capacity exclusively to government contractors would significantly impede the
Companys attempts to market water in California. If implemented, the proposed
plan would further limit the potential for development of a price sensitive
water market in California and the potential purchasers of water arising from
resources owned by the Company that are located in areas north of the Delta
(including Yuba County). As a result of these developments in California, the Company has suspended
its attempts to arrange water transfers in California and has decided to sell
some or all of its California assets. The Companys remaining principal
California water assets consist of certain riparian and appropriative water
rights, together with certain groundwater rights, associated with a large
parcel of real property located along the Yuba River, which is referred to as
the Yuba Goldfields. 1




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The Companys principal Colorado water interests consist of the water
rights associated with an aggregate of 4,559 acres of land and certain other
water rights in the Cherry Creek basin, which is referred to as the Cherry
Creek Project. This land is in the drainage area of Cherry Creek, south of
Denver, in Douglas County, Colorado. It was purchased by the Company in 1992
and most of the land has since then been sold. However, the Company has
retained almost all water rights from the land that was sold. The Cherry Creek
assets were acquired primarily for the purpose of developing, selling or
leasing water in the Cherry Creek basin. The Companys real estate holdings in
Colorado currently consist of approximately 372 acres of primarily undeveloped
land located along Cherry Creek. The Companys real estate and water rights in Colorado have been
consolidated, adjudicated, and developed to form the Cherry Creek Project. The
Company is currently concentrating its efforts on monetizing the Cherry Creek
Project. The Cherry Creek Project is the largest remaining asset on the
Companys consolidated balance sheet. As discussed in greater detail below, on
March 16, 2004, the Company entered into a loan agreement with the holders of
Companys Series C Preferred Stock, which loan is secured by the Cherry Creek
Project. At the end of the fiscal year on March 31, 2004, the balance of that
loan was approximately $559,000. Following the end of the 2004 fiscal year, the
Company borrowed an additional $279,000, and, as of July 15, 2004, the loan
secured by the Cherry Creek Project was approximately $853,000, including
accrued interest. Based on the adverse developments in California, and the Companys
decision to suspend the majority of its water operations in California, the
Companys ability to generate material revenue in the future is dependent on
its ability to (i) sell some or all of its remaining California assets, and
(ii) develop and market the Cherry Creek Project, through the sale of water
delivery contract units, the sale of the entire project, or the creation of a
joint venture to develop the project to a higher long-term value. The Company
can provide no assurance that it will be able to sell its remaining California
assets on favorable terms, if at all, or maximize the value of the Cherry Creek
Project. In fact, following the fiscal year ended March 31, 2004, the
Companys proposal for a plan to effect reliable, all-season deliveries from
the Cherry Creek Project to its downstream customers was denied by the Colorado
Office of the State Engineer. Although the Company is in the process of
appealing the denial, this setback will further delay the sale of water
delivery contract units associated with the Cherry Creek Project and may impair
the Companys liquidity position. In addition, despite recent progress in
establishing infrastructure necessary to make water deliveries from the Cherry
Creek Project to Colorado customers, before the Company can consummate
significant water deliveries from the project, the Company or its prospective
customers or a prospective joint venture partner will have to build additional
infrastructure. The Company does not currently have the financial resources
necessary to complete such infrastructure. The need for such additional
infrastructure will affect the Companys ability to sell water from the Cherry
Creek Project and the prices at which it will be able make such sales. As the Companys financial condition has deteriorated, the varying and
sometimes conflicting interests of the Companys different classes of investors
have made it more difficult and more expensive to operate the Company. For
instance, representatives of some of the Companys unsecured creditors have
registered their concerns about the Company taking on secured debt that the
Company has deemed necessary to maintain its corporate operations. These
representatives have expressed their opinion that certain creditors interests
would be better served by a liquidation of the Company than through the
expenditure of resources to develop the Companys assets for maximum value.
However, while immediate liquidation could benefit certain creditors, such a
liquidation would likely result in less than full recovery for other investors.
Similarly, certain holders of the Companys 9% convertible subordinated
debentures due 2005 have made oral threats of litigation challenging corporate
actions (including the declaration of preferred stock dividends) or forcing
liquidation. Although the Company believes such threats are without legal
foundation, the risk of litigation and of potential personal and/or corporate
liability for certain corporate actions have led the Company to incur
additional expenses beyond what would have been incurred under normal
circumstances. On August 24, 2004, Empire Insurance Company, a debenture holder, filed
suit against the Company challenging certain actions of the Company. See Part
I, Item 3, Legal Proceedingsin this Form 10-K. Based, in part, on its finding that the Companys circumstances and
prospects make it unlikely that the Companys common stockholders will achieve
a meaningful financial return, the Company took certain actions during fiscal
2004 that resulted in a change of control of the Companys Board of Directors.
Perceived differences in the interests of various classes of investors have
also led the Company to expend additional executive time and attention in
evaluating alternative corporate business plans based on the plans potential
varying impacts on the interests of different classes of investors. Because of
the Companys precarious financial position, the Company has also had to
evaluate each major business decision in light of the potential that the
Company will be deemed, in retrospect, to have been operating within the zone
of insolvency. These potential conflicts among the interests of the Companys
investors have been further exacerbated by the expense and difficulty of
communicating with and getting direction from the Companys common
stockholders. The Companys principal executive office is located at 102 Washington
Avenue, Point Richmond, California 94801. Its telephone number is (510)
234-7400. The Company maintains project offices in Marysville, 2




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California (within the Yuba Goldfields) and in Douglas County Colorado (in
proximity to the Cherry Creek Project). Unless the context requires otherwise,
references to the Company in this report include Western Water Company and
all of its subsidiaries. The Companys predecessor was originally incorporated
in California, and on March 23, 1994, the Company changed its state of
incorporation from California to Delaware. Overview of Water Markets California Southern California has been experiencing a water shortage that is
projected to become worse. The reliability of supply predictions has been
complicated by uncertainties related to Californias supply of Colorado River
water. Reacting, in part, to the risk of losing surplus Colorado River water,
the Metropolitan Water District of Southern California, the regions primary
importer of supplemental water supplies, arranged to buy additional water from
farming interests in Northern California. These arrangements, however,
consisted of direct transactions between the Metropolitan Water District of
Southern California and selected Northern California irrigation districts.
Thus, the Company has been unable to arrange high-value, long-distance,
farm-to-urban water transfers, such as it had formerly pursued. A secondary
effect of the Metropolitan Water District of Southern Californias arrangements
has been to absorb available conveyance capacity between Northern and Southern
California, making it more difficult for third-party transfers to be
accommodated. As a result, much of the water to which the Company has access
has been stranded in areas of California where water tends to be more
plentiful and where value, reflected in market prices, tends to be lower. The Sacramento Valley Water Management Agreement constitutes a recent
settlement of contested water rights between water rights holders located
upstream of the Delta and entities that hold water rights in or downstream of
the Delta. Although the Company believes that successful implementation of the
Sacramento Valley Water Management Agreement could enhance the value of senior
water rights and clarify ownership issues necessary to permit efficient water
transfers, the implementation agreements are still in the process of
negotiation. Uncertainty related to those negotiations have caused certain
upstream senior water rights holders, including clients and partners of the
Company, to defer new water transfer transactions until the details of the
Sacramento Valley Water Management Agreement are set, or to undertake only
those near-term water transfers which are sanctioned by participants in the
Sacramento Valley Water Management Agreement. Thus, even though the long-term
implications of successful negotiation of the Sacramento Valley Water
Management Agreement are positive for water transfers in California, the
pending negotiations have caused the deferral or cancellation of transfers that
might otherwise have been completed, including transactions in which the
Company intended to participate. The institutional impediments to a voluntary willing seller/willing buyer
water market in California have severely constrained the Companys ability to
generate revenues either from the sale of water arising under its own water
rights or through joint venture or brokerage arrangements with other water
rights holders to assist them in selling water. As a result, the Company is
currently disposing of most of its California assets, with the exception of
land and water rights associated with the Yuba Goldfields. Colorado Douglas County, Colorado, on the southern edge of the Denver metropolitan
area, is experiencing very rapid population growth. The County also has very
limited local surface water supplies, and is reliant upon groundwater and some
surface water from local streams and the South Platte River. Additional
surface water for the area is not readily available because existing supplies
are already controlled by others, and development of new water supply projects
has been blocked. Local agencies are pursuing new surface water imports as
well as further developing the sustainable use of local groundwater to meet new
demands on their systems. In February, 2004, the South Metro Water Supply Study Board released the
South Metro Water Supply Study. The South Metro Water Supply Study constitutes
the regions integrated water planning document and reviews the available
resource management alternatives available to the planning area, which is also
the Companys market area for the Cherry Creek Project. Therefore, the Company
is evaluating the findings and alternatives discussed in the South Metro Water
Supply Study and attempting to demonstrate the ways in which the Cherry Creek
Project can leverage the efforts of the study participants to implement
preferred alternatives. With demand for water in the study area expected to
more than double over the next 20 years, according to the South Metro Water
Supply Study, the Company believes that the water resources collected within
the Cherry Creek Project may be necessary to meet a portion of that new demand
(along with as-yet-unidentified new surface water imports). 3




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Currently, several of the study participants have agreed to independently
study the Cherry Creek Project in relation to the regional plan. In addition to the regional planning efforts summarized in the South Metro
Water Supply Study, several water purveyors within Douglas County have
undertaken efforts to increase local supply reliability. The Company analyzes
all such efforts of which it becomes aware and attempts to gain consideration
of the Cherry Creek Project in such efforts. There are at least three regional
water retail agencies that are undertaking long-term supply development
projects, including substantial infrastructure projects involving new
pipelines, diversion structures and off-stream reservoirs aimed at meeting
increasing water demands anticipated in the area. The Company is attempting to
induce these and other agencies to evaluate the use of the Companys local
water resources to meet a portion of such future demand. To date, however, the
Company has not sold any water delivery contract units nor has the Company been
successful in persuading any of the local water purveyors to rely upon the
Cherry Creek Project as a supplemental source of its long-term water supply. Regulatory Overview California Water rights in California are subject to complex laws, regulations and
jurisdictions that complicate the development of water for transfer and sale.
Under the doctrine of appropriation, a water user can publicly claim water from
a river for beneficial use, so long as the water is physically available from
the flow of the river after accounting for the rights of prior appropriators.
Beginning in 1914, surface water (generally, water in rivers) has been subject
to regulation by the State Water Resources Control Board. The Company claims
various appropriative rights on the Yuba River that were perfected by its
predecessor in interest, some of which predate State Water Resources Control
Boards jurisdiction (pre-1914 rights) and should therefore be grandfathered
from regulatory jurisdiction. However, recent developments, including the
State Water Resources Control Boards decision in the Lower Yuba River water
rights case (currently on appeal), indicate that development of these rights
associated with the Yuba Goldfields for transfer and use outside the immediate
area of Yuba County will take longer and cost more than the Company had
formerly anticipated. California law also recognizes the rights of landowners adjacent to a
river to divert an unquantified amount of water from the river for beneficial
use on such lands (riparian rights) or for in-stream beneficial use. Through
its interest in the water rights associated with the Yuba Goldfields, the
Company claims riparian rights on the Yuba River; these riparian claims are
supported, as well, by a court decree dating from 1929. Groundwater (generally, water in underground aquifers) is not subject to
statewide regulation in California, as it is in most other states. Overlying
landowners have the right to place wells on their property and pump water from
the underlying aquifer for use on their land. In some cases, such water rights
may be severed from the land and traded separately. The Company has retained
the groundwater rights associated with the Yuba Goldfields. However, the
extension and possible perfection of State Water Resources Control Boards
jurisdiction could further complicate development of the Companys groundwater
rights. In addition, the practical development of groundwater associated with
the Yuba Goldfields depends, in part, on cooperation of the Yuba County Water
Agency, which cooperation has not been forthcoming during the Agencys current
appeal of the State Water Resources Control Boards order, despite the
Companys attempts to induce such cooperation. Recovery and export of
groundwater originating in Yuba County is also subject to extensive area of
origin protections that the Company must observe in realizing value from such
rights. Further, development of marketable water from the water rights
associated with the Yuba Goldfields depends upon access to conveyance (and,
possibly, storage) facilities controlled by government agencies who have
repeatedly acted to impede development of California water markets. Finally,
use of water developed from the Companys water rights in the Yuba Goldfields
depends upon identification of an end use and end user capable of sustaining
the required physical and regulatory investment necessary to development. In
light of these interrelated and complicating factors, the Company believes that
development of its water rights will take longer and cost more than the Company
formerly anticipated. Accordingly, the Company does not currently anticipate
that it will derive significant revenues from its water rights associated with
the Yuba Goldfields in the near future. Colorado The Company believes the regulatory environment in Colorado is
substantially more transparent, less costly and more predictable in terms of
outcome than in California. The Company believes the Colorado system is more
conducive to water asset development and protection and more hospitable to
water sales than Californias 4




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system. First, water rights matters are adjudicated by a state-wide
system of Water Courts presided over by judges with specialized subject matter
knowledge from which appeal may be taken directly to the Colorado Supreme
Court. The Water Courts retain jurisdiction over cases, so that changes of
facts or circumstances can be submitted to further adjudication without
re-trying complicated issues determined in prior phases of the case. Second,
the Colorado Office of the State Engineer and regional Water Commissioners are
independent and disinterested regulators who oversee compliance with
well-developed and integrated precepts of water use administration without
conflict based on direct competition for water. Water rights are described as
being tributary (generally similar to surface water in California) or
nontributary (generally similar to groundwater in California). The Company owns the Cherry Creek Project which includes Water
Court-recognized rights to a minimum of 6,511 acre-feet of annual production of
nontributary water, additional rights to tributary appropriations from Cherry
Creek, potential near-stream water storage sites, as well as a Water Court
approved plan for augmentation to operate the separate elements of the project
on a conjunctive basis that increases overall flexibility, reliability and
value. Colorado has enacted various laws and regulations that identify and
establish rights to tributary water which grant the holders thereof the right
to use specified amounts of tributary water on a fixed priority basis. Because
junior water rights do not constitute a reliable source of water and because of
the scarcity of tributary resources in the area, municipalities and water
districts in the Cherry Creek basin have relied primarily on local groundwater
resources and other nontributary supplies. However, under Colorado law, by
combining various water rights under a court-approved plan for augmentation,
junior water rights can effectively be used out of priority without injury to
the senior appropriators. Because court-approved plans for augmentation allow
water to be diverted from junior tributary water sources without regard to the
priority system, such plans are currently the most common method by which new
reliable water supplies are developed for municipal uses in Colorado. As a
result, the Company believes that water derived from the Cherry Creek Project
constitutes a reliable future supply to meet the growing demand within the
area. In addition, the Companys plans for developing the Cherry Creek Project
are consistent with prevailing Colorado water law as well as the precepts
embedded in the South Metro Water Supply Study. As a result of the more
hospitable regulatory environment in Colorado, the Company has concentrated its
efforts there to develop the Cherry Creek Project in conformance with Colorado
law and in cooperation with regional water purveyors. Description of Business The Companys business goal has been to create recurring income through
identifying undervalued and/or underused water assets, and enhancing the value
of those assets via development, transmission and delivery to customers in the
arid regions of California and Colorado. However, significant delays in the
Companys attempts to overcome regulatory obstacles to economic water transfers
in California and the Companys financial constraints have forced it to
reconsider its business plans. In accordance with a plan to manage the
Companys liquidity position and to reduce its operating expenses, the Company,
during the three most recent fiscal years, has sold most of the assets that the
Company no longer believed it would be able to profitably develop and manage
within a reasonable period. On June 18, 2003, the Company sold its interest in the Bear Valley Mutual
Water Company to a local city water department. Upon disposition, the Company
received cash proceeds of approximately $723,000 and realized a gain on the
sale of approximately $73,000. During the fiscal year ended March 31, 2004, the Company sold its two farm
properties (Byington and Magnolia Ranches) in the Wheatland Water District.
Byington Ranch was sold to an unaffiliated purchaser in December 2003 for net
proceeds of $1,170,000 and realized a gain of $208,000. In March 2004, the
Company sold the Magnolia Ranch to a different unaffiliated purchaser and
received net proceeds of $1,916,000 and realized a gain of $463,000. In May 2004, the Company sold its last remaining ranch in Yuba County
(Loma Rica Ranch) to a different unaffiliated purchaser for net proceeds of
$599,000 and realized a gain of $85,000. In June 2004, the Company sold the
Cardozo Ranch in San Bernardino County to a different unaffiliated purchaser
for a combination of cash in the amount of $224,000 plus a purchase money note
in the amount of $230,000 which was secured by the property. After deductions
for back property taxes, sales commission, and other costs of disposition
relating to the Cardozo Ranch, and following the subsequent retirement of the
purchase money note, the Company received approximately $454,000 in net
proceeds which resulted in a gain of $2,000 in fiscal 2005. On July 26, 2004, the Company sold its last remaining ranch in San
Bernardino County, California (Lewis Ranch) to an unaffiliated purchaser in a
transaction recorded as an installment sale. The Company retains ownership of 242 acre-feet per year of West Basin (Los
Angeles County, California) groundwater pumping rights. These rights, together
with certain West Basin groundwater pumping rights that the Company has leased
from others, had been pledged to meet the Companys obligations to sell water
to the City of 5




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Inglewood, California. During the fiscal year ended March 31, 2003, the
Company repaid the remaining principal of the bank loan arranged in 1998 to
support the Inglewood transaction and thereby cancelled the banks security
interest in the West Basin groundwater pumping rights. The five-year term of
the Inglewood transaction expired on September 30, 2003. The Company has
decided to sell its residual West Basin groundwater pumping rights and this
asset is recorded as an asset held for sale on its balance sheet as of March
31, 2004. The following is a summary of the assets the Company sold or disposed of
during the three most recent fiscal years: Fiscal Year ended March 31, 2004: CashAsset
    
    Proceeds
    
    GainInvestment in Bear Valley Municipal Water Company,
California
    
    $
    723,000
    
    
    $
    73,000Yuba County, California, Farmland
    
    
    3,086,000
    
    
    
    671,000Douglas County, Colorado, Land
    
    
    406,000
    
    
    
    406,000
 Fiscal Year ended March 31, 2003: CashAsset
    
    Proceeds
    
    GainMojave Water Rights, California
    
    $
    2,632,000
    
    
    $
    964,000Possessory Interest in Land in Douglas County, Colorado
    
    
    294,000
    
    
    
    11,000
 Fiscal Year ended March 31, 2002: CashAsset
    
    Proceeds
    
    GainGlenn County, California Farmland
    
    $
    299,000
    
    
    $
    1,000
 California  Yuba Goldfields Water Rights The Company has been attempting to develop its Yuba Goldfields water for
sale or lease through a long-term conjunctive use program in cooperation with
the Yuba County Water Agency. The Company has not, however, developed a plan
for marketing and selling water arising under its Yuba Goldfields water rights.
In addition, there are various regulatory hurdles that could delay or limit
the Companys ability to deliver or sell such water. Based on regulatory
limitations as well as on delays in negotiating a satisfactory conjunctive use
program, the Company believes that the development and delivery of water from
the Yuba Goldfields will take longer and cost more than it had formerly
anticipated. The Companys carrying value of these Yuba Goldfields-related
assets (including water rights, land and improvements, equipment, and certain
capitalized project development costs) is approximately $280,000. Colorado  Cherry Creek Project In July 1992, the Company initiated the Cherry Creek Project. The Company
has retained substantially all of the water rights associated with the Cherry
Creek Project. The Company has the right to operate 14 wells drawing tributary
water in the Cherry Creek alluvium, of which 12 are existing wells. Ten of the
14 well rights (including two completed alluvial wells on property recently
acquired by the Parker Water & Sanitation District under threat of
condemnation) are located on property that is not owned by the Company. With
respect to these ten wells, the Company owns the right to drill, maintain and
operate the wells and to enter the real property on which such wells are
located in order to operate, maintain or establish such wells. In April 1995,
the Company transferred 6




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approximately 257 acres of its Cherry Creek Project real estate to the
State of Colorado for annexation into the Castlewood Canyon State Park in
exchange for the rights to withdraw and use 1,290 acre-feet of nontributary
water per year associated with the adjacent park land owned by the state. The Company currently has the right to sell or lease each of the various
water rights it owns. However, in order to package its water rights so that it
can sell long-term, reliable water resources to municipalities and other larger
water users located in the Cherry Creek basin, the Company combined its various
water resources in a plan for augmentation approved by the Colorado Water Court
in February 1998. During the fourth quarter of the year ended March 31, 1999,
the Company drilled its first nontributary well to begin implementation of the
plan for augmentation. This well provides the Company with additional
information on the water resources in the aquifer. In addition, water from
this well is available for future water sales. During the fiscal year ended
March 31, 2003, the Company produced and sold its first water from this
nontributary source. Although the amount and value of these water sales are
not material, the Company believes that completion of construction, permitting,
and the initial sale and successful delivery of Cherry Creek Project water are
important milestones in the development of the Cherry Creek Project. During the year ended March 31, 2003, the Company (i) acquired a permanent
easement for the development of a series of additional nontributary wells, (ii)
sought and received federal regulatory approval to complete the conveyance and
delivery structures, and (iii) successfully constructed an Arapahoe aquifer
well and related outfall facilities to connect the new well to Cherry Creek.
Based on completion of the additional water production and delivery facilities,
the Cherry Creek Project increased its legal and physical capability of
delivering in excess of 600 acre-feet of water per year to users with alluvial
production facilities along Cherry Creek. During the year ended March 31, 2004, the Company entered into a water
sale agreement with the Cottonwood Water & Sanitation District, a public water
purveyor in northern Douglas County. Cottonwood is one of the entities that
have executed non-binding letters of intent to purchase water delivery contract
units representing an undivided interest in the permanent production capacity
of the Cherry Creek Project, at a value of approximately $4,500 per acre-foot
of firm water supply. One of the remaining conditions to the sale of the water
delivery contract units is the demonstration of reliable delivery of water
under all stream and weather conditions. Under the Cottonwood water sale
agreement, the Company contracted to deliver up to 100 acre-feet of Cherry
Creek Project water to Cottonwood during the year beginning July 1, 2003 and
ending June 30, 2004. The Company has fulfilled all of its obligations under
that contract by making deliveries to Cottonwood from the Cherry Creek Project
via Cherry Creek. One of the purposes of the Cottonwood water sale agreement
was to demonstrate and gain approval for a reliable delivery regime, via Cherry
Creek, that could satisfy the delivery condition for the planned sale by the
Company and purchase by Cottonwood and others of Cherry Creek Project water
delivery contract units. Following execution of the Cottonwood water sale agreement, Cottonwood and
the Company filed a joint application to the Colorado Office of the State
Engineer for approval of a substitute water supply plan. The proposed
substitute water supply plan included elements designed to assure the Cherry
Creek Projects current and prospective customers of reliable water deliveries
via Cherry Creek. Unless the Company is able to provide its customers timely
assurance of reliable deliveries of water produced by the Cherry Creek
Projectthrough implementation of an approved substitute water supply plan or
other meansthe Company may not be able to sell the water delivery contract
units. The proposed substitute water supply plan constituted an integrated
approach to tracking and accounting for water deliveries from the projects
upstream nontributary production wells to Cottonwoods downstream alluvial
wells. Essentially, the substitute water supply plan proposed that the Company
deliver the nontributary water to Cherry Creek and use the Creek itself to
convey the water to its downstream customer. The proposed delivery
arrangements were uncontested as to periods when Cherry Creek exhibits surface
flow between the point of introduction of the nontributary water and the
downstream point of withdrawal by Cottonwood. However, two parties filed
objections to the substitute water supply plans delivery regime as to periods
when Cherry Creek exhibits dry reaches between the point of introduction and
the downstream point of withdrawal. The Company responded to the objections by
attempting to demonstrate that operation of the substitute water supply plan
could not cause an injury to any water right on Cherry Creek, even during
periods when the Creek exhibits dry reaches. The Companys application for approval of the substitute water supply plan
was unexpectedly denied by the Colorado Office of the State Engineer in April
2004. As a result of that denial, the schedule for sale of water delivery
contract units has been delayed and the likelihood of such sales has been
diminished. On May 6, 2004, the Company filed a Notice of Appeal of the denial
with the Colorado Water Court, as permitted under applicable Colorado statute.
The Company cannot predict the outcome of the appeal or when a decision will be
forthcoming from the Water Court. In addition to pursuing the appeal, the Company also prepared and filed a
new substitute water supply plan application with limiting terms and conditions
aimed at gaining approval. As a prerequisite to filing for approval of a
revised substitute water supply plan, the Company and the Cottonwood Water &
Sanitation District mutually 7




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##### Table of Contents



executed a new water sale agreement on August 17, 2004. The new water sale
agreement is substantially similar to the one-year agreement signed in 2003 and
completed during 2003-4, except that the new agreement provides greater
operational flexibility and calls for the sale of up to 200 acre-feet of water
from the Cherry Creek Project. In addition to entering into the new water sale
agreement, the Company and Cottonwood have worked cooperatively with the Office
of the State Engineer to develop terms and conditions for a revised substitute
water supply plan that might improve the likelihood of approval by the Office
of the State Engineer. The Company can provide no assurances that the revised
terms and conditions acceptable to the Office of the State Engineer or that
such revised terms and conditions will be economically viable for the Cherry
Creek Project. Further, the Company cannot predict (i) whether the new
substitute water supply plan application will be approved or (ii) the period of
time required for review of the new application. As a result, the Company can
provide no assurance that it will succeed in generating meaningful revenue from
the Cherry Creek Project, particularly in light of the Companys dwindling
financial resources. Moreover, based on its current estimates, unless the
Company is able to consummate sales of the water delivery contract units
associated with the Cherry Creek Project by August 2005, the Company will not
have sufficient funds to continue its operations thereafter. Environmental Regulation The Companys operations are or may become subject to federal, state and
local laws and rules regulating the discharge of materials into the
environment, air quality standards, pollution of stream and freshwater sources,
odor, noise, dust and other environmental protection controls. The Company
believes that it currently is in substantial compliance with all material
environmental laws governing its operations. Furthermore, the Company does not
believe that federal or state environmental laws will hinder or adversely
affect its proposed operations. However, future legislation designed to
protect the environment, as well as future interpretations of existing laws,
could require further expenditures by the Company, or have adverse effects on
its operations, the extent and nature of which cannot now be predicted. Water
leased or sold by the Company may be subject to regulation as to quality by the
United States Environmental Protection Agency (or EPA) acting pursuant to the
Federal Safe Drinking Water Act. In California, the responsibility for
enforcing the Federal Safe Drinking Water Act is delegated to the California
Department of Health Services and to the State Water Resources Control Board
acting pursuant to the California Safe Drinking Water Act. The Federal Safe
Drinking Water Act provides for the establishment of uniform minimum national
water quality standards, as well as governmental authority to specify the type
of treatment processes to be used for public drinking water. The California
Safe Drinking Water Act and the mandate of the California Department of Health
Services are similar to the Federal Safe Drinking Water Act and the mandate of
the EPA, and in many instances the maximum contaminant levels and other
requirements of the California Department of Health Services are more
restrictive than those promulgated by the EPA. Both the EPA and the California Department of Health Services have
promulgated regulations and other pronouncements, which require various testing
and sampling of water and inspections by distributors and retailers and which
set the maximum levels for numerous contaminants. Because the Company does not
intend to sell water directly to consumers, it believes that these standards
only affect the water agencies that may buy or lease the Companys water.
While drinking water regulations do not directly affect the Company, the
regulations regarding the quality of water distributed for human consumption
affects the Companys intended customers and may, therefore, depending on the
quality of the Companys water, impact the price and terms upon which the
Company may in the future sell its water or water rights. Under various federal, state and local laws, regulations and ordinances,
an owner or operator of real estate interests may be liable for the costs of
cleaning up, as well as certain damages resulting from, past or present spills,
disposals or other releases of hazardous or toxic substances or wastes on, in
or from a property. Certain environmental laws including the federal
Comprehensive Environmental Response Compensation and Liability Act and
Resource Conservation and Recovery Act, impose such liability without regard to
whether the owner knew of, or was responsible for, the presence of hazardous or
toxic substances or wastes at or from the property. The presence of such
substances or wastes, or the failure to properly remediate any resulting
contamination, also may adversely affect the owners or operators ability to
sell, lease, or operate its property or to borrow using its property as
collateral. Although the Company is not aware of any such environmental
contamination on any of its real estate holdings or on any locations adjacent
to its holdings, there can be no assurance that such environmental
contamination does not exist. During the fiscal year ended March 31, 2004, the Company discovered that
an isolated portion of its land within the Yuba Goldfields had previously been
used as a domestic refuse disposal site. The Company does not know what
materials were disposed at the site. Use of the site was apparently abandoned
approximately 40 years ago. The Company has not been notified of any potential
liability with respect to the abandoned disposal site, and no claims related to
the site have been made against the Company. In June 2004, the Company
contracted with an 8




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##### Table of Contents



unaffiliated waste management company to take soil samples from various
locations around the former disposal site for laboratory analysis. The
analytical results indicate normal readings without any indication of abnormal
or hazardous materials at the site. Based on these results, the Company does
not believe that the former dump site constitutes an environmental or financial
liability to the Company. Employees As of the date of this report, the Company has seven employees, none of
whom is covered by any collective bargaining agreement. The Company believes
that its relations with its employees are good. However, in light of the
Companys precarious financial position, the Company is at risk of losing
employees to more stable employers. After the year ended March 31, 2004, the
Company agreed to pay a retention bonus to assure the continued service of the
Companys Vice President-Engineering through September 30,
2005. 
 Item 2.Properties The principal properties owned by the Company at March 31, 2004 consisted
of the following:  
    
    Undeveloped land in the Cherry Creek basin, Colorado, consisting of a
total of approximately 372 acres and associated water rights. See
Item 1. Business  Description of Business  Colorado Cherry Creek
Project. The Companys Colorado land is currently zoned and used
primarily for agricultural uses.  
    
    A 225-acre rice farm located in Yuba County, California (known as Loma
Rica Ranch). The Company sold Loma Rica Ranch on May 20, 2004 and
received net proceeds of approximately $599,000, generating a gain of
$85,000.  
    
    Two parcels of real estate situated within the Yuba Goldfields in Yuba
County, California, approximately ten miles northeast of Marysville,
California. The two parcels, aggregating approximately 30 acres, are
zoned industrial-extractive and may be used for commercial but not
residential purposes. The Company maintains its Yuba Goldfields
project office on one of the parcels. The Company also owns the water
rights associated with a substantial portion of the Yuba Goldfields.  
    
    Certain mineral interests and other property rights including the
right to enter for the purpose of extracting hydrocarbons, related to
440 acres of land in Chico, California, and to 2,578 acres of land in
Sacramento County, California.  
    
    Lewis Ranch, an 80-acre unimproved parcel in San Bernardino County,
California and Cardozo Ranch, a 139-acre ranch with four single family
houses situated thereon. The Company sold Cardozo Ranch on June 7,
2004, and received net proceeds of approximately $454,000, resulting
in a gain of $2,000. On July 26, 2004, the Company sold Lewis Ranch
to an unaffiliated purchaser for $250,000 for which the Company
received $30,000 in cash and a long-term amortizing purchase note in
the amount of $220,000. The sale of the Lewis Ranch is being recorded
as an installment sale. As of March 31, 2004, both Lewis Ranch and
Cardozo Ranch were accounted for among assets held for sale on the
Companys balance sheet. The Companys foregoing real estate properties in Colorado, part of the
Cherry Creek Project, are encumbered by a deed of trust securing a note payable
by the Company to holders of the Companys Series C Preferred Stock. For a
description of the note, see Note 12: Long-Term Debt to the Companys
consolidated financial statements included as part of this annual report on
Form 10-K. The Company leases its principal executive office at 102 Washington Avenue
in Point Richmond, California, containing 2,400 net square feet, pursuant to a
lease that expires in February 2006. The Companys current monthly rental
obligation for the facility is $4,800. 9




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##### Table of Contents



Item 3.Legal Proceedings During the fiscal year ended March 31, 2002, the Parker Water & Sanitation
District commenced a condemnation action in order to take ownership of a
36-acre portion of a land parcel owned by the Company and held as part of the
Cherry Creek Project in Colorado. In the fiscal year ended March 31, 2003, the
Company and the Parker Water & Sanitation District entered into a Stipulation
for Immediate Possession under which the Company agreed to allow the Parker
Water & Sanitation District to take possession of the 36-acre portion of the
land parcel. Under the Stipulation for Immediate Possession, the Company
preserved the water rights associated with that parcel of land and was granted
easements necessary for the Company to access and use such water rights. The
Parker Water & Sanitation District made a deposit to the Court of $294,134
against the to-be-determined value of the parcel of land. The court
subsequently paid the deposit to the Company. In September 2003, the Company
reached a settlement with the Parker Water & Sanitation District, and the
settlement was entered as a final rule and order of the Court terminating the
condemnation action. Under the settlement, the parties agreed to total
valuation (including costs of condemnation) of $700,000. Thus, the Parker
Water & Sanitation District supplemented the preliminary deposit with a further
payment to the Company of $405,866. The Company collected the supplemental
payment in October 2003, and recorded a gain of $405,866 as a result of
completing the settlement. On August 24, 2004, Empire Insurance Company, a holder of $3 million of
the Companys 9% Convertible Subordinated Debentures, due September 30, 2005
filed suit against the Company, its directors and certain holders of Series C
Convertible Redeemable Preferred Stock in the Court of Chancery for the State
of Delaware. (Empire Insurance Company v. Western Water Co., et al, C.A. No.
660-N, Filing ID 4093647.) The complaint challenges the March 16, 2004
decisions of the Companys Board of Directors to declare and pay a dividend on
the Series C Preferred Stock and to take other related actions. See Part II,
Item 5, Series C Preferred Stockin this Form 10-K. The complaint seeks
equitable relief including rescission of the dividend, voidance of the loan
with which the dividend was funded, cancellation of the security for the loan,
injunction against the declaration of future dividends in favor of the Series C
Preferred Stock and other unspecified damages. The Company believes that the
outcome of the litigation is unlikely to have a material effect on the
Companys financial position, except for the cost of responding to and
defending against the allegations in the complaint. The Company may, from time to time, become involved in other litigation
relating to claims arising from its ordinary course of business activities. 
 Item 4.Submission of Matters to a Vote of Security Holders Because no stockholder requested an annual meeting of stockholders to be
held in 2003, and because of the expense of holding an annual meeting, the
Company decided not to convene an annual meeting during 2003, as required under
Delaware law. Therefore, no matters have been submitted for stockholders vote
since the annual meeting held in September 2002. For similar reasons, the
Company does not currently expect to call an annual meeting of stockholders
during 2004, unless there are proposed actions requiring approval of
stockholders, unless requested to do so by a substantial number of
stockholders, or unless compelled to do so by the Delaware courts. 
 PART II 
 Item 5.Market for Registrants Common Equity Securities and Related Stockholder
Matters Common Stock The Companys common stock is currently traded electronically on the OTC
Bulletin Board under the symbol WWTR.OC. The following table sets forth for
the prior two fiscal years the high and low closing sales prices of the common
stock. Low
    
    HighYEAR ENDED MARCH 31, 2004First Quarter (April-June)
    
    $
    .20
    
    
    $
    .35Second Quarter (July-September)
    
    
    .08
    
    
    
    .22Third Quarter (October-December)
    
    
    .10
    
    
    
    .16Fourth Quarter (January-March)
    
    
    .06
    
    
    
    .11YEAR ENDED MARCH 31, 2003First Quarter (April-June)
    
    $
    .86
    
    
    $
    1.24Second Quarter (July-September)
    
    
    .25
    
    
    
    .85Third Quarter (October-December)
    
    
    .17
    
    
    
    .37Fourth Quarter (January-March)
    
    
    .19
    
    
    
    .36
 10




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##### Table of Contents



On October 8, 2004, the Company had 1,535 record holders of its common
stock. The Company believes there are numerous additional beneficial owners of
the common stock whose shares are held in street name. To date, the Company has not declared or paid any cash dividends with
respect to its common stock, and the current policy of the Board of Directors
is to retain earnings, if any, to provide for the expenses of the Company.
Consequently, no cash dividends are expected to be paid on the common stock in
the foreseeable future. During the quarter ended March 31, 2004, the Company
conducted a thorough review of its then-current financial position, legal and
contractual obligations (including those to investors in the Company), business
environment, and staffing. The review took into consideration the projected
cost of operating the Company during the period necessary to monetize its
assets and the inherent uncertainty related to the timing of and net proceeds
that could be achieved in an orderly process of developing and/or selling such
assets. The review also considered the substantial uncertainty with respect to
whether orderly development and disposition of the Companys assets would
result in net proceeds sufficient to meet the Companys obligations as those
obligations come due. As a result of that review, the Company reached the
conclusion that it is unlikely that the Company can provide a meaningful
financial return for its common stockholders. Series C Preferred Stock As of March 31, 2004 and 2003, there were 7,708 shares of the Companys
Series C Convertible Redeemable Preferred Stock outstanding. The Series C
Preferred Stock provides for annual dividends, when and if declared, in the
amount of $72.50 per year (7.25%), payable semi-annually in arrears in January
and July. During the fiscal year ended March 31, 2003, the Company declared
and paid the Series C Preferred Stock dividend due on July 15, 2002 but
deferred declaring the Series C dividend due on January 15, 2003 in order to
preserve the Companys interim liquidity. On June 25, 2003 the Companys Board
of Directors declared the Series C dividend which had been deferred from its
due date of January 15, 2003. The dividend was paid on June 26, 2003. In order to preserve the Companys interim liquidity, the Board of
Directors of the Company did not declare the Series C Preferred Stock dividends
originally due on either July 15, 2003 or January 15, 2004 on a timely basis.
As a result of the decisions to withhold payment of two successive dividends,
the Series C Preferred Stock holders gained the right to nominate a majority of
the Companys Board of Directors. In light of that right, the Company
initiated discussions with representatives of the Series C Preferred Stock
holders to arrange an orderly transition of the Board majority to nominees of
the Series C Preferred Stock holders. As a result, directors David A. Abel,
Robert A. Baker and Lee K. Harrington resigned from the Companys Board of
Directors on March 1, 2004, and Reginald M. Norris, Jr. and Dennis J. Kenny,
nominees of the Series C Preferred Stock holders, were elected to serve the
remaining terms of Messrs. Abel and Baker. On March 16, 2004, following the sale of Magnolia Ranch, the Companys
reconstituted Board of Directors declared a dividend in the amount of
approximately $559,000, which represented the aggregation of the previously
undeclared semi-annual dividends for July 15, 2003 and January 15, 2004.
Simultaneously with the declaration of the Series C Preferred Stock dividend,
the Series C Preferred Stock holders agreed to lend to the Company an amount
equal to the aggregate declared dividend of $559,000. The loan is evidenced by
a note secured by a deed of trust on the Cherry Creek Project. For more
information related to the note see Note 12: Long-Term Debt to the Companys
consolidated financial statements included as part of this annual report on
Form 10-K. On July 15, 2004, the Board of Directors declared a dividend on the Series
C Preferred Stock in the amount of approximately $279,000. Simultaneously, the
Company borrowed $279,000 from the Series C Preferred Stock holders in order to
fund the July 15, 2004 dividend. As of July 15, 2004, the balance of the
Companys notes payable to the Series C Preferred Stock holders was
approximately $853,000, consisting of $838,000 in principal, plus $15,000 in
accrued interest. See Item 3, Legal Proceedings. Series F Preferred Stock As of March 31, 2004 and 2003, there were 2,388.105 and 2,251.018 shares
of the Companys Series F Convertible Redeemable Preferred Stock outstanding.
The Series F Preferred Stock provides for annual dividends, in the amount of
$60.00 per year (6%), payable semi-annually in arrears in January and July.
Such dividends may be paid in cash or in additional shares of Series F
Preferred Stock, at the sole discretion of the Companys Board of Directors.
To date, such dividends have been declared and paid through the issuance of
388.105 additional shares of 11




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##### Table of Contents



Series F Preferred Stock. On July 15, 2004, the Board of Directors declared a
semi-annual dividend on the Series F Preferred Stock at the semi-annual rate of
3%. The dividend was paid in additional shares and, accordingly, the Company
issued 71.643 additional shares of Series F Preferred Stock in satisfaction of
the dividend requirement. Equity Compensation Plan Information The following table sets forth certain information as of March 31, 2004
regarding securities authorized for issuance under the Companys equity
compensation plans. Number of Securities
    
    
    
    
    
    Number of Securitiesto be Issued upon
    
    Weighted-Average
    
    Remaining AvailableExercise of
    
    Exercise Price of
    
    for Future IssuanceOutstanding Options,
    
    Outstanding Options,
    
    under EquityWarrants and Rights
    
    Warrants and Rights
    
    Compensation PlanEquity compensation
plans approved by
security holders
(1)
    
    
    1,379,167
    
    
    $
    .43
    
    
    
    820,833Equity compensation
plans not approved
by security holders
    
    
    -0-
    
    
    
    N/A
    
    
    
    N/ATotal
    
    
    1,379,167
    
    
    $
    .43
    
    
    
    820,833
 (1) The compensation plans approved by the security holders represent the
Companys 1993 and 1997 Stock Option Plans. 
 Item 6.Selected Financial Data The table below summarizes certain financial data for the periods shown
and is qualified in its entirety by, and should be read in conjunction with,
the Companys Consolidated Financial Statements and the Notes thereto, and
Managements Discussion and Analysis of Financial Condition and Results of
Operations, included elsewhere in this annual report. 2004
    
    2003
    
    2002
    
    2001
    
    2000Statement of Operations Data:Revenue
    
    $
    903,948
    
    
    $
    1,529,235
    
    
    $
    1,464,200
    
    
    $
    2,126,695
    
    
    $
    2,796,037Cost of revenue
    
    
    493,885
    
    
    
    1,040,917
    
    
    
    981,311
    
    
    
    1,517,610
    
    
    
    1,767,714Gross profit
    
    
    410,063
    
    
    
    488,318
    
    
    
    482,889
    
    
    
    609,085
    
    
    
    1,028,323General and administrative expenses
    
    
    (3,137,437
    )
    
    
    (3,080,810
    )
    
    
    (3,075,609
    )
    
    
    (3,933,995
    )
    
    
    (7,448,615
    )Gain on disposition of assets
    
    
    1,142,631
    
    
    
    977,582
    
    
    
    16,747
    
    
    
    1,775,320
    
    
    
    40,000Operating loss
    
    
    (1,584,743
    )
    
    
    (1,614,910
    )
    
    
    (2,575,973
    )
    
    
    (1,549,590
    )
    
    
    (6,380,292
    )Interest income (expense), net
    
    
    (759,662
    )
    
    
    (766,094
    )
    
    
    (689,693
    )
    
    
    (660,745
    )
    
    
    (624,966
    )Other income (expense), net
    
    
    (78,598
    )
    
    
    238,003
    
    
    
    (11,528
    )
    
    
    1,136,098
    
    
    
    3,823,155Loss from operations before income taxes
and change in accounting principle
    
    
    (2,423,003
    )
    
    
    (2,143,001
    )
    
    
    (3,277,194
    )
    
    
    (1,074,237
    )
    
    
    (3,182,103
    )Income taxes
    
    
    (4,800
    )
    
    
    (3,200
    )
    
    
    (3,200
    )
    
    
    (3,200
    )
    
    
    (3,200
    )Loss before cumulative effect of change
in accounting principle
    
    
    (2,427,803
    )
    
    
    (2,146,201
    )
    
    
    (3,280,394
    )
    
    
    (1,077,437
    )
    
    
    (3,185,303
    )Cumulative effect of change in
accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (237,065
    )
    
    
    Net loss
    
    
    (2,427,803
    )
    
    
    (2,146,201
    )
    
    
    (3,280,394
    )
    
    
    (1,314,502
    )
    
    
    (3,185,303
    )Accretion of preferred stock to
redemption
value
    
    
    (181,596
    )
    
    
    (130,604
    )
    
    
    (108,298
    )
    
    
    (38,255
    )
    
    
    (35,819
    )Excess of carrying value over amount
paid to retire convertible
redeemable preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,678,597
    
    
    
    Preferred stock dividends
    
    
    (863,233
    )
    
    
    (303,565
    )
    
    
    (860,453
    )
    
    
    (930,977
    )
    
    
    (1,486,954
    )Net income (loss) applicable to common
stockholders
    
    $
    (3,472,632
    )
    
    $
    (2,580,370
    )
    
    $
    (4,249,145
    )
    
    $
    5,394,863
    
    
    $
    (4,708,076
    )
 12




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##### Table of Contents



2004
    
    2003
    
    2002
    
    2001
    
    2000Basic net income (loss) per common share
applicable to common stockholders:Income (loss) before cumulative
effect of change in accounting
principle
    
    $
    (0.43
    )
    
    $
    (.32
    )
    
    $
    (.53
    )
    
    $
    .71
    
    
    $
    (0.59
    )Cumulative effect of change in
accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (.03
    )
    
    
    Net income (loss) per common share
applicable to common stockholders
    
    $
    (0.43
    )
    
    $
    (.32
    )
    
    $
    (.53
    )
    
    $
    .68
    
    
    $
    (0.59
    )Diluted net income (loss) per common
share applicable to common
stockholders:Income (loss) before cumulative
effect of change in accounting
principle
    
    $
    (0.43
    )
    
    $
    (0.32
    )
    
    $
    (0.53
    )
    
    $
    .69
    
    
    $
    (0.59
    )Cumulative effect of change in
accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (.03
    )
    
    
    Net income (loss) per common share
applicable to common stockholders
    
    $
    (0.43
    )
    
    $
    (0.32
    )
    
    $
    (0.53
    )
    
    $
    0.66
    
    
    $
    (0.59
    )
 As of March 31,2004
    
    2003
    
    2002
    
    2001
    
    2000Balance Sheet Data:Current assets
    
    $
    3,177,490
    
    
    $
    2,419,099
    
    
    $
    6,350,497
    
    
    $
    7,701,501
    
    
    $
    3,117,578Total assets
    
    
    16,860,318
    
    
    
    19,914,197
    
    
    
    24,224,892
    
    
    
    29,646,307
    
    
    
    37,700,950Working capital
    
    
    2,110,513
    
    
    
    1,134,371
    
    
    
    3,900,325
    
    
    
    5,932,450
    
    
    
    703,780Long-term debt and debentures
    
    
    8,876,635
    
    
    
    8,446,675
    
    
    
    9,011,979
    
    
    
    10,325,976
    
    
    
    12,015,366Redeemable preferred stock
    
    
    8,333,723
    
    
    
    8,127,179
    
    
    
    7,972,495
    
    
    
    7,842,030
    
    
    
    19,816,686Common stockholders equity (deficit)
    
    
    (1,417,017
    )
    
    
    2,055,615
    
    
    
    4,790,245
    
    
    
    8,885,130
    
    
    
    3,451,767
 
 Item 7.Managements Discussion and Analysis of Financial Condition and Results
of Operations General Business Condition 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 is a growing demand for water resources
in both of these areas in which demand is expected to exceed the water
resources currently available. However, the Company has encountered
significant regulatory obstacles in its attempts to develop and transfer water
for delivery to potential customers in California. These regulatory obstacles
were compounded by the electric energy crisis in California, which rendered
many transfers uneconomic because of the high and unrecoverable cost of pumping
water over long distances, and by the Companys weakened financial condition.
The Company has also faced significant competition in arranging water transfers
from governmental agencies. In addition, the process for developing the
regulatory framework and physical infrastructure necessary to complete
commercial deliveries in Colorado has taken longer than originally anticipated. Over the last few years, the Company has investigated and actively pursued
several potential alternatives for achieving profitable operations in the
emerging water market or a sale or merger of the Company which would recover
fair value for its investors. In that process, the Company has evaluated
numerous asset development, asset sale, and business combination strategies in
concert with a variety of counter-parties. The Company has entered into
confidentiality agreements and due diligence processes with several such
counter-parties. However, none of these proposed transactions was successfully
concluded and none is currently under consideration. Several of the transactions that were proposed to the Company, but not
consummated, were predicated upon retiring obligations of the Company at deep
discounts from their carrying values. Despite having made a number of debt and
preferred stock purchases at discounts over the years, the Company has been
unable to reduce its debt and dividend expenses sufficiently to maintain
liquidity, except through the periodic sale of assets. In the year ended March
31, 2004, the Company continued its efforts to reduce operating expenses which
consisted of eliminating two executive and one staff positions, and continuing
to carefully restrict expenditures to those that are essential for the
management and development of the Companys assets or the continuation of its
operations. 13




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##### Table of Contents



Liquidity and Capital Resources During fiscal year 2004, the Company operated at a net loss of
$(2,428,000) and generated an increase in cash and cash equivalents of
$272,000, primarily by selling certain of its real estate assets in California.
Because the Company does not generate operating revenues sufficient to meet
its operating expenses, the Companys current strategy is to fund its current
level of operations through the orderly sale of assets, primarily in
California, until the Company can realize the full value of its Cherry Creek
Project. The Company has monetized many of its physical assets, and therefore
retains fewer and less liquid assets to either generate cash flow or sales
proceeds in the future. Moreover, the Companys ability to develop and market the Cherry Creek
Project, through the sale of water delivery contract units, the sale of the
entire project, or the creation of a joint venture to develop the project to a
higher long-term value, is uncertain after its application for approval of a
substitute water supply plan was unexpectedly denied by the Colorado Office of
the State Engineer in April 2004. Unless the Company is able to provide its
customers timely assurance of reliable deliveries of water produced by the
Cherry Creek Projectthrough implementation of an approved substitute water
supply plan or other meansthe Company may not be able to sell the water
delivery contract units associated with the Cherry Creek Project. The Company
can provide no assurance that its new application for approval of a substitute
water supply plan (filed on September 22, 2004) includes revised terms and
conditions acceptable to the Colorado Office of the State Engineer or that such
revised terms and conditions will be economically viable for the Cherry Creek
Project, if approved. Further, the Company cannot predict (i) whether the new
substitute water supply plan application will be approved or (ii) the period of
time required for the Colorado Office of the State Engineer to review the new
application. As a result, the Company can provide no assurance that it will
succeed in realizing any meaningful value from the Cherry Creek Project,
particularly in light of the Companys dwindling financial resources. As of March 31, 2004, the Company had cash and cash equivalents of
$1,416,645. Based on its current estimates, unless the Company is able to
consummate sales of the water delivery contract units associated with the
Cherry Creek Project prior to approximately August 2005, or otherwise generates
additional cash, the Company will not be financially able to sustain business
operations thereafter. In light of the uncertainties associated with the
Companys ability to continue as a going concern, the Companys independent
registered public accounting firm provided a going concern uncertainty
explanatory paragraph in its unqualified opinion with respect to the Companys
consolidated financial statements for the year ended March 31, 2004. See the
report of the independent registered public accounting firm included as a part
of this annual report on Form 10-K. Change of Majority Control of the Companys Board and Declaration of
Dividend on the Companys Series C Preferred Stock The Certificate of Designations of the Series C Preferred Stock provides
that the holders of the outstanding Series C Preferred Stock are entitled to
receive, if and when declared by the Board of Directors, dividends at the
annual rate of 7.25% of the stated value per share of Series C Preferred Stock.
The Certificate of Designations further provides that the dividends shall be
payable semi-annually on January 15 and July 15. The dividends are
non-cumulative. However, in the event that two dividends are not declared and
paid, the holders of the Series C Preferred Stock gain the right to elect a
majority of the Companys Board of Directors. In order to preserve its liquidity, the Company had not declared the
dividend due in July 2003. In early January 2004, and in the course of
considering the declaration and payment of scheduled dividends on the Series C
Preferred Stock, the Company conducted a thorough review of its financial
position, legal and contractual obligations (including those to investors in
the Company), business environment, and staffing. The review took into
consideration the projected cost of operating the Company during the period
necessary to monetize its assets and the inherent uncertainty related to the
timing of and net proceeds that could be achieved in an orderly process of
developing and/or selling such assets. The review also considered the
substantial uncertainty with respect to whether orderly development and
disposition of the Companys assets would result in proceeds sufficient to meet
the Companys obligations as those obligations come due. As a result of that
review, the Company reached the conclusion that it is unlikely that the Company
can provide a meaningful financial return for its common stockholders. In light of that conclusion and in order to preserve the Companys
liquidity, the Board of Directors decided, in January 2004, not to declare
either of the then pending cash dividends (scheduled for July 2003 and January
2004) on the Companys Series C Preferred Stock. As a result of the decision
to withhold payment of two consecutive cash dividends, the Series C Preferred
Stock holders gained the right to nominate a majority of the Companys Board of
Directors. In light of that right, the Company initiated discussions with
representatives of the Series C Preferred Stock holders to arrange an orderly
transition of the Board majority to the nominees of the holders of the Series C
Preferred Stock. In the course of these discussions, the Series C Preferred
Stock holders nominated Reginald M. Norris, Jr. and Dennis J. Kenny to serve as
directors. (For biographical information on Messrs. Norris and Kenny, see Part
III, Item 10.) 14




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##### Table of Contents



On March 1, 2004 Directors David A. Abel, Robert A. Baker, and Lee K.
Harrington tendered their resignations from the Companys Board of Directors.
Also on March 1, 2004, Reginald M. Norris, Jr. was elected to serve the
remainder of Mr. Abels term and Dennis J. Kenny was elected to serve the
remainder of Mr. Bakers term. On March 16, 2004, following the sale of Magnolia Ranch, and after a
further review of the Companys asset development program and cash flow
forecasts, the Company determined that it had both the cash available and the
statutory surplus required to support the declaration of a dividend on the
Series C Preferred Stock. The Board of Directors subsequently declared and
paid a dividend to the holders of Series C Preferred Stock. The dividend that
was declared on March 16, 2004, in the aggregate amount of approximately
$559,000, represented the aggregate amount of the semi-annual dividends for
July 15, 2003 and January 15, 2004. In connection with the declaration of the
dividend, the Company and each of the holders of the Series C Preferred Stock
entered into a Stockholder Loan and Security Agreement pursuant to which the
holders of Series C Preferred Stock agreed to (i) lend to the Company the
entire $559,000 proceeds of the dividend payment, and (ii) lend to the Company
funds sufficient to pay any and all dividends that the Board of Directors of
the Company may declare on the Series C Preferred Stock with respect to the
semi-annual periods ending July 15, 2004, January 15, 2005 and July 15, 2005.
The $559,000 loan is evidenced by a Secured Promissory Note, and any future
loans will be evidenced by additional promissory notes that will be
substantially identical to the Secured Promissory Note. The notes bear
interest at the rate of eight percent (8%) per annum from their inception,
compounded semi-annually on July 15 and January 15 and computed on a 360-day
year of twelve 30-day months. On July 15, 2004, the Board of Directors declared a dividend on the Series
C Preferred Stock in the amount of approximately $279,000. Simultaneously, the
Company borrowed that amount from the Series C Preferred Stock holders and
entered into an additional Secured Promissory Note. The entire principal
balance plus all accrued and unpaid interest on the notes is due and payable on
August 31, 2005. In order to secure the repayment of the notes and the
performance of the Companys obligations under the Stockholder Loan and
Security Agreement, the Company granted to the holders of the Secured
Promissory Notes a security interest in the Cherry Creek Project. Critical Accounting Policy The Company prepares its financial statements in conformity with U.S.
generally accepted accounting principles. These accounting principles require
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements. The Companys management
is also required to make certain judgments that affect the reported amounts of
revenues and expense during the reporting period. The Company bases its
estimates on past experience and various other assumptions that it believes to
be reasonable based on the specific circumstances, the results of which form
the basis for making judgments about the carrying value of certain assets and
liabilities that are not readily apparent from other sources. Actual results
could differ from these estimates. The Company has identified its accounting policy relating to the
assessment of potential impairment of the carrying value of its water rights as
the Companys most critical accounting policy. Under this policy, the
Companys water rights are carried at cost. Any event or circumstance that
indicates to the Company that there is an impairment of the carrying value of
any of its water rights triggers a two-step analysis pursuant to Statement of
Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets issued by the Financial Accounting Standards
Board. Under this two-step analysis, the second step requires the reduction of
the carrying value of the water rights to their fair value in the event that
under step one the total of the undiscounted cash flows the Company estimates
the water rights will generate is less than their carrying value. Such
reduction in carrying value would be recorded as an expense in the Companys
statement of operations during the period that such impairment occurs. The critical estimates of future cash flows made by the Company in
assessing whether there is an impairment of the carrying value of its water
rights are based upon managements assessment of a variety of factors. In the
past, when considered necessary, management obtained third-party valuations to
assist and support its estimate of fair value. In the case of the Cherry Creek
Project, which comprises the Companys water interests in Colorado and is the
largest single asset on its consolidated balance sheet, the Companys estimate
of fair value is based upon comparison with water rights sales in the area,
with various third-party valuations performed for the Company in the context of
the Parker Water & Sanitation District condemnation case, actual sales of water
derived from the Cherry Creek Project to unaffiliated third parties, and
current negotiations for the sale of water delivery contract units associated
with the Cherry Creek Project. Because there is no quoted market for water rights, valuation of such
rights is inherently subjective and uncertain. The value of water rights
varies, sometimes dramatically, based on, among other factors: 15




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##### Table of Contents




    
    regional weather conditions (which affect short-term supply);
    
    significant increases/decreases in regional demand;  
    
    perceived regulatory certainty/uncertainty;  
    
    the perceived validity and defensibility of title;  
    
    changes in patterns of local use (for example, from agricultural to urban uses);  
    
    the availability and cost of treatment, storage, conveyance and distribution;  
    
    the cost of power (consumed in the production and management of water);  
    
    the perceived value of reserve or redundant supplies for urban uses;  
    
    decisions in court cases which impact water rights generally, types of water
rights specifically, or a specific water right;  
    
    changes in political, regulatory, and environmental requirements; and  
    
    the availability of financial resources to urban water purveyors (consumers). In light of the foregoing, there can be no assurance that the value of the
Companys water rights will not vary from current estimates as a result of
potential future changes in circumstances or as a result of the Company
becoming aware of new information, and such changes could be material. As
previously reported, the Colorado Office of the State Engineer unexpectedly
denied the Companys application for a substitute water supply plan in April of
2004. In light of this denial, the Company undertook a thorough analysis of
the valuation of the Cherry Creek Project. Based on that review, the Company
has concluded that the carrying value of the Cherry Creek Project is
appropriately stated. Results of Operations The following is a description of the Companys results of operations for
its three most recent fiscal years. California Operations Years Ended March 31,2004
    
    2003
    
    2002Revenue
    
    $
    754,000
    
    
    
    1,519,000
    
    
    
    1,464,000Cost of Revenue
    
    
    468,000
    
    
    
    1,041,000
    
    
    
    981,000Gross Profit
    
    
    286,000
    
    
    
    478,000
    
    
    
    483,000Gain on disposition of assets
    
    
    737,000
    
    
    
    975,000
    
    
    
    17,000Other, net
    
    
    (79,000
    )
    
    
    (6,000
    )
    
    
    5,000
 Revenue for fiscal 2004 decreased from revenue generated in fiscal 2003,
primarily because the Companys five-year water sale agreement with the City of
Inglewood, California, concluded on September 30, 2003. Revenues 16




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from the
Inglewood transaction totaled $641,000 in fiscal 2004 (based on sales booked in
the first two quarters) versus $1,295,000 in the prior fiscal year (based on
sales booked throughout all four quarters). The Company and Inglewood have not
renewed the agreement, and the Company is not currently pursuing further water
sales in California because the prospects for such sales have significantly
diminished as a result of regulatory and competitive obstacles and because the
Company no longer has the resources necessary to pursue such water sales.
Revenue for the fiscal year ended March 31, 2004, included revenue of
approximately $113,000 from consulting services. There can be no assurance of
the Companys ability to earn future revenues from consulting, particularly in
light of recent staffing reductions. Water revenues for fiscal 2003 increased
$55,000 over fiscal 2002, primarily due to the completion of a sale of water to
the United States Bureau of Reclamation. Cost of Revenue consists of lease payments to support production of water
sold to the City of Inglewood. The Companys five-year water sale agreement
with the City of Inglewood, California, concluded on September 30, 2003, and
Cost of Revenue in fiscal 2004 reflects six-months of such lease payments
compared to a full year of such lease payments in each of fiscal 2003 and 2002. Gain on Disposition of Assets In June 2003, the Company sold its shares in the Bear Valley Mutual Water
Company to a California municipality. The sale provided cash proceeds of
approximately $723,000 and resulted in a gain of approximately $73,000. In
December 2003, the Company sold Byington Ranch, a rice farm in Yuba County,
California. The sale provided cash proceeds of $1,170,000 and resulted in a
gain of $208,000. In March 2004, the Company sold Magnolia Ranch, a rice farm
in Yuba County, California. The sale provided cash proceeds of $1,916,000 and
resulted in a gain of $456,000. During fiscal 2003 the Company sold 1,966
acre-feet of groundwater pumping rights in the Mojave Basin of California to
two municipalities in San Bernardino County and realized an aggregate gain on
those sales of $964,000. There were no comparable sales in fiscal 2002. Subsequent to March 31, 2004, the Company sold three separate properties
in California to unaffiliated purchasers for aggregate net proceeds of
approximately $1,052,000 in cash, plus, a secured note in the amount of
$220,000. These sales resulted in an aggregate gain of approximately $85,000. Other, net Other, net consists primarily of approximately $108,000 in rental income
in fiscal 2004 and a charge of approximately $141,000 for property taxes
assessed by San Bernardino County for water rights the Company previously sold.
Rental income will be lower in future periods because of sales of land and
other assets on which the Company formerly earned rental income. Colorado Operations Years Ended March 31,2004
    
    2003
    
    2002Revenue
    
    $
    150,000
    
    
    
    10,000
    
    
    
    Cost of Revenue
    
    
    26,000
    
    
    
    
    
    
    
    Gross Profit
    
    $
    124,000
    
    
    
    10,000
    
    
    
    Gain on disposition of assets
    
    
    406,000
    
    
    
    
    
    
    
    
 All of the Companys Colorado operations involve the Companys Cherry
Creek Project. During the years ended March 31, 2004, and 2003, the Company
delivered 99.7 and 21.7 acre-feet, respectively, from nontributary resources of
the Cherry Creek Project to customers of the project. Cost of revenue
consisted primarily of the amortization of the value of water rights from which
the deliveries were made together with the energy-related expenses for
delivering water. The Company believes that these initial sales of water,
entailing perfection of the underlying water right, completion of physical infrastructure, acquisition
of various permits required for water production and delivery, and physical
delivery via Cherry Creek (under live stream conditions) represent important
milestones in the development of the Cherry Creek Project. 17




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The Company has continued implementing a plan to market and sell water
delivery contract units associated with the Cherry Creek Project, which are
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 water
delivery contract units 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
water delivery contract units will, in fact, be sold on terms satisfactory to
the Company. The Company has previously entered into non-binding letters of intent from
three Cherry Creek area water purveyors for their purchase of water delivery
contract units at a value of $4,500 per acre-foot of firm water supply. In
order to close these sales, and in order to support its other water delivery
contract unit sales efforts, the Company filed an application with the Colorado
Office of the State Engineer for approval of a substitute water supply plan.
The proposed substitute water supply plan included elements designed to assure
the Cherry Creek Projects current and prospective customers of reliable water
deliveries via Cherry Creek. The Companys application for approval of the
substitute water supply plan was unexpectedly denied by the Office of the State
Engineer in April 2004. As a result of such denial, the schedule for sale of
water delivery contract units has been delayed and the likelihood of such sales
has diminished. The Company has filed an appeal of the denial with the
Colorado Water Court, as permitted under applicable Colorado statute. The
Company cannot predict the outcome of the appeal or when a decision will be
forthcoming from the Colorado Water Court. On September 22, 2004, the Company
filed a new substitute water supply plan application with limiting terms and
conditions aimed at gaining the approval of the Office of the State Engineer.
There can be no assurance that the Companys new application includes terms and
conditions that will prove acceptable to the Office of the State Engineer, or
whether effective terms and conditions will be economically viable for the
Cherry Creek Project. Further, the Company cannot predict (i) whether the new
substitute water supply plan application will be approved or (ii) the period of
time required for the Office of the State Engineer to review the new
application. Unless the Company is able to provide its customers timely assurance of
reliable deliveries of water produced by the Cherry Creek Projectthrough
implementation of an approved substitute water supply plan or other meansthe Company may not be able to sell water delivery contract units. Without
such water delivery contract unit sales, the Company may run out of cash to
fund its operations and meet its financial obligations. Because the Company
has monetized many of its physical assets, the Company retains fewer and less
liquid assets to generate either cash flow or sales proceeds. Therefore, while
current cash reserves are sufficient to fund the Companys forecast operating
expenses for the next several months, the Company faces increased liquidity
risk as a result of the denial of the substitute water supply plan. During the year ended March 31, 2004, the Company also reached settlement
with Parker Water & Sanitation District which had condemned certain of the
Companys property in Colorado. Under the terms of the cash settlement with
Parker Water & Sanitation District, the Company recognized a gain of $406,000.
The Company intends to sell other assets in order to generate cash for
operations and will continue to restrict operating expenses while it develops
the Cherry Creek Project. General and Administrative Expenses Years Ended March 31,2004
    
    2003
    
    2002General and
Administrative
Expenses
    
    $
    3,137,000
    
    
    
    3,081,000
    
    
    
    3,076,000
 During fiscal 2004, general and administrative expenses increased $56,000
to $3,137,000, as compared to fiscal 2003. The increase was primarily
attributable to termination benefits in the amount of $131,000 for employees
whose positions were eliminated during the year, and an increase in legal fees
in the amount of $275,000 resulting from outside counsels participation in an
increased level of discussions regarding the Companys operations and potential transactions. These increases were partially
offset by a reduction in bonus compensation of $75,000, and a $270,000
reduction in salary resulting from staff reductions. General and administrative expenses for fiscal 2003 increased by $5,000
(less than 1%) from fiscal 2002. A 5% increase in employment-related expenses
was partially offset by a reduction in professional fees in fiscal 2003, and a
reversal of the fiscal 2002 non-cash expense for deferred compensation arising
from variable plan accounting for certain incentive stock options granted to an
officer and director of the Company. 18




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##### Table of Contents



Other Non-Segment Information Years Ended March 31,2004
    
    2003
    
    2002Interest Income
    
    $
    16,000
    
    
    
    91,000
    
    
    
    170,000Interest Expense
    
    
    (775,000
    )
    
    
    (857,000
    )
    
    
    (860,000
    )Gain on early
extinguishment of
debt
    
    
    
    
    
    
    219,000
    
    
    
    5,900
 Interest Income Interest income is composed of interest earned on the Companys cash and
cash equivalents and investments, and interest earned on the secured promissory
notes the Company received in connection with the real estate that it has sold.
Interest income decreased for fiscal 2004 from fiscal 2003, and for fiscal
2003 from fiscal 2002 due primarily to progressively lower interest rates and
investment balances. Interest Expense Interest expense for fiscal 2004, fiscal 2003 and fiscal 2002 included
interest of $749,000, $794,000, and $794,000, respectively, paid to the holders
of the Companys outstanding 9% convertible subordinated debentures due 2005.
The reduction in such interest expense for fiscal 2004 reflected the
extinguishment of $500,000 in such debentures in March 2003. Fiscal 2004
interest expense also included interest paid on a short-term secured loan
during the quarter ended December 31, 2003, and the Secured Promissory Note to
Series C Preferred Stock holders commencing on March 16, 2004. The short-term
secured loan was repaid with the proceeds of the sale of Byington Ranch in
December 2003. During fiscal 2003 and 2002, the Company incurred $25,000, and
$63,000 respectively, of interest related to the secured five-year amortizing
term loan for the Inglewood water sale agreement. The loan was repaid and
extinguished in fiscal 2003. Additionally, during fiscal 2003, $38,000 of
interest was paid in connection with the purchase of 12,000 acre-feet of water. Gain on Early Extinguishment of Debt In fiscal 2003, the Company repurchased $500,000 of its outstanding 9%
convertible subordinated debentures due 2005, plus accrued interest of $21,000
for $296,000 in cash. After reducing related net deferred debt costs of
$6,000, the Company recognized a $219,000 gain on the early extinguishment of
debt. There were no material debt extinguishments in fiscal 2004 or 2002. Liquidity and Capital Resources Liquidity As of March 31, 2004, the Company had cash and cash equivalents of
$1,416,000. As of March 31, 2004, the Company had working capital and a current
ratio of $2,111,000 and 1.98:l, respectively, as compared to working capital
and a current ratio of $1,134,000 and 1.88:1, respectively, at March 31, 2003.
During fiscal 2004, the Company operated at a net loss of $(2,428,000) and
generated an increase in cash and cash equivalents of $272,000 (primarily by
selling certain of its assets). The net increase in cash and cash equivalents
resulted from net cash uses of $(3,240,000) and $(434,000) for operations and
financing activities, respectively, which were offset by net cash of $3,946,000
provided by investing activities. The principal cash uses for operating
purposes were: compensation and termination benefits of $1,545,000; interest
expense of $775,000; professional and legal fees of $684,000; and 19




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total administrative expenses of $897,000. The foregoing cash expenses
were partially offset by proceeds from water sales and consulting revenues of
$904,000 and rental income of $108,000 collected during the year. The net
cash of $3,946,000 provided by investing activities was principally from the
sale of the Companys shares in Bear Valley Mutual Water Company in California,
the sale of certain properties in California and from the settlement of a
condemnation action involving a parcel of the Companys land in Colorado. The
use of cash of $434,000 for financing activities was principally for dividend
payments on the Companys Series C Preferred Stock in the amount of $838,000
and principal payments on the Companys long-term debt in the amount of
$155,000, which were partially offset by the proceeds in the amount of $559,000
from the loan by the Series C Preferred Stock holders. Primarily as a result
of continuing operating losses, the Company had a deficit in stockholders
equity, in the amount of $(1,417,000), as of March 31, 2004, as compared to
positive stockholders equity of $2,055,615 at March 31, 2003. The Company faces acute and increasing pressure on its liquidity. Since
the fiscal year ended March 31, 2004, the Companys operating expenses have
further depleted cash while asset sales have replenished cash. Because the
Company does not generate operating revenues sufficient to meet its operating
expenses, the Company is dependent on projected asset sales, which are not
certain of completion, to replenish its cash reserve and maintain operating
liquidity until such time that the Company can derive meaningful returns from
its Cherry Creek Project. However, (i) there is material uncertainty regarding
the Companys ability to negotiate and sell assets at fair value in a timely
manner in order to fund operations; (ii) the Company has few assets left to
sell; and (iii) while management believes that demand for the Companys water
resources in Colorado continues to increase, the schedule for monetizing the
value of the Cherry Creek Project is currently uncertain in light of the
Colorado Office of the State Engineers denial of the Companys application for
a substitute water supply plan. Subsequent to the end of fiscal 2004, and in light of recent property
sales and the uncertainties surrounding the planned sales of water delivery
contract units, the Company has revised its cash forecast and operating plans.
The Company has also further reduced its operating expenses in order to
conserve cash. Based on its current forecast of operating expenses, further
asset sales, the expectation that it will be able to arrange interim financing
on a secured basis, if necessary, and the amount of its cash, the Company
believes that it has sufficient capital resources to fund its operations until
approximately August 2005. However, based on its current estimates, unless it
is able to consummate sales of its water delivery contract units associated
with the Cherry Creek Project before approximately August 2005, the Company
will not have sufficient funds to continue its operations thereafter. In light of uncertainty as to whether the Company can meet its operating
expenses and financial obligations once current cash reserves are depleted, the
Companys independent registered public accounting firm has concluded that
there is substantial doubt that the Company can continue as a going concern. As
a result of the uncertainties associated with the Companys ability to continue
as a going concern, the Companys independent registered public accounting firm
provided a going concern uncertainty explanatory paragraph in its unqualified
opinion with respect to the Companys consolidated financial statements for the
year ended March 31, 2004. See the report of the independent registered public
accounting firm included as a part of this annual report on Form 10-K. Capital Resources Although the Company has attempted to reduce its future commitments, as of
March 31, 2004, the Company was still committed to certain material
expenditures on existing indebtedness and estimates substantial payments for
operations through at least September 30, 2005, which is the current planning
horizon to develop and monetize the Cherry Creek Project. The Company
estimates expenditures for operations through September 30, 2005 based on
current staffing levels, anticipated asset disposition strategies, and
activities associated with the development of the Cherry Creek Project. The Company is currently committed to make semi-annual interest payments
of $375,000 on its 9% convertible subordinated debentures through their
maturity, payment of $8,318,000 upon maturity of the debentures on September
30, 2005, and mandatory redemption payments on the Series C Preferred Stock in
fiscal 2006 and 2007. If and when declared by the Companys Board of
Directors, holders of Series C Preferred Stock have the right to receive
semi-annual dividend payments of $279,000 on January 15 and July 15 of each
year until the mandatory redemption dates. The following table summarizes the Companys committed disbursements for
debt and preferred stock instruments outstanding as of March 31, 2004. The
table assumes the declaration of Series C Preferred Stock dividends by the
Companys Board of Directors and provides an estimate of anticipated operating
expenditures through March 31, 2005. 20




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##### Table of Contents



2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    ThereafterScheduled payments on existing outstanding indebtedness and
preferred stockSemi-annual interest payments on debentures
    
    $
    749,000
    
    
    $
    375,000
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Principal redemption of debentures
    
    
    
    
    
    
    8,318,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Principal repayment on Series C Loan
    
    
    
    
    
    
    559,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Dividends on Series C Preferred Stock (1)
    
    
    559,000
    
    
    
    559,000
    
    
    
    280,000
    
    
    
    280,000
    
    
    
    
    
    
    
    Dividends on Series F Preferred Stock (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Redemption of Series C Preferred Stock
    
    
    
    
    
    
    
    
    
    
    3,854,000
    
    
    
    3,854,000
    
    
    
    
    
    
    
    Redemption of Series F Preferred Stock in FY2010 and FY 2011 (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,306,000Total - Scheduled payments on existing outstanding indebtedness
and preferred stock
    
    $
    1,308,000
    
    
    
    10,185,000
    
    
    $
    4,509,000
    
    
    $
    4,134,000
    
    
    
    
    
    
    
    3,306,000Estimated expenditures for operations during the period through
March 31, 2005 (3)
    
    $
    1,571,000
    
    
    
    (3
    )
    
    
    (3
    )
    
    
    (3
    )
    
    
    (3
    )
    
    
    (3
    )
   (1)
    
    The Series C Preferred Stock holders have committed to lend to the
Company an amount equal to any and all dividends that the Company may
declare on the Series C Preferred Stock with respect to the semi-annual
periods ending July 15, 2004, January 15, 2005 and July 15, 2005.(2)
    
    Dividends may be paid in additional shares of Series F Redeemable
Preferred Stock, or in cash, at the Companys option. Interim dividends
and redemption value are illustrated assuming that dividends are paid in
additional Series F Redeemable Preferred Stock, with the entire issue,
including interim issuance of dividend shares, aggregating to $3,306,000,
through maturity in 2010 and 2011.(3)
    
    The expenditures for operations in periods beyond September 30, 2005, are
subject to an even greater range of variability and uncertainty from
estimates shown for fiscal 2005. As a result, the Company is unable to
estimate reasonably the likely amounts of payments for operations in
fiscal 2006. In addition, the Companys ability to continue operations or
meet its obligations beyond approximately August 2005 is subject to
substantial uncertainty because the Companys plan to generate the cash
required for such purposes is dependent upon the sale of water delivery
contract units in the Cherry Creek Project. Contractual Obligations The following table aggregates the Companys material expected obligations
and commitments as of March 31, 2004: Payment Due By PeriodLessThan
    
    
    
    
    
    
    
    
    
    More ThanContractual Obligations
    
    Total
    
    1 Year
    
    1-3 Years
    
    3-5 Years
    
    5 YearsLong-Term Debt (1)
    
    $
    19,891,000
    
    
    $
    
    
    
    $
    12,731,000
    
    
    $
    3,854,000
    
    
    $
    3,306,000Operating Lease Commitments (2)
    
    
    455,000
    
    
    
    73,000
    
    
    
    179,000
    
    
    
    68,000
    
    
    
    135,000Total Contractual Obligations
    
    $
    20,346,000
    
    
    $
    73,000
    
    
    $
    12,910,000
    
    
    $
    3,922,000
    
    
    $
    3,441,000
  (1)
    
    Represents the following long-term debt commitments:  (a)
    
    Principal redemption at maturity of the subordinated debentures due
on September 30, 2005;(b)
    
    Note payable to Series C Preferred Stock holders due on maturity
at August 31, 2005;(c)
    
    Redemption of Series C Preferred Stock, at the option of the
holders, at the rate of one-half of the outstanding shares on April 1,
2006 and redemption, at the option of the holders, of the remaining
outstanding shares on April 1, 2007; and(d)
    
    Redemption, at the option of the holders, of the Series F
Preferred stock in 2010 and 2011.  (2)
    
    Represents the following operating lease commitments:  (a)
    
    Monthly rent for office and related facilities in California and
Colorado; and(b)
    
    Annual rental payments for pumping rights of groundwater in
California through 2012. Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements, as such term
is defined in rules recently enacted by the Securities and Exchange Commission,
that have or are reasonably likely to have a current or future effect on its
financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity,
capital expenditures or capital resources. 21




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##### Table of Contents



New Accounting Pronouncements Issued But Not Yet Adopted In March 2004, the FASB issued an exposure draft of a proposed standard
that, if adopted, will significantly change the accounting for employee stock
options and other equity-based compensation. The proposed standard would
require companies to expense the fair value of stock options on the grant date
and would be effective at the beginning of the 2006 fiscal year. The Company
will evaluate the requirements of the final standard, which is expected to be
finalized in 2005, to determine the impact on its results of operations,
assuming the Company is able to continue its operation into fiscal 2006. 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 its common stock. The Companys history of losses and failure to generate sufficient operating
revenue to meet its operating expenses cause substantial doubt about the
Companys ability to continue operations, and the report of the Companys
independent registered public accounting firm with respect to the Companys
financial statement includes a going concern explanatory paragraph. The Company has incurred net losses of $2,428,000, $2,146,000, and
$3,280,000 during the fiscal years ended March 31, 2004, 2003 and 2002,
respectively. The Company does not generate sufficient operating revenues to
meet its operating expenses. As of March 31, 2004, the Company had cash and
cash equivalents of $1,417,000. The Company is currently committed to make
semi-annual interest payments of $375,000 on its convertible subordinated 9%
debentures through their maturity on September 30, 2005, semi-annual dividend
payments of $279,000 on its Series C Preferred Stock, payment of $8,318,000
upon maturity of the 9% debentures, repayment of a secured loan with a current
balance of $853,000, plus all accrued and unpaid interest, on August 31, 2005,
mandatory redemption payments on the Series C Preferred Stock in fiscal 2006
and 2007, and mandatory redemption payments on the Series F Preferred Stock in
fiscal 2010 and 2011. Based on the Companys recent estimates, it believes that it currently has
sufficient funds to meet its operating expenses and capital requirements
through early 2005. Notwithstanding the Companys current financial condition,
the Company believes it will be able to obtain additional financing or sell
additional assets to generate the funds necessary to carry on its operations
and development of the Cherry Creek Project through approximately August 2005,
even if the Company is unable to sell Cherry Creek Project water delivery
contract units within that period. The Company currently funds its operations
through the sale of assets, primarily in California. The Company also has
attempted to lower its operating expenses through staff reductions and other
expense realignments. However, the Company has sold many of its physical
assets, and therefore retains fewer and less liquid assets to either generate
cash or sales proceeds in the future. The Company can provide no assurance
that it will, in fact, be able to sell its remaining assets or obtain interim
financing sufficient to meet its costs of operations beyond the period that can
be funded from its current cash. In light of the uncertainties associated with the Companys ability to
continue as a going concern, the Companys independent registered public
accounting firm provided a going concern uncertainty explanatory paragraph in
its unqualified opinion with respect to the Companys consolidated financial
statements for the year ended March 31, 2004. See the report of the
independent registered public accounting firm included as a part of this annual
report on Form 10-K. The Companys ability to continue operations is dependent on its ability to
generate meaningful revenue from the Cherry Creek Project, but there are many
obstacles to the Companys ability to realize value on this project. The Cherry Creek Project currently is the largest single asset remaining
on the Companys consolidated balance sheet. The Company operates to provide
sufficient time and financial resources to properly develop and monetize the
Cherry Creek Project. The timing and amount of revenue generated by the Cherry
Creek Project will depend significantly on the development of its service area,
on regulatory, judicial and administrative decisions, and on the financial
capabilities and resource planning decisions of the projects potential
customersall of which factors are beyond the Companys control. Therefore,
the Company is not able to determine the timing of water sales. Given the
Companys current financial condition, it does not have the financial resources
to devote to the 22




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##### Table of Contents



establishment of incremental infrastructure necessary to support the sale
of incremental water delivery contract units beyond those units that are
already subject to non-binding letters of intent for purchase. Before the
Company can consummate significant water deliveries from the Cherry Creek
Project beyond the deliveries called for under the initial water delivery
contract units already committed, the Company, its prospective customers or a
prospective joint venture partner will have to build additional infrastructure
to fully develop the project. The need for such additional infrastructure
adversely affects the Companys ability to sell water from the Cherry Creek
Project and the prices at which the Company can make such sales. Moreover, following the fiscal year ended March 31, 2004, the Companys
application for a substitute water supply plan to effect reliable, all-season
deliveries from the Cherry Creek Project to downstream customers was denied by
the Colorado Office of the State Engineer. Unless the Company is able to
provide its customers timely assurance of reliable deliveries of water produced
by the Cherry Creek Projectthrough implementation of an approved substitute
water supply plan or other meansthe Company may not be able to generate
meaningful revenue from the project. Although the Company is pursuing a
judicial appeal from the denial of its application, the setback represented by
the denial from the Office of the State Engineer will further delay efforts to
monetize the Cherry Creek Project. The Company cannot predict the outcome of
the appeal or when a decision will be forthcoming from the Water Court. On
September 22, 2004, the Company filed a new substitute water supply plan
application with limiting terms and conditions aimed at gaining approval.
However, the Company can give no assurance that the new application includes
revised terms and conditions acceptable to the Office of the State Engineer or
that such revised terms and conditions will be economically viable for the
Cherry Creek Project. As a result, the Company cannot guarantee that the
Cherry Creek Project will generate meaningful revenue in time to meet the
Companys financial obligations or to sustain the Companys operations beyond
approximately August 2005. The Company cannot provide any assurance that further development of the
Cherry Creek Project will occur, or that water sales will occur on acceptable
terms or in the amounts or time required to support continued operations.
Based on the Companys current estimates, unless it is able to generate
meaningful revenue from the Cherry Creek Project before approximately August
2005, the Company will not have sufficient funds to continue to operate. Based on its estimates of the costs that will be incurred in the orderly
development and disposition of the Companys assets and its estimates of the
net proceeds from asset disposition in relation to the Companys obligations,
the Company has reached the conclusion that it is unlikely that the Company can
provide a meaningful financial return for its common stockholders. The Company does not generate sufficient revenue to cover operating expenses
and its ability to generate meaningful revenue in the foreseeable future is
uncertain. The Company has encountered significant regulatory obstacles in its
attempts to develop and transfer water for delivery to customers in California.
The Company has also faced significant competition in arranging water
transfers from governmental agencies. This competition is significant because
these agencies also control, influence and/or price access to publicly-owned
conveyance, storage and distribution facilities necessary to carry out
California water transfers. As an example, during the year ended March 31,
2004, these entities announced that they plan to allocate virtually all water
conveyance capacity across the Sacramento/San Joaquin River Delta and virtually
all water storage above the Delta among themselves. The implementation of the
plan would severely limit the potential purchasers of water arising from
resources owned by the Company and located in areas north of the Delta
(including Yuba County). As a result of these developments, the Company has
suspended attempts to arrange water transfers in California and has decided to
sell many of its California assets. The Companys ability to generate material revenue in the future is
dependent on its ability to (i) sell some of its few remaining California
assets, and (ii) develop and market the Cherry Creek Project. As noted above,
the recent denial of the Companys application for a substitute water supply
plan has delayed the Companys schedule for monetizing the Cherry Creek
Project. Furthermore, the Company cannot provide any assurances that it will
be able to sell the remaining California assets on favorable terms, if at all.
As noted above, if the Company is unable to generate meaningful revenue from
the Cherry Creek Project before approximately August 2005, the Company may not
have sufficient funds to continue to operate thereafter. Because the Company may be deemed to have no independent directors, actions
taken and expenses incurred by its officers and directors on the Companys
behalf may not be deemed to have received independent review. The Companys Board of Directors is comprised of three directors, two of
whom were nominated by holders of the Series C Preferred Stock and one of whom
is also the Companys President and Chief Executive 23




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##### Table of Contents



Officer. Because of their relationship to the Company or their
relationship to the holders of the Series C Preferred Stock, the Companys
directors may not be deemed independent. If the Company has no independent
directors, the Companys ability to take certain actions could be restricted,
and actions of the directors taken on behalf of the Company could be
challenged. The Company is subject to various restrictions and must comply with various
covenants under its outstanding indebtedness which restricts the manner in
which the Company can operate its business and the violation of any covenant
could adversely affect the Companys financial condition. As of March 31, 2004, the Company had approximately $8.9 million of debt,
consisting of (i) $8,318,000 in principal amount of 9% convertible subordinated
debentures which carry an interest rate of 9% per annum, payable semi-annually,
and which mature on September 30, 2005, and (ii) $559,000 (plus interest
accrued from March 16, 2004 at 8% per annum) payable to holders of its Series C
Preferred Stock at maturity on August 31, 2005. The loan from the Series C
Preferred Stock holders is evidenced by a note secured by a deed of trust on
the Cherry Creek Project. This level of indebtedness may adversely affect the
Companys stockholders by:  
    
    requiring the dedication of a substantial portion of the
Companys available cash and cash equivalents to the payment of
interest on such indebtedness, thereby further reducing the
availability of cash to fund the development of the Cherry Creek
Project, working capital, capital expenditures and other general
corporate purposes;  
    
    making it more difficult for the Company to satisfy its
obligations with respect to such indebtedness;  
    
    limiting the Companys ability to obtain additional
financing;  
    
    limiting the Companys flexibility in planning for, or
reacting to, changes in its business and the industry; and  
    
    placing the Company at a competitive disadvantage relative to
its competitors with less debt or more resources. Furthermore, covenants contained in the 9% convertible subordinated
debentures require the Company to fulfill various obligations, including using
its best efforts to file its reports under the Securities Exchange Act of 1934,
as amended, on a timely basis. These covenants could hinder the Companys
flexibility in planning for, and reacting to, changes in its business. In
addition, the Companys ability to develop and monetize the Cherry Creek
Project could be limited, in some circumstances, by the fact that it is pledged
as security for the loan from the Series C Preferred Stock holders. The Company only has seven employees and may not be able to manage the demands
of its operations. As a result of its current financial condition, the Company has
implemented a number of staff reductions, including the most recent in the
second quarter of fiscal 2004, which resulted in the termination of employment
of the Chief Operating Officer and Chief Financial Officer. The Company
depends significantly on the services of Michael Patrick George, the Chairman
of the Board of Directors, President, Chief Executive Officer and Chief
Financial Officer. Loss of the services of Mr. George would cause a
significant interruption of corporate operations. Due to limited manpower, the

Company may not be able to maximize the value of its water assets or properly
manage the operation of its business. The Company cannot assure investors that
its reduced staff can successfully manage the Companys assets, including the
development of the Cherry Creek Project. Furthermore, the staff reductions could erode morale and affect the focus
and productivity of the Companys remaining employees, including those directly
responsible for development, management and monetization of the Companys
assets, which in turn may affect the Companys revenue in the future. In order
to deter the resignation of the Vice President-Engineering, the Company paid
him a retention bonus of $50,000 in August 2004. The Companys common stock qualifies as a penny stock under SEC rules which
may make it more difficult for stockholders to resell their shares of the
Companys common stock. Because the Company has net tangible assets of less than $5,000,000 and
because the Companys common stock has a market price per share of less than
$5.00, transactions in the Companys common stock are subject to the penny
stock rules promulgated under the Securities Exchange Act of 1934. Under
these rules, broker-dealers who recommend such securities to persons other than
institutional accredited investors must, among other things: 24




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##### Table of Contents




    
    make a special written suitability determination for the purchaser;
    
    receive the purchasers written agreement to a transaction prior to sale;
    
    provide the purchaser with risk disclosure documents which
identify certain risks associated with investing in penny stocks
and which describe the market for these penny stocks as well as a
purchasers legal remedies; and
    
    obtain a signed and dated acknowledgment from the purchaser
demonstrating that the purchaser has actually received the required
risk disclosure document before a transaction in a penny stock can
be completed. Because the Companys common stock is subject to these rules,
broker-dealers may find it difficult to effectuate customer transactions and
trading activity in the Companys securities. As a result, the market price of
the Companys securities may be depressed, and investors may find it more
difficult to sell the Companys securities. Because the Companys securities are quoted on the OTC Bulletin Board,
investors experience limitations on the liquidity and price of such securities
more than if such securities were quoted or listed on the NASDAQ Stock Market
or a national exchange. The Companys common stock is quoted on the OTC Bulletin Board, an
NASD-sponsored and operated inter-dealer automated quotation system for equity
securities not included on the Nasdaq Stock Market. As a result, the holders
of the Companys common stock may find it more difficult to obtain accurate
quotations concerning the market value of the stock. Quotation of the
Companys common stock on the OTC Bulletin Board limits the liquidity and price
of such securities more than if the securities were quoted or listed on The
Nasdaq Stock Market or a national exchange. New laws and regulations affecting corporate governance impede the Companys
ability to retain and attract board members and executive officers, and
increase the costs associated with being a public company. On July 30, 2002, President George W. Bush signed into law the
Sarbanes-Oxley Act of 2002. The new act is designed to enhance corporate
responsibility through new corporate governance and disclosure obligations,
increase auditor independence, and impose tougher penalties for securities
fraud. In addition, the Securities and Exchange Commission and Nasdaq have
adopted rules in furtherance of the Sarbanes-Oxley Act. This act and the
related new rules and regulations have increased the complexity and cost of the
Companys corporate governance and the time the Companys executive officer
spends on such issues, and may increase the risk of personal liability for the
Companys directors and executive officer. As a result, it has become more
difficult for the Company to attract and retain board members and executive
officers involved in the corporate governance process. In addition, the
Company has experienced, and will continue to experience, increased costs
associated with being a public company, including additional professional and
independent registered public accounting firm fees. Circumstances relating to the Companys commitments for purchase and sale of
water to a customer may result in the Company not being able to recognize a
substantial amount of deferred revenue recorded on its books. 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 or by
no later than February 2003. 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. During the year ended
March 31, 2001 the Company took delivery of 2,000 acre-feet of this water and
redelivered the water to its customer. In accordance with the terms of the May
1999 purchase agreement, the Company paid the seller the remaining 50% of the
purchase price for the 2,000 acre-feet delivered to the Company and redelivered
to the Companys customer. During fiscal 2003, the Company paid the seller for
the remaining 12,000 acre-feet of water available under the May 1999 purchase
agreement. However, the remaining 12,000 acre-feet of water cannot currently
be delivered to the Companys customer due to a dispute between that customer
and certain other water agencies who control the means of conveying such water
to the customer. The customer and the Company have mutually acknowledged that
the dispute (which does not involve the Company) represents a force majeure
event preventing current delivery. Although the customer has not been able to
accept delivery of the water, the customer has paid the Company the entire
re-sale purchase price for the full 14,000 acre-feet, as required in the
December 1999 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 expense of $75,880). The Company
continues to be willing to deliver 25




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##### Table of Contents



the remaining 12,000 acre-feet of water to the contracted customer if and
when the force majeureissues are resolved. The Company and the customer
continue to explore alternatives. Currently, the Company cannot provide any
assurance that viable and mutually attractive alternatives will be identified
and/or implemented. 
 Item 7A.Quantitative and Qualitative Market Risk Disclosures The Company has no variable rate debt outstanding. Its fixed rate debt
consists of (i) $8,318,000 in principal amount of its 9% convertible
subordinated debentures which carry an interest rate of 9% per annum, payable
semi-annually, and which mature on September 30, 2005 and (ii) $561,000
(including interest accrued through March 31, 2004 at 8% per annum) payable to
holders of the Companys Series C Preferred Stock. The loan proceeds from the
holders of Series C Preferred Stock were used by the Company to fund dividends
on the Series C Preferred Stock in the same amount. The loan is evidenced by a
note secured by a deed of trust on the Cherry Creek Project. Twelve-monthperiods endingMarch 31:
    
    2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    Thereafter
    
    TotalFixed rate Debentures
    
    
    
    
    
    $
    8,318,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    8,318,000Fixed rate Note from
Series C
Stockholders
    
    
    
    
    
    $
    559,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    559,000Weighted Average
interest rate
    
    
    
    
    
    
    8.8
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8.8
    %
 The carrying amount of the convertible subordinated debentures due 2005 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 current marketplace for similar
instruments. Through voluntary, arms length, negotiated transactions, the
Company has repurchased more than $6.6 million of its debentures over the last
few years at prices which, in the aggregate, represented 36% of the face value
of debentures so repurchased. 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. No such repurchase transactions have been
completed since March 2003. Because there is no quoted market for the
debentures, estimating fair value is inherently uncertain. The carrying amount of the loan from the Series C Preferred Stock holders
is a reasonable estimate of fair value based on managements belief that the
terms of the debt reflect terms that are at least as attractive as terms
currently available to the Company in the capital markets, assuming the Company
could actually arrange such debt in its current circumstances. 
 Item 8.Consolidated Financial Statements and Supplementary Data The consolidated financial statements and the report thereon and notes
thereto, which are attached hereto as pages F-1 through F-24, and indexed at
page 2, are incorporated herein by reference. In light of the uncertainties
associated with the Companys ability to continue as a going concern, the
Companys independent registered public accounting firm provided a going
concern uncertainty explanatory paragraph in its unqualified opinion with
respect to the Companys consolidated financial statements for the year ended
March 31, 2004. See the report of the independent registered public accounting
firm included as a part of this annual report on Form 10-K. 
 Item 9.Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure There have been no disagreements with the Companys independent registered
public accounting firm. 
 Item 9A.Controls and Procedures As of the end of the period covered by this report, the Companys sole
executive officer, who performs the functions of both Chief Executive and Chief
Financial Officer, evaluated the effectiveness of the design and operation of
the Companys disclosure controls and procedures. Based upon this evaluation,
the Companys sole executive officer concluded that the Companys disclosure
controls and procedures are effective in ensuring that 26




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##### Table of Contents



material information required to be disclosed is included in the reports
that the Company files with the Securities and Exchange Commission. There were no significant changes in the Companys internal controls over
financial reporting or, to the knowledge of the management of the Company, in
other factors that materially affected or is reasonably likely to materially
affect these controls subsequent to the evaluation date. 
 PART III 
 Item 10.Directors and Executive Officers of the Company The authorized number of directors of the Company is currently fixed at
six and is divided into three classes, each having two members. The directors
in each class are elected for three-year terms, so that the term of office of
one class of directors expires annually. On March 1, 2004, Messrs. David A.
Abel, Robert A. Baker, and Lee K. Harrington resigned as directors. Also on
March 1, 2004, Mr. Reginald M. Norris, Jr. was elected to serve the remainder
of Mr. Abels term, which expires in 2005, and Dennis J. Kenny was elected to
serve the remainder of Mr. Bakers term which expires in 2004. The vacancy
resulting from Mr. Harringtons resignation has not been filled. Messrs.
Norris and Kenny were nominated to serve as directors by the Series C Preferred
Stock holders in accordance with rights triggered when the Company did not
declare the dividends on the Series C Preferred Stock due on July 15, 2003 and
January 15, 2004. Mr. Norris has represented the Series C Preferred
Stockholders in the past in regard to their investment in the Company and he is
currently a consultant to Ashford Capital Management, a holder of Series C
Preferred Stock. Michael Patrick George, the Companys sole executive officer, is a
director having been last elected by the stockholders at the annual meeting in
2000. Mr. George serves as Chairman of the Board of Directors notwithstanding
the fact that Mr. Georges term as a director was scheduled to expire at the
annual meeting in 2003. Because the Company did not hold an annual meeting in
2003, Mr. George continues to serve as a director until his successor is
chosen. Due to the Companys financial constraints and the costs associated
with the preparation and mailing of a proxy statement relating to an annual
meeting of stockholders, and the preparation and holding of an annual meeting,
the Company has not held an annual meeting since September of 2002 and does not
expect to hold an annual meeting of stockholders for the foreseeable future. As of October 1, 2004, there were three vacancies on the Board of
Directors. Because the Company declared and paid the March 16, 2004 dividend
on its Series C Preferred Stock, the Company believes that the right to elect
all directors of the Company has reverted to the common stockholders voting as
a single class, with the holders of the Companys convertible securities
eligible to vote for directors in proportion to the number of shares of common
stock into which their respective securities are convertible. However, the
Company does not currently plan to convene an annual meeting of the
stockholders until (i) petitioned to do so by a significant number of common
stockholders, (ii) there are matters which must be voted on by the
stockholders, or (iii) so ordered by the Delaware courts. As a result, it is
unlikely that the composition of the Board of Directors of the Company will
change in the near future without future action by the common stockholders or
the Delaware courts. The following chart sets forth biographical information concerning the
directors and executive officers of the Company as of October 1, 2004. Current Positions with
    
    Principal Occupation for the Past Five YearsName
    
    Age
    
    Company
    
    and Certain Other DirectorshipsDennis J. Kenny
    
    
    68
    
    
    Director
    
    Director of the Company since
March 2004. Mr. Kenny is
retired. From April 1998 to
December 2001, Mr. Kenny was
legal consultant to
Transamerica Leasing, Inc.,
prior to which Mr. Kenny was
Senior Vice President, General
Counsel, Assistant Secretary
and Director of Transamerica
Leasing, Inc., from May 1969
to March 1998.Reginald M. Norris, Jr.
    
    
    68
    
    
    Director
    
    Director of the Company since
March 2004. From 1991 to the
present, Mr. Norris has been a
consultant to companies in the
investment, apparel
manufacturing, trucking,
intermodal
 27




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##### Table of Contents



Current Positions with
    
    Principal Occupation for the Past Five YearsName
    
    Age
    
    Company
    
    and Certain Other Directorshipstransportation,
leasing and restaurant
supplies industries. From
1985 to 1991, Mr. Norris was
Executive Vice President of
Motor Carriers, Transamerica
Corp, prior to which, Mr.
Norris was Vice President,
Finance, of Transamerica
Leasing, Inc., from 1979 to
1985.Michael Patrick George
    
    
    54
    
    
    Director,
President, Chief
Executive Officer,
Chief Financial
Officer, and
Chairman of the
Board of Directors
    
    Chief Financial Officer of the
Company since 2003; Chairman
of the Board of Directors of
the Company since September
1999; President and Chief
Executive Officer of the
Company since April 1998;
Managing Director of J.P.
Morgan, an investment banking
firm, from 1992 to 1998.
 Committees and Meetings of the Board of Directors The Companys Audit Committee consists of Messrs. Norris (Chairman), and
Kenny. The Audit Committee reviews the independence, professional services,
fees, plans and results of the independent registered public accounting firms
engagement, and recommends the engagement, retention or discharge of the
independent registered public accounting firm to the Board of Directors.
Although the Company is not required to comply with the independence rules
because its common stock is quoted on the OTC Bulletin Board, the Board of
Directors has determined that members of the Audit Committee are independent as
defined by the rules and regulations of the Nasdaq Stock Market. The Companys Compensation Committee consists of Messrs. Kenny (Chairman),
and Norris. The Compensation Committee establishes the compensation of
executive officers and administers the Companys stock option plans. Although
the Company is not required to comply with the independence rules because its
common stock is quoted on the OTC Bulletin Board, the Board of Directors has
determined that members of the Compensation Committee are independent as
defined by the rules and regulations of the Nasdaq Stock Market. The Audit Committee and Compensation Committee are the only standing
committees of the Companys Board of Directors. Mr. George is not a member of
any Board committees. Messrs. George, Norris, and Kenny also serve as the members of the Board
of Directors of the Cherry Creek Water Company, the Companys wholly-owned
subsidiary incorporated in Colorado. Audit Committee Financial Expert The Company does not have an audit committee financial expert, as defined
under the applicable rules of the SEC issued pursuant to Section 407 of the
Sarbanes-Oxley Act of 2002, on its Audit Committee. Nonetheless, the Company
believes that both members of the Audit Committee are sufficiently experienced
and skilled in the area of financial management, application of accounting
principles and internal control procedures. Section 16(A) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires the
Companys directors and executive officers, and persons who own more than 10%
of a registered class of the Companys equity securities, to file with the SEC
initial reports of ownership and reports of changes in ownership of common
stock and other equity securities of the Company. Officers, directors and
greater than 10% stockholders are required by SEC regulation to furnish the
Company with copies of all Section 16(a) forms they file. To the Companys knowledge, based solely on review of the copies of such
reports furnished to the Company and written representations that no other
reports were required during the fiscal year ended March 31, 2004, the Company
s officers, directors, and greater than 10% beneficial owners complied with all
Section 16(a) filing requirements. Code of Business Conduct and Ethics The Company has not adopted a formal code of business conduct and ethics.
Because the Company has only seven employees, almost all of its important
activities are conducted directly by or under the direct supervision 28




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##### Table of Contents



of the Companys directors and executive officer. In light of the lack of
perceived benefit from adopting a formal code considered against the time and
cost for management to consider and implement a code, the Company has decided
not to do so at the present time. The Company believes that it can address
issues relating to conflicts of interests, including internal reporting of
violations and disclosures, and compliance with applicable laws, rules and
regulations, without the necessity of a formal code. The Company will continue
to monitor the possible benefits of adopting a formal code and will consider
adopting a formal code if circumstances so warrant. 
 Item 11.Executive Compensation The following table sets forth certain information concerning the annual
and long-term compensation for services rendered to the Company in all
capacities for the fiscal years ended March 31, 2004, 2003, and 2002 of (i) all
persons who served as the Chief Executive Officer of the Company during the
fiscal year ended March 31, 2004 and (ii) each of the other executive officers
of the Company whose total annual salary and termination benefits during the
fiscal year ended March 31, 2004 exceeded $100,000. (The Chief Executive
Officer and the other named officers are collectively referred to as the Named
Executive Officers.) AnnualCompensation
    
    
    
    
    
    Long-TermCompensation AwardsNumber Stock OptionName and Principal Position
    
    Year
    
    Salary
    
    Bonus
    
    Shares GrantedMichael Patrick George
    
    
    2004
    
    
    $
    389,568
    
    
    $
    
    
    
    
    50,000Chairman, President,
    
    
    2003
    
    
    $
    382,875
    
    
    $
    75,000
    
    
    
    50,000Chief Executive Officer and
Chief Financial Officer
    
    
    2002
    
    
    $
    367,496
    
    
    $
    75,000
    
    
    
    50,000James E. Sherman
    
    
    2004
    
    
    $
    230,016
    
    
    
    
    
    
    
    30,000Executive Vice President,
    
    
    2003
    
    
    $
    236,976
    
    
    $
    
    
    
    
    30,000Chief Operating Officer and
Secretary (1)
    
    
    2002
    
    
    $
    225,417
    
    
    $
    17,906
    
    
    
    20,000William T. Gochnauer
    
    
    2004
    
    
    $
    129,487
    
    
    
    
    
    
    
    Senior Vice President,
    
    
    2003
    
    
    $
    159,863
    
    
    $
    
    
    
    
    25,000Treasurer and Chief Financial
Officer(2)
    
    
    2002
    
    
    $
    152,250
    
    
    $
    6,906
    
    
    
    6,000
  (1)
    
    Mr. Shermans employment with the Company concluded on December 20, 2003. Mr. Shermans
compensation for fiscal 2004 included a severance payment of $62,178.  (2)
    
    Mr. Gochnauers employment with the Company concluded on October 3, 2003. Mr. Gochnauers
compensation for fiscal 2004 included a severance payment of $55,952. Option Grants in Last Fiscal Year The following table sets forth certain information with respect to stock
options granted during fiscal year 2004 to each of the Named Executive
Officers. In accordance with the rules of the Securities and Exchange
Commission, also shown below is the potential realizable value over the term of
the option (the period from the grant date to the expiration date) based on
assumed rates of stock appreciation of 5% and 10%, compounded annually. These
amounts are based on certain assumed rates of appreciation and do not represent
the Companys estimate of future stock price. Actual gains, if any, on stock
option exercises will be dependent on the future performance of the Companys
common stock. 29




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##### Table of Contents



Potential Realizable Value atNumber of
    
    % of Total Options
    
    
    
    
    
    
    
    
    
    Assumed Annual Rates ofSecurities
    
    Granted to
    
    
    
    
    
    
    
    
    
    Stock Price Appreciation forUnderlying Options
    
    Employees
    
    
    
    
    
    
    
    
    
    Option TermName
    
    Granted
    
    in Fiscal 2004
    
    Exercise Price
    
    Expiration Date
    
    5%
    
    10%Michael Patrick George
    
    
    50,000
    
    
    
    21
    %
    
    $
    0.25
    
    
    April 1, 2013
    
    $
    153,000
    
    
    $
    207,000James E. Sherman (1)
    
    
    30,000
    
    
    
    13
    %
    
    $
    0.25
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )William T. Gochnauer (1)
    
    
    25,000
    
    
    
    11
    %
    
    $
    0.25
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )
 (1) Messrs. Gochnauer and Sherman were employed by the Company through October
3, and December 20, 2004, respectively. Options granted to Messrs. Sherman and
Gochnauer during fiscal 2004 did not vest by the time of their respective dates
of termination, and consequently, the options are not exercisable pursuant to
the Companys stock option plan. Aggregated Option Exercises in Last Fiscal Year and Year-End Option Values The following table sets forth information regarding stock options that
were exercised by the Named Executive Officers during fiscal 2004 and the
number and value of unexercised options owned at March 31, 2004 by the Named
Executive Officers. Number of
    
    Value ofUnexercised Options
    
    Unexercised OptionsShares
    
    
    
    
    
    at March 31, 2004
    
    At March 31, 2004(1)Acquired
    
    ValueName
    
    On Exercise
    
    Realized
    
    Exercisable
    
    Unexercisable
    
    Exercisable
    
    UnexercisableMichael Patrick George
    
    
    -0-
    
    
    $
    -0-
    
    
    
    450,000
    
    
    
    250,000
    
    
    $
    -0-
    
    
    $
    -0-James E. Sherman
    
    
    -0-
    
    
    $
    -0-
    
    
    
    156,666
    
    
    
    93,334
    
    
    $
    -0-
    
    
    $
    -0-William T. Gochnauer
    
    
    -0-
    
    
    $
    -0-
    
    
    
    32,333
    
    
    
    58,667
    
    
    $
    -0-
    
    
    $
    -0-
  (1)
    
    The value of unexercised options represents the excess, if any, of the market value of the Common Stock on March 31, 2004, based on the closing price
on that day of $.065 per share, over the exercise price of the options. Director Compensation For the period from April 1, 2003 through February 29, 2004, directors who
were not employees of the Company received a fee of $10,000 per year for
service on the Board of Directors and an additional fee of $10,000 per year for
service as the chairman of any committee of the Board of Directors. In
addition, all directors during that period received $1,000 for each Board
meeting they attended. On March 1, 2004, the Board of Directors adopted a
revised director compensation policy under which non-employee directors receive
a monthly fee of $2,500 plus an additional fee of $1,000 for each meeting that
a director attends in any quarter in excess of six meetings. In addition,
directors are reimbursed for out-of-pocket expenses incurred by them in
connection with attending Board meetings or attending to other Company
business. Each non-employee director is automatically granted an option on the
first business day of each fiscal year to purchase 20,000 shares of common
stock at an exercise price equal to the closing price for the common stock as
reported on the date of grant of such option. Such options are exercisable as
to one-third on the first, second, and third anniversary of the grant. Based
on the foregoing automatic grant policy, Messrs. Norris and Kenny each received
a grant of options for 20,000 shares of the Companys common stock exercisable
at a price of $.10 per share. 30




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##### Table of Contents



Employment Contracts, Termination of Employment and Change-in-Control
Arrangements Mr. George is the only current executive officer of the Company, and he
has no written or oral employment agreement with the Company but serves at the
pleasure of the Board. Prior to March 1, 2004, the Company had an Employee Retention Policy under
which the Company agreed to provide any employee (with the exception of the
Chief Executive Officer) whose position was eliminated as a result of a
corporate reduction in force one month notice of such termination and three
months of salary continuation upon satisfactory conclusion of employment.
During the year ended March 31, 2004, as a result of a corporate reduction in
force, the Company eliminated the positions of Messrs. Sherman and Gochnauer
and, accordingly, paid each of them the severance benefit provided in the
Employee Retention Policy. The Company also paid severance benefits under the
policy to two other staff members whose positions were eliminated during the
fiscal year ended March 31, 2004. The Company no longer has an Employee
Retention Policy, and all regular, full-time employees are at will employees.
In order to assure the continued service of the Vice
President-Engineering through September 30, 2004, the
Company paid him a retention bonus of $50,000 in August 2004. Compensation Committee Interlocks and Insider Participation No members of the Compensation Committee are, or since April 1, 2002 have
been, officers of the Company, nor have such members had any material business
relationship with the Company. Report of the Compensation Committee Notwithstanding anything to the contrary set forth in any of the Companys
previous filings under the Securities Act of 1933, or the Exchange Act of 1934,
that might incorporate future filings with the Securities and Exchange
Commission, in whole or in part, the following report shall not be deemed to be
incorporated by reference into any such filings, nor shall the following report
be deemed to be incorporated by reference into any future filings under the
Securities Act or the Exchange Act. Introduction For most of fiscal 2004, the Compensation Committee was chaired by Mr.
Abel until his resignation as a director on March 1, 2004. Throughout fiscal
2004 and continuing to the present, the membership of the Compensation
Committee has been made up exclusively of non-management directors. During Mr. Abels chairmanship, the Committees primary focus was on
reducing the Companys compensation expense while maintaining the Companys
ability to pursue its business objectives and meet its obligations. During Mr.
Abels period as chairman of the Committee, the Committees meetings were held
during executive sessions of the Board of Directors. The Committee recommended
grants of options to key employees (as a means of aligning managements
interests with those of the Companys common stockholders), elimination of
bonuses, maintenance of the Boards Severance Policy, and reductions in the
Companys work force. The Committee also approved a plan for the Chief
Executive Officer to temporarily forego his salary as an emergency means to
conserve corporate cash for a period in the third fiscal quarter of 2004,
pending sale of certain assets. In February of 2004, the Board of Directors evaluated the Companys
situation and made a finding that it is unlikely that the Company can achieve a
return for its common stockholders. Consistent with that finding, the
Companys historic compensation frameworkrelying heavily on stock options to
incentivize the management teamhas become practically irrelevant. Changes in Composition of the Board and Committee On March 1, 2004, Mr. Kenny was elected chairman of the Committee, which
consists of himself and Mr. Norris. In light of the Companys fiscal condition, the focus of the Committee
for the last month of fiscal 2004 (and continuing into fiscal 2005) shifted to
evaluating performance of the Companys chief executive officer, retaining the
Companys key employees, and incentivizing them to meet difficult corporate
objectives under seriously cash-constrained operating conditions. Revision of the Compensation Model The Committee has reviewed and evaluated several potential revisions to
the Companys compensation model in light of the small number of critical
employees. Development of a revised compensation model is complicated by the
different interests of different investors and by constraints on operational
decisions imposed by 31




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##### Table of Contents



the realization that the Company may be operating within the zone of
insolvency. The Committee has concluded that the Companys option program is
no longer a viable tool for aligning the interests of the Companys managers
with those of the common stockholders nor for retaining and incentivizing such
managers. The Committees investigation of potential revisions to the Companys
compensation model is continuing. Performance Review of the CEO and Vice President of Engineering The Committee has also identified Mr. George, the Companys sole remaining
executive officer, and Mr. Garcia, the Companys Vice President of Engineering,
as key employees without whose services the Company is unlikely to be able to
reach its objectives. The Committee recently approved a Service Retention
Agreement with Mr. Garcia under which he has agreed to continue his service as
an employee with the Company, at least through September 30, 2005. In the period since Mr. Kenny assumed the Committees chairmanship, the
Committee considered the following factors in evaluating Mr. Georges
performance and made the following findings:  
    
    Mr. George has done an excellent job of managing the
Companys downsizing, asset disposition program and balance sheet
de-leveraging.
    
    As a result of reduced manpower, Mr. George has progressively
assumed additional operating responsibilities, provided a smooth
transition for the majority control of the Board of Directors, and
has performed well in leading and carrying out the Companys
responsibilities for public company reporting which have become
substantially more complex in recent years.
    
    Additionally, Mr. George developed and has led implementation
of the Companys plan to monetize the Cherry Creek Project, which is
critical to the Companys ability to meet its obligations; has
sustained focus on the Companys key strategic objectives,
maintained high employee morale in trying circumstances, and
provided detailed and complete reports on corporate operations,
risks and opportunities.
    
    Mr. George manages the Companys relationships with its
attorneys so as to contain costs and maximize value.
    
    Mr. George is uniquely qualified by training, experience and
dedication to see the Company through the current difficult
challenges. The Committee has reviewed Mr. Georges compensation for the fiscal year
ended March 31, 2004 and made the following findings:  
    
    Mr. George has had no adjustment to salary since April of
2003 despite increased responsibility and burdens. There is little
or no perceived value in the options granted to Mr. George. Mr.
George has no retirement program, no employment security
arrangements, and no incentive compensation plan.
    
    The Committee believes that the salary paid to Mr. George for
the fiscal year ended March 31, 2004 was below what it perceives Mr.
George could earn with another employer (and below his compensation
prior to joining the Company in 1998).
    
    As a result of the foregoing findings, the Committee is
working with Mr. George to develop a compensation plan that will
assure Mr. Georges continued service to the Company, at least
through the Companys planning horizon. Until such plan is in place,
the Committee believes the Company is vulnerable to the loss of Mr.
George as its sole executive officer.Submitted by the Compensation Committee: Dennis J. Kenny, Chairman
Reginald M. Norris, Jr. Report of the Audit Committee Notwithstanding anything to the contrary set forth in any of the Companys
previous filings under the Securities Act of 1933, or the Exchange Act of 1934,
that might incorporate future filings with the Securities and Exchange
Commission, in whole or in part, the following report shall not be deemed to be
incorporated by reference 32




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##### Table of Contents



into any such filings, nor shall the following report be deemed to be
incorporated by reference into any future filings under the Securities Act or
the Exchange Act. The primary role of the Audit Committee, pursuant to its written charter,
is to provide assistance to the Board of Directors of the Company in fulfilling
its oversight responsibilities to the Companys stockholders with respect to
the Companys corporate accounting and reporting practices as well as the
quality and integrity of the Companys financial statements and reports. The Audit Committee was chaired by Mr. Baker until his resignation on
March 1, 2004. Messrs. Norris and Kenny were elected to the Audit Committee by
the Board of Directors on March 1, 2004, and Mr. Norris was elected as Chairman
of the Audit Committee on the same date. In performing its role, the Audit Committee met on four separate dates
during the year ended March 31, 2004, and fulfilled its responsibility for the
following functions:  
    
    Recommend annually to the Board of Directors the independent
registered public accounting firm to be retained by the Company for
the ensuing year;
    
    Review the engagement of the independent registered public
accounting firm, including the scope, extent and procedures of the
audit and fees to be paid therefor, and all other matters that the
Audit Committee deems appropriate, including the pre-approval of any
non-audit services that the Companys independent registered public
accounting firm is engaged to perform;
    
    Review and discuss the audited financial statements for the
fiscal year ended March 31, 2004 with the Companys management;
    
    Meet with the independent registered public accounting firm
and obtain written disclosures and the letter from its independent
registered public accounting firm as required by Independence
Standards Board Standard No. 1 (Independence Discussions with Audit
Committees);
    
    Review the percentage services provided to the Company by the
independent registered public accounting firm designated for audit
fees, audit-related fees and tax fees that were pre-approved by the
Audit Committee, and consider whether such audit and non-audit
services provided by its independent registered public accounting
firm are compatible with maintaining its independence from the
Company;
    
    Discuss with the independent registered public accounting
firm the results of the annual audit, including the assessment of
the quality, not just the acceptability, of accounting principles,
the reasonableness of significant judgments, the nature of
significant risks and exposures, the adequacy of the disclosures in
the financial statements and any other matters required to be
communicated to the Audit Committee by the independent registered
public accounting firm, including Statement on Auditing Standards
No. 61, Communication with Audit Committees; and,
    
    Based on the reviews and discussions referred to above,
recommend to the Board of Directors that the audited financial
statements of the Company for the fiscal year ended March 31, 2004
be included in the Companys annual report on Form 10-K.Submitted by the Audit Committee: Reginald M. Norris, Jr., Chairman
Dennis J. Kenny Comparative Stock Performance The chart below sets forth a line graph comparing the performance of the
Companys Common Stock against the Total Return Index for the Nasdaq Stock
Market (US) (Nasdaq Broad Market Index) and the Nasdaq Other Financial Stocks
Index for the period commencing March 31, 1997, and ending March 31, 2004. The
chart sets the value of an investment in Western Water Company Common Stock and
the value of each index at 100 on March 31, 1997. Western Water Company
Proxy - Stock Performance Table
March 31, 2004 
 33




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##### Table of Contents



Item 12.Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters The following table sets forth certain information regarding the
beneficial ownership of the Companys Common Stock, Series C Preferred Stock
and Series F Preferred Stock as of September 1, 2004 by (i) each person who is
known by the Company to own more than 5% of the outstanding common stock,
Series C Preferred Stock or Series F Preferred Stock; (ii) each of the
Companys directors and the Named Executive Officers; and (iii) all current
officers and directors of the Company as a group. Common Stock
    
    Series C Preferred Stock
    
    Series F Preferred Stock% Votes Of AllName and Address of
    
    Number
    
    Percent
    
    Number
    
    Percent
    
    Number
    
    Percent
    
    Classes of CapitalBeneficial Owner (1)
    
    of Shares
    
    of Class
    
    of Shares
    
    of Class
    
    of Shares
    
    of Class
    
    Stock(2)Michael Patrick George
    
    
    716,165
    (3)
    
    
    8.2
    %
    
    
    0
    
    
    
    0
    %
    
    
    0
    
    
    
    0
    %
    
    
    7.4
    %Reginald M. Norris, Jr. (10)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Dennis J. Kenny (10)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    James E. Sherman (9)
    
    
    211,389
    (3)
    
    
    2.5
    %
    
    
    0
    
    
    
    0
    %
    
    
    0
    
    
    
    0
    %
    
    
    2.3
    %William T. Gochnauer (9)
    
    
    62,501
    (3)
    
    
    *
    
    
    
    0
    
    
    
    0
    %
    
    
    0
    
    
    
    0
    %
    
    
    *T. Rowe Price Associates, Inc.
    
    
    1,040,524
    (4)(5)
    
    
    12.9
    %
    
    
    4,516
    
    
    
    58.6
    %
    
    
    0
    
    
    
    0
    %
    
    
    11.6
    %100 East Pratt Street
Baltimore, MD 21202T. Rowe Price New Era Fund Inc.
    
    
    135,912
    (5)
    
    
    1.7
    %
    
    
    2,259
    
    
    
    29.3
    %
    
    
    0
    
    
    
    0
    %
    
    
    1.5
    %100 East Pratt Street
Baltimore, MD 21202T. Rowe Price Small-Cap Value
Fund, Inc.
    
    
    800,412
    (4)(5)
    
    
    9.9
    %
    
    
    2,259
    
    
    
    29.3
    %
    
    
    0
    
    
    
    0
    %
    
    
    8.9
    %100 East Pratt Street
Baltimore, MD 21202Wisconsin Alumni Research
Foundation
    
    
    67,928
    (5)
    
    
    *
    
    
    
    1,129
    
    
    
    14.6
    %
    
    
    0
    
    
    
    0
    %
    
    
    *One Walkers Mill Road
P.O. Box 4172
Wilmington, DE 19807Ashford Capital Management,
    
    
    124,007
    (5)
    
    
    1.5
    %
    
    
    2,061
    (6)
    
    
    26.7
    %
    
    
    0
    
    
    
    0
    %
    
    
    1.4
    %Inc. as investment advisor for
certain investment accounts
One Walkers Mill Road
P.O. Box 4172
Wilmington, DE 19807Interagua, Servicios Integrales del
    
    
    601,447
    (7)
    
    
    7.0
    %
    
    
    0
    
    
    
    0
    %
    
    
    2,388.105
    
    
    
    100
    %
    
    
    6.7
    %Agua, S.A. Paseo de San Juan, 39
Barcelona, Spain 08009All directors and executive
officers as a group (5
persons)
    
    
    990,055
    (8)
    
    
    10.9
    %
    
    
    0
    
    
    
    0
    %
    
    
    0
    
    
    
    0
    %
    
    
    10.0
    %
   *
    
    Less than 1%.(1)
    
    Except as otherwise indicated, the address of each stockholder is c/o the
Company at 102 Washington Street, Point Richmond, California 94801.(2)
    
    Based on 8,069,012 votes entitled to be cast by the holders of the
outstanding Common Stock, 463,779 votes entitled to be cast by the holders
of the 7,708 shares of outstanding Series C Preferred Stock, and 426,446
votes entitled to be cast by the holder of the 2,388.1 shares of
outstanding Series F Preferred Stock.(3)
    
    With respect to Michael Patrick George, the share number includes 699,985
shares issuable under options exercisable within 60 days of September 1,
2004. With respect to James E. Sherman and William T. Gochnauer, their
share numbers include 211,389 34




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##### Table of Contents



shares and 62,501 shares, respectively, issuable under options exercisable
at the time of their termination of employment with the Company.(4)
    
    Based on information contained in a statement on Schedule 13G filed by T.
Rowe Price Associates, Inc. with the Securities and Exchange Commission on
February 13, 2004. Represents 768,700 shares of Common Stock beneficially
owned by T. Rowe Price Associates, Inc., and 271,824 shares of Common
Stock issuable upon the conversion of the 4,516 shares of Series C
Preferred Stock beneficially owned by T. Rowe Price Associates, Inc. T.
Rowe Price Associates, Inc. is the investment advisor of various
registered investment companies and investment advisory clients, including
(a) T. Rowe Price Small-Cap Value Fund, Inc. representing 664,500 shares
of Common Stock owned by T. Rowe Price Small-Cap Value Fund, Inc. and
135,912 shares of Common Stock issuable upon the conversion of 2,258
shares of Series C Preferred Stock beneficially owned by T. Rowe Price
Small-Cap Value Fund Inc., and (b) T. Rowe Price New Era Fund Inc.,
representing 135,912 and shares of Common Stock issuable upon the
conversion of 2,258 shares of Series C Preferred Stock beneficially owned
by T. Rowe Price New Era Fund Inc. T. Rowe Price Associates, Inc.
disclaims beneficial ownership of the shares described under (a) and (b),
above.(5)
    
    Represents shares of Common Stock issuable upon the conversion of the
shares of Series C Preferred Stock owned by such beneficial owners.(6)
    
    Reflects shares held of record and beneficially owned by separate
investment accounts on behalf of 10 different investors for which Ashford
Capital Management, Inc. acts as investment advisor and has the sole power
to vote and dispose of such securities as attorney-in-fact with respect to
such accounts.(7)
    
    Includes 426,227 shares of Common Stock issuable upon the conversion of
the shares of Series F Preferred Stock owned by such beneficial owner.(8)
    
    Includes 973,875 shares of Common Stock issuable upon exercise of options
which are exercisable within 60 days hereof.(9)
    
    Messrs. Gochnauer and Sherman were employed by the Company through
October 3, and December 20, 2004, respectively.(10)
    
    Messrs. Norris and Kenny each have been granted options to purchase
20,000 shares of the Companys common stock, of which no options are
exercisable within 60 days from September 1, 2004. 
 Item 13.Certain Relationships and Related Transactions The Company has entered into indemnification agreements with each of its
directors and its executive officer. Such agreements require the Company to
indemnify such individuals to the fullest extent permitted by Delaware law. All transactions between the Company and its officers, directors,
principal stockholders and affiliates have been and will be approved by a
majority of the Companys Board of Directors and have been or will be on terms
no less favorable to the Company than could be obtained from unaffiliated third
parties. 
 Item 14.Principal Accountant Fees and Services Audit Fees KPMG LLP performed services for the Company in fiscal 2004 and 2003
related to financial statement audit work, quarterly reviews, and tax services.
Fees paid to KPMG LLP in fiscal 2004 and 2003 were as follows: 2004
    
    2003Audit Fees
    
    $
    110,000
    
    
    $
    100,000Audit-Related Fees
    
    
    
    
    
    
    Tax Fees
    
    
    19,655
    
    
    
    20,740All Other Fees
    
    
    
    
    
    
    
 Audit and Non-Audit Services Pre-Approval Policy Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services
performed by KPMG LLP, the Companys independent registered public accounting
firm, must be approved in advance by the Audit Committee to assure that such
services do not impair the registered public accounting firms independence
from the Company. The Audit Committee pre-approved 100% of the fees paid to
KPMG LLP for its performance of audit and non-audit services for the Company in
fiscal 2004. 35




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##### Table of Contents



PART IV 
 Item 15.Exhibits, Consolidated Financial Statement Schedules and Reports On Form 8-K Exhibits The following exhibits are filed as a part of this report: 3.1
    
    Certificate of Incorporation.(1)3.2
    
    By-laws of the Company.(2)4.1
    
    Form of Common Stock Certificate.(1)4.2
    
    Form of Convertible Subordinated Debenture Due 2005.(3)4.3
    
    Certificate of Designations for Series C Convertible Redeemable Preferred Stock.(5)4.4
    
    Certificate of Designations for Series D Convertible Redeemable Preferred Stock.(7)4.5
    
    Certificate of Designations of Series E Participating Preferred Stock.(9)4.6
    
    Certificate of Designations of Series F Convertible Redeemable Preferred Stock.(10)10.1
    
    Form of Indemnity Agreement between the Company and its officers and directors.(2)10.2
    
    1993 Stock Option Plan.(4)10.3
    
    Amendment to 1993 Stock Option Plan.(4)10.4
    
    1997 Stock Option Plan.(6)10.5
    
    Point Richmond Office Lease, dated March 1, 2003, as amended, by and between Western Water Company and Janis & Martin McNair.(9)21
    
    Subsidiaries of the Company.23.1
    
    Consent of Independent Registered Public Accounting Firm  KPMG LLP.31.1
    
    Certification of the Chief Executive and Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of the Chief Executive and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1
    
    Rights Agreement, dated as of July 23, 1999, between the Company and ChaseMellon Shareholder Services, L.L.C., as Rights Agent, which includes the Form of Right          Certificate.(8)99.2
    
    Investment Restructure Agreement, dated March 16, 2001.(10)99.3
    
    Stockholder Loan and Security Agreement dated March 16, 2004. (11)99.4
    
    Form of Promissory Note. (11)
   (1)
    
    Previously filed as an exhibit to the Companys Form S-1, file no. 33-47606, and incorporated herein by reference.(2)
    
    Previously filed as an exhibit to the Companys Form 10, file no. 000-18756, and incorporated herein by reference.(3)
    
    Previously filed as an exhibit to the Companys Form 8-K dated September 22, 1995, and incorporated herein by reference.(4)
    
    Previously filed as an exhibit to the Companys Proxy Statement on Schedule 14A filed on February 7, 1994, which exhibit is hereby incorporated herein by reference.(5)
    
    Previously filed as an exhibit to the Companys annual report on Form 10-K for the year ended March 31, 1996, which exhibit is hereby incorporated herein by reference.(6)
    
    Previously filed as an exhibit to the Companys Proxy Statement on Schedule 14A filed on September 12, 1997, which exhibit is hereby incorporated herein by reference.(7)
    
    Previously filed as an exhibit to the Companys current report on Form 8-K filed on November 25, 1998, which exhibit is hereby incorporated herein by reference.(8)
    
    Previously filed as an exhibit to the Companys Registration Statement on Form 8-A filed on August 8, 1999, which exhibit is hereby incorporated herein by reference.(9)
    
    Previously filed as an exhibit to the Companys annual report on Form 10-K for the year ended March 31, 2000, which exhibit is hereby incorporated herein by reference.(10)
    
    Previously filed as an exhibit to the Companys current report on Form 8-K filed on March 19, 2001, which exhibit is hereby
incorporated herein by reference.(11)
    
    Previously filed as an exhibit to the Companys current report Form 8-K filed on April 1, 2004, which exhibit is hereby
incorporated herein as reference. 36




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##### Table of Contents



Financial Statements The following financial statements are filed as a part of this report,
appearing at the pages indicated: Report of Independent Registered Public Accounting Firm  KPMG LLP
    
    
    F-1Consolidated Balance Sheets as of March 31, 2004 and 2003
    
    
    F-2Consolidated Statements of Operations for the years ended March 31,
2004, 2003 and 2002
    
    
    F-3Consolidated Statements of Stockholders Equity (Deficit) for the
years ended March 31, 2004, 2003 and 2002
    
    
    F-4Consolidated Statements of Cash Flows for the years ended March 31,
2004, 2003 and 2002
    
    
    F-5Notes to Consolidated Financial Statements
    
    
    F-7
 Reports on Form 8-K The Company furnished the following Current Reports on Form 8-K during the
three months ended March 31, 2004:  (1)
    
    A Form 8-K on January 29, 2004 in which the Company disclosed its
decision not to declare a dividend on its existing Series C Preferred Stock,
the ramification of its decision not to declare the dividend and the intention
of certain members of the Companys board of directors to resign. The Form 8-K
also attached a press release that announced the intention of certain members
of the Companys board of directors to resign.(2)
    
    A Form 8-K on March 2, 2004 in which the Company disclosed the
resignation of three members of its Board of Directors and the election of two
new directors. The Form 8-K also attached a press release about the same
topic. 37




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##### Table of Contents



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. WESTERN WATER COMPANY By: /s/ MICHAEL PATRICK GEORGE  President, Chief Executive Officer and Chief Financial Officer
 Date: October 15, 2004 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. Signature
    
    Title
    
    Date/s/ MICHAEL PATRICK GEORGE
Michael Patrick George

    
    President, Chief Executive Officer, Chief
Financial Officer, and
Chairman of the Board
    

October 15, 2004/s/ REGINALD M. NORRIS, Jr.
Reginald M. Norris, Jr.
    
    Director
    
    October 15, 2004/s/ DENNIS J. KENNY
Dennis J. Kenny
    
    Director
    

October 15, 2004
 38




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders
Western Water Company: We have audited the accompanying consolidated balance sheets of Western Water
Company and subsidiaries (the Company) as of March 31, 2004 and 2003, and the
related consolidated statements of operations, stockholders equity (deficit)
and cash flows for each of the years in the three-year period ended March 31,
2004. These consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits. We conducted our audits 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. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide 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 Western Water
Company as of March 31, 2004 and 2003, and the results of their operations and
their cash flows for each of the years in the three-year period ended March 31,
2004, in conformity with accounting principles generally accepted in the United
States of America. The accompanying consolidated financial statements have been prepared assuming
that Western Water Company will continue as a going concern. As discussed in
Note 2 to the consolidated financial statements, the Company has suffered
recurring losses from operations, has net capital deficiencies and is dependent
on uncommitted sales of Cherry Creek Project Water Delivery Contract Units or
other assets in order to generate cash for operations. Such conditions raise
substantial doubt about the Companys ability to continue as a going concern.
Managements plans in regard to these matters are also described in Note 2.
The 2004 consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty. /S/ KPMG LLP San Francisco, California
October 6, 2004 F-1




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES Consolidated Balance Sheets
March 31, 2004 and 2003 2004
    
    2003AssetsCurrent Assets:Cash and cash equivalents
    
    $
    1,416,645
    
    
    $
    1,144,292Accounts receivable - trade
    
    
    50,369
    
    
    
    20,335Current portion of notes receivable (Note 3)
    
    
    9,434
    
    
    
    6,491Assets held for sale (Note 4)
    
    
    1,623,851
    
    
    
    1,196,937Other current assets
    
    
    77,191
    
    
    
    51,044Total Current Assets
    
    
    3,177,490
    
    
    
    2,419,099Notes receivable, less current portion (Note 3)
    
    
    152,889
    
    
    
    160,319Land (Notes 5 and 12)
    
    
    1,503,517
    
    
    
    4,367,932Water rights (Note 6)
    
    
    11,045,848
    
    
    
    11,605,014Prepaid leasing costs, net of accumulated amortization (Note 7)
    
    
    
    
    
    
    474,104Other water assets, net of accumulated amortization
    
    
    661,261
    
    
    
    656,755Deferred debt costs, net of accumulated amortization (Note 13)
    
    
    64,668
    
    
    
    112,879Property and equipment, net of accumulated depreciation (Note 4)
    
    
    254,645
    
    
    
    93,767Other assets
    
    
    
    
    
    
    24,328Total Assets
    
    $
    16,860,318
    
    
    $
    19,914,197Liabilities and Stockholders Equity (Deficit)Current Liabilities:Accounts payable
    
    $
    32,729
    
    
    $
    352,522Accrued expenses and other liabilities (Notes 11)
    
    
    210,128
    
    
    
    82,228Deferred revenue on water contract (Note 1)
    
    
    824,120
    
    
    
    824,120Current maturities of long-term debt (Note 12)
    
    
    
    
    
    
    25,858Total Current Liabilities
    
    
    1,066,977
    
    
    
    1,284,728Long-term debt, less current maturities (Note 12)
    
    
    558,857
    
    
    
    128,8979% Convertible subordinated debentures (Note 13)
    
    
    8,317,778
    
    
    
    8,317,778Total Liabilities
    
    
    9,943,612
    
    
    
    9,731,403Series C convertible redeemable preferred stock, $1,000 stated value, 100,000
shares authorized; 7,708 shares issued and outstanding (aggregate liquidation
preference of $7,708,000) at March 31, 2004 and 2003 (Note 14)
    
    
    7,581,810
    
    
    
    7,532,179Series F convertible redeemable preferred stock, $1,000 stated value, 6,000 shares
authorized; 2,388.105 and 2,251.018 shares issued and outstanding (aggregate
liquidation
preference of $2,388,105 and $2,251,018) at March 31, 2004 and 2003, respectively
(Note 14)
    
    
    751,913
    
    
    
    595,000Stockholders Equity (Deficit) (Notes 14, 15 , 17 and 18):Common stock, $.001 par value, 20,000,000 shares authorized; 8,410,212
shares issued at March 31, 2004 and 2003
    
    
    8,410
    
    
    
    8,410Additional paid-in capital
    
    
    24,487,116
    
    
    
    24,487,116Accumulated deficit (accumulated since October 1, 1994)
    
    
    (24,537,673
    )
    
    
    (21,065,041
    )Treasury stock, at cost, 341,200 shares at March 31, 2004 and 2003
    
    
    (1,374,870
    )
    
    
    (1,374,870
    )Total Stockholders Equity (Deficit)
    
    
    (1,417,017
    )
    
    
    2,055,615Commitments and contingencies (Note 22)Total Liabilities and Stockholders Equity (Deficit)
    
    $
    16,860,318
    
    
    $
    19,914,197
 See accompanying notes to consolidated financial statements. F-2




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES Consolidated Statements of Operations
Years Ended March 31, 2004, 2003 and 2002 2004
    
    2003
    
    2002Revenue
    
    $
    903,948
    
    
    $
    1,529,235
    
    
    $
    1,464,200Cost of Revenue
    
    
    493,885
    
    
    
    1,040,917
    
    
    
    981,311Gross Profit
    
    
    410,063
    
    
    
    488,318
    
    
    
    482,889General and Administrative Expenses (Note 19)
    
    
    (3,137,437
    )
    
    
    (3,080,810
    )
    
    
    (3,075,609
    )Gain on disposition of assets (Note 9)
    
    
    1,142,631
    
    
    
    977,582
    
    
    
    16,747Operating Loss
    
    
    (1,584,743
    )
    
    
    (1,614,910
    )
    
    
    (2,575,973
    )Other Income (Expenses):Interest income
    
    
    15,822
    
    
    
    90,508
    
    
    
    170,006Interest expense
    
    
    (775,484
    )
    
    
    (856,602
    )
    
    
    (859,699
    )Gain on early extinguishment of debt
    
    
    
    
    
    
    219,000
    
    
    
    5,925Other
    
    
    (78,598
    )
    
    
    19,003
    
    
    
    (17,453
    )(838,260
    )
    
    
    (528,091
    )
    
    
    (701,221
    )Loss Before Income Taxes
    
    
    (2,423,003
    )
    
    
    (2,143,001
    )
    
    
    (3,277,194
    )Income Taxes (Note 16)
    
    
    4,800
    
    
    
    3,200
    
    
    
    3,200Net Loss
    
    
    (2,427,803
    )
    
    
    (2,146,201
    )
    
    
    (3,280,394
    )Accretion of preferred stock to redemption value
    
    
    (181,596
    )
    
    
    (130,604
    )
    
    
    (108,298
    )Preferred stock dividends
    
    
    (863,233
    )
    
    
    (303,565
    )
    
    
    (860,453
    )Net Loss Applicable to Common Stockholders
    
    ($
    3,472,632
    )
    
    ($
    2,580,370
    )
    
    ($
    4,249,145
    )Basic and diluted net loss per share applicable to
common stockholders
    
    $
    (0.43
    )
    
    $
    (0.32
    )
    
    $
    (0.53
    )
 See accompanying notes to consolidated financial statements. F-3




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES Consolidated Statements of Stockholders Equity (Deficit)
Years Ended March 31, 2004, 2003 and 2002 TotalAdditional
    
    
    
    
    
    
    
    
    
    
    
    
    
    StockholdersCommon Stock
    
    Paid-In
    
    Deferred
    
    Accumulated
    
    Treasury
    
    EquityShares
    
    Amount
    
    Capital
    
    Compensation
    
    Deficit
    
    Stock
    
    (Deficit)Balance at March 31, 2001
    
    
    8,410,212
    
    
    $
    8,410
    
    
    $
    24,487,116
    
    
    
    
    
    
    ($
    14,235,526
    )
    
    ($
    1,374,870
    )
    
    $
    8,885,130Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,280,394
    )
    
    
    
    
    
    
    (3,280,394
    )Preferred dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (860,453
    )
    
    
    
    
    
    
    (860,453
    )Accretion of preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (108,298
    )
    
    
    
    
    
    
    (108,298
    )Deferred compensation
    
    
    
    
    
    
    
    
    
    
    300,000
    
    
    ($
    145,740
    )
    
    
    
    
    
    
    
    
    
    
    154,260Balance at March 31, 2002
    
    
    8,410,212
    
    
    $
    8,410
    
    
    
    24,787,116
    
    
    
    (145,740
    )
    
    
    (18,484,671
    )
    
    
    (1,374,870
    )
    
    
    4,790,245Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,146,201
    )
    
    
    
    
    
    
    (2,146,201
    )Preferred dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (303,565
    )
    
    
    
    
    
    
    (303,565
    )Accretion of preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (130,604
    )
    
    
    
    
    
    
    (130,604
    )Deferred compensation
    
    
    
    
    
    
    
    
    
    
    (300,000
    )
    
    
    145,740
    
    
    
    
    
    
    
    
    
    
    
    (154,260
    )Balance at March 31, 2003
    
    
    8,410,212
    
    
    $
    8,410
    
    
    
    24,487,116
    
    
    
    
    
    
    
    (21,065,041
    )
    
    
    (1,374,870
    )
    
    
    2,055,615Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,427,803
    )
    
    
    
    
    
    
    (2,427,803
    )Preferred dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (863,233
    )
    
    
    
    
    
    
    (863,233
    )Accretion of preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (181,596
    )
    
    
    
    
    
    
    (181,596
    )Balance (Deficit) at March 31, 2004
    
    
    8,410,212
    
    
    $
    8,410
    
    
    $
    24,487,116
    
    
    
    
    
    
    ($
    24,537,673
    )
    
    ($
    1,374,870
    )
    
    ($
    1,417,017
    )
 See accompanying notes to consolidated financial statements. F-4




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES Consolidated Statements of Cash Flows
Years ended March 31, 2004, 2003 and 2002 2004
    
    2003
    
    2002Cash Flows from Operating Activities:Net loss
    
    $
    (2,427,803
    )
    
    $
    (2,146,201
    )
    
    $
    (3,280,394
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation and amortization
    
    
    561,278
    
    
    
    1,059,672
    
    
    
    1,034,378Compensation (income) expense on vesting of
compensatory stock options
    
    
    
    
    
    
    (154,260
    )
    
    
    154,260Gain on disposition of assets
    
    
    (1,142,631
    )
    
    
    (977,582
    )
    
    
    (16,747
    )Loss on write-off of property and equipment
    
    
    
    
    
    
    14,580
    
    
    
    Gain on early extinguishment of debt
    
    
    
    
    
    
    (219,000
    )
    
    
    (5,925
    )Changes in assets and liabilities:(Increase) decrease in:Accounts receivable
    
    
    (30,034
    )
    
    
    (7,710
    )
    
    
    Other current assets
    
    
    (26,147
    )
    
    
    52,513
    
    
    
    360,291Other assets
    
    
    24,328
    
    
    
    108,029
    
    
    
    5,895Increase (decrease) in:Accounts payable
    
    
    (319,793
    )
    
    
    247,813
    
    
    
    (84,858
    )Accrued expenses and other liabilities
    
    
    120,900
    
    
    
    (136,655
    )
    
    
    (580,099
    )Net cash used in operating activities
    
    
    (3,239,902
    )
    
    
    (2,158,801
    )
    
    
    (2,413,199
    )Cash Flows from Investing Activities:Principal payments received on notes receivable
    
    
    4,487
    
    
    
    49,918
    
    
    
    107,594Purchase of equipment
    
    
    (197,825
    )
    
    
    (96,722
    )
    
    
    (12,802
    )Sale of land, net of selling costs
    
    
    3,021,435
    
    
    
    
    
    
    
    371,476Proceeds from settlement of condemnation proceedings
    
    
    405,866
    
    
    
    176,371
    
    
    
    Sale of investment in municipal water district, net
of selling costs
    
    
    716,981
    
    
    
    
    
    
    
    Sales of water rights, net of selling costs
    
    
    
    
    
    
    2,636,300
    
    
    
    Additions to water rights
    
    
    (4,506
    )
    
    
    (2,270
    )
    
    
    (3,510
    )Additions to other water assets
    
    
    
    
    
    
    (300,000
    )
    
    
    Additions to land and land improvements
    
    
    
    
    
    
    (370,200
    )
    
    
    (68,978
    )Prepayment of leasing costs
    
    
    
    
    
    
    (215,190
    )
    
    
    (173,879
    )Net cash provided by investing activities
    
    
    3,946,438
    
    
    
    1,878,567
    
    
    
    219,901
 (Continued) F-5




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued
Years ended March 31, 2004, 2003 and 2002 2004
    
    2003
    
    2002Cash Flows from Financing Activities:Proceeds from short-term loan
    
    
    1,000,000
    
    
    
    
    
    
    
    Repayment of short-term loan
    
    
    (1,000,000
    )
    
    
    
    
    
    
    Preferred stock dividends
    
    
    (838,285
    )
    
    
    (279,485
    )
    
    
    (838,286
    )Proceeds from loan by stockholders of Series CPreferred Stock
    
    
    558,857
    
    
    
    
    
    
    
    Principal payments on long-term debt
    
    
    (154,755
    )
    
    
    (1,341,906
    )
    
    
    (778,705
    )Purchase of convertible subordinated debentures
    
    
    
    
    
    
    (295,836
    )
    
    
    (7,409
    )Net cash used in financing activities
    
    
    (434,183
    )
    
    
    (1,917,227
    )
    
    
    (1,624,400
    )Net increase (decrease) in cash and cash equivalents
    
    
    272,353
    
    
    
    (2,176,625
    )
    
    
    (3,817,698
    )Cash and Cash Equivalents, beginning of year
    
    
    1,144,292
    
    
    
    3,320,917
    
    
    
    7,138,615Cash and Cash Equivalents, end of year
    
    $
    1,416,645
    
    
    $
    1,144,292
    
    
    $
    3,320,917Supplemental disclosure of cash flow information:Cash paid during the period for interest
    
    $
    773,497
    
    
    $
    850,796
    
    
    $
    982,067Cash paid during the period for income taxes
    
    
    4,800
    
    
    
    3,200
    
    
    
    3,200Supplemental disclosure of non-cash investing and financing
activities:Issuance of paid-in-kind Series F Preferred Stock dividend
    
    
    24,948
    
    
    
    24,080
    
    
    
    21,840Accretion of Series C and F Preferred Stock to redemption
value
    
    
    181,596
    
    
    
    130,604
    
    
    
    108,298Intrinsic value of variable plan stock options:Deferred compensation
    
    
    
    
    
    
    (300,000
    )
    
    
    300,000Additional paid-in capital
    
    
    
    
    
    
    300,000
    
    
    
    (300,000
    )Transfer of assets held for sale:Assets held for sale
    
    
    1,070,846
    
    
    
    
    
    
    
    2,863,158Land
    
    
    (513,696
    )
    
    
    
    
    
    
    (553,005
    )Water rights
    
    
    (557,150
    )
    
    
    
    
    
    
    (1,668,153
    )Other water assets
    
    
    
    
    
    
    
    
    
    
    (642,000
    )Sale of land:Notes receivable
    
    
    
    
    
    
    
    
    
    
    102,000Land
    
    
    
    
    
    
    
    
    
    
    (102,000
    )
 See accompanying notes to consolidated financial statements. F-6




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Organization and Summary of Significant Accounting Policies and
Practices: Description of Business
Western Water Company and subsidiaries (the Company) manage, develop,
sell and lease water and water rights in the western United States. The
Company, directly and indirectly, owns a select portfolio of water rights
and real estate in California and Colorado. The Companys current
principal activity is the development of water rights and the sale or
lease of its water. The Company is also engaged in assisting
unaffiliated owners of water rights in obtaining revenue from their water
rights. Principles of Consolidation
The consolidated financial statements of Western Water Company include
Western Water Service Company, YG Procyon Corporation and Cherry Creek
Water Company, the Companys wholly-owned subsidiaries, and YG Rice
Farms, L.P., a limited partnership directly and indirectly wholly-owned
and controlled by the Company. All inter-company balances and
transactions have been eliminated in consolidation. Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. Allowance for Doubtful Accounts
The Company provides for valuation allowances for notes receivable when
repayment becomes doubtful or amounts due are delinquent and in excess of
the value of the collateral. Notes are deemed delinquent when they are
more than 90 days past due. As of March 31, 2004 and 2003, no allowance
for doubtful accounts has been provided because the Companys management
believes that the value of the collateral is in excess of the total
receivables, and there are no delinquent notes. Assets Held for Sale
Assets held for sale are carried at the lower of the carrying amount or
fair value less costs to sell. Land
Land is carried at cost based on its purchase price, and, in some cases,
consists of an allocation of the original purchase price between land and
water rights based on their relative fair values at the time of purchase. Water Rights and Other Water Assets
Water rights consist of various water interests acquired directly or
through the acquisition of land. Other water assets represent the right
to purchase limited water interests from the owner of the water rights.
Water rights are stated at cost and consist of an allocation of the
original purchase price between water rights and land based on their
relative fair values, plus other direct development and acquisition costs
and an adjustment as a result of the quasi-reorganization (see Note 17).
Other water assets are stated at cost. Costs are allocated to water rights by the specific identification
method. Prepaid Leasing Costs
Prepaid leasing costs resulted from lease payments or other development
costs related to water rights leased by the Company that were considered
probable of providing future benefit to the Company at the time the costs
were incurred. The Company provided an allowance for certain prepaid
leasing costs in which the Company has not entered into a related water
contract to sell such leased water, based primarily upon the Companys
historical experience with similar projects. Upon the execution of a
contract to sell such leased water to a customer, the Company amortized
the prepaid leasing costs over the life of the water sales contract using
the straight-line method. As of March 31, 2004, all prepaid leasing costs
had been fully amortized. Deferred Debt Costs
Deferred debt costs are amortized using the straight-line method, which
approximates the interest method, over the life of the related debt. Property and Equipment
Property and equipment are stated at cost. Depreciation expense is
computed on the straight-line method over the estimated useful lives
ranging from five to ten years and totaled $36,947, $40,081, and $47,372
for the years ended March 31, 2004, 2003, and 2002, respectively. F-7




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) 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 of the stock option.
Such deferred compensation is expensed pro-rataover 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. The Company
recorded no options-related compensation expense for any of its
stock options during the fiscal year ended March 31, 2004. During
the fiscal years ended March 31, 2003, and 2002, the Company
recorded options-related compensation (income) expense of
$(145,740) and $145,740, respectively. Had the Company determined compensation expense based on the fair value
at the grant date for its stock options under Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock Based
Compensation, the Companys net loss and basic and diluted loss per
share applicable to common stockholders would have been increased as
noted in the pro formaamounts indicated below. 2004
    
    2003
    
    2002Net income (loss) applicable
to common stockholders:
    
    As reported
    
    $
    (3,472,632
    )
    
    $
    (2,580,370
    )
    
    $
    (4,249,145
    )Pro forma
    
    
    (3,535,727
    )
    
    
    (2,610,749
    )
    
    
    (4,217,333
    )Basic loss per common share:
    
    As reported
    
    
    (0.43
    )
    
    
    (0.32
    )
    
    
    (0.53
    )Pro forma
    
    
    (0.44
    )
    
    
    (0.32
    )
    
    
    (0.52
    )Diluted loss per common share:
    
    As reported
    
    
    (0.43
    )
    
    
    (0.32
    )
    
    
    (0.53
    )Pro forma
    
    $
    (0.44
    )
    
    $
    (0.32
    )
    
    $
    (0.52
    )
 The per share weighted-average fair value of stock options granted during
the years ended March 31, 2004, 2003, and 2002 were $.21, $.46, and $.26,
respectively, on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions: year ended March
31, 2004  expected dividend yield of zero, expected volatility of
164.69%, risk-free interest rate of 2.03%, and an expected life of 3
years; year ended March 31, 2003  expected dividend yield of zero,
expected volatility of 125.62%, risk-free interest rate of 4.84%, and an
expected life of 5 years; and, year ended March 31, 2002  expected
dividend yield of zero, expected volatility of 98.75%, risk-free
interest rate of 4.47%, and an expected life of 5 years. Revenue Recognition  Water
Water revenue is recorded when realizable and earned. Revenue from
long-term water rights leasing contracts with fixed rate increases are
recognized on a straight line method over the contractual period of the
water rights lease. Revenue from water sales contracts are recognized in
conjunction with the delivery of such water. Payments received in excess
of such revenue earned are deferred until such water is delivered. Sales
of water rights are accounted for under the full accrual method. Under
that method, gain is recognized when the collectibility of the sales
price is reasonably assured and the earnings process is virtually
complete. When a sale does not meet the requirements for full accrual
recognition, gain is deferred until the requirements are met. Revenue Recognition  Sales of Land
Sales of land are generally accounted for under the full accrual method.
Under that method, a gain is recognized when the collectibility of the
sales price is reasonably assured and the earnings process is virtually
complete. When a sale does not meet the requirements for full accrual
recognition, the gain is deferred until these requirements are met. Income Taxes
Income taxes are accounted for by recording deferred tax assets and
liabilities for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax
credit carry-forwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered or
settled. The effect of F-8




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) a change in tax rates on deferred tax assets and liabilities is
recognized in the period that the change in the rates is enacted. A
valuation allowance is provided when the realization of deferred tax
assets is not assured. Accounting for the Impairment or Disposal of Long-Lived Assets
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Under this policy,
the Companys land and water rights are carried at cost. Any event or
circumstance that indicates that there is an impairment of the carrying
value of any of these assets triggers a two step analysis pursuant to
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. Under this two step analysis, the second step requires the
reduction of the carrying value of the water rights to their estimated
fair value in the event that under step one, the total of the
undiscounted cash flows the Company estimates will be generated by the
assets is less than their carrying value. Such reduction in carrying
value would be recorded as an impairment expense in the Companys
consolidated statement of operations. Loss Per Share
Basic and diluted loss per share is computed by dividing net loss
applicable to common stockholders by the weighted average number of
common shares outstanding during each period. The weighted average shares
used for determining the basic and diluted
loss per share computation were 8,069,012 shares for the years ended
March 31, 2004, 2003, and 2002, respectively. Stock options to purchase the following number of shares of common stock
at exercise prices per share ranging from $.10  $.86, $.23  $18.69,
and $.23  $18.69 in fiscal years ended March 31, 2004, 2003, and 2002,
respectively, were not included in the computation of diluted earnings
per share as their effect would have been anti-dilutive. 2004
    
    2003
    
    2002Stock options
    
    
    1,379,167
    
    
    
    1,599,666
    
    
    
    1,546,166
 The following items were convertible into the following number of shares
of common stock at the conversion prices listed below and were not
included in the computation of diluted earnings per share for the years
presented below, as their effect would have been anti-dilutive. 2004
    
    2003
    
    2002Convertible Debentures
    
    
    524,450
    
    
    
    524,450
    
    
    
    555,976Series C Preferred Stock
    
    
    463,779
    
    
    
    463,779
    
    
    
    463,779Series F Preferred Stock
    
    
    426,447
    
    
    
    401,968
    
    
    
    378,893
 The conversion prices per share for the 9% Convertible Subordinated
Debentures (the Debentures), Series C Convertible Redeemable Preferred
Stock (the Series C Preferred Stock) and Series F Convertible
Redeemable Preferred Stock (the Series F Preferred Stock) are $15.86,
$16.62 and $5.60, respectively. New Accounting Pronouncements Adopted and Issued But Not Yet Adopted
In January 2003, the Financial Accounting Standards Board (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 support from other parties.
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
the adoption of FIN 46 on July 1, 2003, did not have a material impact on
its consolidated financial statements upon adoption. In December 2003,
the FASB completed deliberations of proposed modifications to FIN 46
(Revised Interpretations) resulting in multiple effective dates based
on the nature as well as the creation date of the variable interest
entities. The Company has evaluated the impact of the Revised
Interpretations and has concluded that the Company is not involved with
any variable interest entities and therefore the adoption of the Revised
Interpretations on January 1, 2004, did not 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 circumstances) 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 F-9




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) beginning after June 15, 2003. The Company adopted the provisions of
SFAS No. 150 on July 1, 2003 for existing financial
instruments, all of which were entered into prior to June 30, 2003, and
the Company has concluded that the adoption of SFAS No. 150 did not have
a material impact on its consolidated financial statements. In June 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires the Company to record the fair value
of an asset retirement obligation as a liability in the period in which
it incurs a legal obligation associated with the retirement of tangible
long-lived assets that result from the acquisition, construction,
development, and/or normal use of the assets. SFAS No. 143 also requires
the Company to record a corresponding asset that is depreciated over the
life of the asset. Subsequent to the initial measurement of the asset
retirement obligation, the obligation will be adjusted at the end of each
period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. The adoption of SFAS No. 143 on
April 1, 2003 did not have a material effect on the Companys
consolidated financial statements. In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of SFAS No. 13, and Technical
Corrections. SFAS No. 145 amends existing guidance on reporting gains
and losses on the extinguishment of debt to prohibit the classification
of the gain or loss as extraordinary. SFAS No. 145 also amends SFAS No.
13 to require sale-leaseback accounting for certain lease modifications
that have economic effects similar to sale-leaseback transactions. The
provisions of the Statement related to the rescission of Statement No. 4
were applied in fiscal years beginning after May 15, 2002. The provisions
of the Statement related to Statement No. 13 were effective for
transactions occurring after May 15, 2002. The adoption of SFAS No. 145
on April 1, 2003, resulted in the reclassification of the $219,000 gain
on the early extinguishment of debt from an extraordinary item, as
originally reported in the 2003 fiscal year, to an element of continuing
operations. In March 2004, the FASB issued an exposure draft of a proposed standard
that, if adopted, will significantly change the accounting for employee
stock options and other equity-based compensation. The proposed standard
would require companies to expense the fair value of stock options on the
grant date and, if adopted, is anticipated to be effective at the
beginning of the Companys 2006 fiscal year. The Company will evaluate
the requirements of the final standard, which is expected to be issued in
2005, to determine the impact on the results of its operations. Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenue and expenses during the reporting
period to prepare these financial statements in conformity with
accounting principles generally accepted in the United States of America.
Actual results could differ from those estimates. Reclassifications
Certain reclassifications of prior year balances have been made in order
to conform to the current years presentation. Such reclassifications had
no net effect on previously reported results of operations, total assets
or accumulated deficit. Note 2. Liquidity: The Company has been and continues to be unable to generate sufficient
cash from operations to pay for operating expenses, to meet debt service
obligations, and to pay preferred stock dividends. The Company had paid
for these financial obligations using cash from its consulting
activities, the sale of assets, and short-term, asset-secured loans.
There is substantial doubt about the Companys ability to generate
additional cash from asset sales and loans to fund its operations through
March 31, 2005, and beyond or to meet other financial obligations
following the expenditure of its current cash balance. In order to preserve the Companys liquidity, the Board of Directors
decided, in January 2004, not to declare either of the then pending cash
dividends (scheduled for July, 2003 and January, 2004) on the Series C
Preferred Stock. As a result of the decision to withhold payment of two
consecutive cash dividends, the Series C Preferred Stock holders gained
the right to nominate a majority of the Companys Board of Directors. In
light of that right, the Company initiated discussions with
representatives of the Series C Preferred Stock holders to arrange an
orderly transition of the Board majority to the nominees of the holders
of the Series C Preferred Stock. In the course of these discussions,
representatives of the Series C Preferred Stock holders indicated their
intention to nominate qualified individuals to serve as directors. On March 1, 2004, directors David A. Abel, Robert A. Baker and Lee K.
Harrington tendered their resignations from the Companys Board of
Directors. Also on March 1, 2004, Reginald M. Norris, Jr. was elected to
serve the remainder of Mr. Abels F-10




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) term and Dennis J. Kenny was elected to serve the remainder of Mr.
Bakers term. Messrs. Norris and Kenny were nominated as directors by the
holders of the Series C Preferred Stock. On March 16, 2004, the Board of Directors declared and paid a dividend to
the holders of the Series C Preferred Stock. The dividend that was
declared on March 16, 2004, in the aggregate amount of $558,857,
represents the Series C Preferred Stock dividends, the declaration of
which had been deferred from July 15, 2003 and January 15, 2004. In
connection with the declaration of the dividends, the Company and each of
the holders of the Series C Preferred Stock entered into a Stockholder
Loan and Security Agreement, dated as of March 16, 2004 (the Loan
Agreement), pursuant to which the holders of the Series C Preferred
Stock agreed to (i) lend to the Company an amount equal to the entire
$558,857 proceeds of the March 16, 2004 dividend payment, and (ii) lend
to the Company in the future an amount equal to any and all dividends
that the Board of Directors of the Company may declare on the Series C
Preferred Stock with respect to the semi-annual periods ending July 15,
2004, January 15, 2005 and July 15, 2005. The $558,857 loan is evidenced
by a Secured Promissory Note, dated March 16, 2004 (the Note), and any
future loans will be evidenced by additional promissory notes that will
be substantially identical to the Note (collectively, the Notes). The
Notes bear interest at the rate of eight percent (8%) per annum from
inception, compounded semi-annually on July 15th and January 15th and
computed on a 360-day year of twelve 30-day months. The entire principal
balance plus all accrued and unpaid interest on the Notes is due and
payable on August 31, 2005. In order to secure the repayment of the Notes
and the performance of the Companys obligations under the Loan
Agreement, the Company granted to the holders of the Series C Preferred
Stock a security interest in all of the assets, property and property
rights owned by the Company in Douglas County, Colorado, which assets and
property essentially constitute the Companys Cherry Creek Project (the
Project) which has a book value of $12,258,000. The Company is dependent upon the orderly and timely sales of its
California assets to provide a portion of the cash necessary to fund the
Companys operations for the next twelve months ended March 31, 2005.
However, there can be no assurance regarding the Companys ability to
sell its California assets at fair value in a timely manner in order to
fund operations. The Companys water resources in Colorado consist of the Project, which
is the largest asset on the Companys consolidated balance sheet. While
management believes that demand for the Companys water resources in
Colorado continues to increase, the schedule for monetizing the value of
the Project is uncertain (based, in part, on the denial by the Colorado
Office of the State Engineer of the Companys application for approval of
a substitute water supply plan which proposed plan included elements
designed to assure the Projects current and prospective customers of
reliable water deliveries from the Project). Management believes that the
fair value of the Project, if and when fully developed or sold, will
exceed the current carrying value of that asset on the Companys balance
sheet. Accordingly, the Company is attempting to marshal its assets in a
manner that will provide the Company the working capital required to
finance the orderly development and disposition of the Project. However,
the Company can provide no assurance regarding its ability to monetize
the value of the Project, or that any revenue generated from the Project
will occur in a timely manner to fund the Companys operations. Moreover,
the Company will be required to incur additional expenses to develop the
Project in order to position it to be monetized. The Company can provide
no assurances that the Company will have the necessary funds to do so. The Company plans to fund its foreseeable working capital needs from
existing cash, from on-going operating income, from net proceeds of the
anticipated sale of certain existing assets, from the sale of Cherry
Creek Project Water Delivery Contract Units, and/or from the proceeds of
asset-secured loans. No assurance can be given that the Company will be
able to sell its assets as planned or that the Company will be able to
raise additional funds on commercially reasonable terms when and if
needed to sustain its operations and Cherry Creek Project development
activities. The inability of the Company to sell its assets as planned or
raise additional funds on commercially reasonable terms when and if
needed could impair the Companys ability to continue recurring
operations as a going concern. Additionally, the Debentures mature in
September 2005 (see Note 13) and the Series C Preferred Stock and Series
F Preferred Stock (see Note 14) are subject to mandatory redemption
beginning in Fiscal 2006 and Fiscal 2010, respectively. The consolidated
financial statements do not include any adjustments that might be
necessary should the Company be unable to continue as a going concern. Note 3. Notes Receivable: Notes receivable arose from the sale of farm property in California and
Colorado. The notes receivable bear interest at rates ranging from 9% to
9.5%, with a weighted average of 9.3%. The notes receivable maturity
dates range from April 2005 to August 2011. The notes are secured by the
farm properties sold. F-11




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) Aggregate principal maturities due on notes receivable at March 31, 2004
were as follows. Year ending March 31,
    
    Total2005
    
    $
    9,4342006
    
    
    109,8562007
    
    
    6,5322008
    
    
    7,4732009
    
    
    7,846Thereafter
    
    
    21,182Total
    
    $
    162,323
 Note 4. Assets Held for Sale: Assets held for sale are those California segment assets which are being
actively marketed, and which are expected to be sold within one year. As
of March 31, 2004 and 2003, the following assets were held for sale. Asset Category:
    
    2004
    
    2003Land
    
    $
    1,066,701
    
    
    $
    553,005Water rights and other water assets
    
    
    557,150
    
    
    
    643,932$
    1,623,851
    
    
    $
    1,196,937
 Note 5. Land: Land at March 31, 2004 and 2003 consisted of the following. 2004
    
    2003Colorado
    
    $
    1,503,517
    
    
    $
    1,504,551California
    
    
    
    
    
    
    2,863,381$
    1,503,517
    
    
    $
    4,367,932
 Note 6. Water Rights: Water rights held at March 31, 2004 and 2003 consisted of the following. 2004
    
    2003Colorado
    
    $
    10,754,206
    
    
    $
    10,756,222California
    
    
    291,642
    
    
    
    848,792$
    11,045,848
    
    
    $
    11,605,014
 Note 7. Property and Equipment: Property and equipment at March 31, 2004 and 2003 consisted of the following. 2004
    
    2003Equipment
    
    $
    368,731
    
    
    $
    170,906Less accumulated depreciation
    
    
    (114,086
    )
    
    
    (77,139
    )$
    254,645
    
    
    $
    93,767
 F-12




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) Note 8. Prepaid Leasing Costs: On September 30, 1998, the Company entered into a pumping rights lease
and a water sale agreement with the City of Inglewood, California (Inglewood). Beginning October 1, 1998,
Inglewood leased the rights to pump 4,450 acre-feet of water per year to
the Company for a five-year period ended September 30, 2003. In
consideration of the lease, the Company made a $3,603,200 lump-sum cash
payment to Inglewood. Under the water sale agreement, the Company agreed
to sell, and Inglewood agreed to buy, 5,950 acre-feet of water each year
for the ensuing five years. For the years ended March 31, 2004, 2003 and
2002, the Company recognized revenue of $641,330, $1,282,661, and
$1,305,809, respectively, from the agreement with Inglewood. In order to secure a portion of the water that the Company agreed to sell
to Inglewood, the Company entered into a five-year water rights lease and
a fifteen-year water rights lease. See Note 22 for a discussion of these
lease commitments. Accumulated amortization as of March 31, 2003 was $4,153,737, and all
prepaid leasing costs of $4,627,841 were fully amortized as of March 31,
2004. Note 9. Disposition of Assets In June 2003, the Company sold its shares in the Bear Valley Mutual Water
Company (BVMWC), California to a California municipality. These BVMWC shares were reported as Assets Held for Sale as of March 31, 2003. The
sale provided cash proceeds of approximately $723,000 and resulted in a
gain of approximately $73,000. During the quarter ended September 30, 2003, the Company entered into a
settlement agreement relating to the condemnation proceedings concerning
its Vessel Parcel of land at the Project. The parcel, comprising 36
acres of land, had been condemned in 2002 by the Parker Water and
Sanitation District (PW&SD) for its own use. In July 2002, the Company
received a preliminary deposit of $294,000 from PW&SD pending a judicial
hearing before the Douglas County, Colorado court with jurisdiction over
the condemnation action (the Court) to establish the final value of the
property. The Company recorded a gain on the disposition of assets of
$11,000 during the fiscal year ended March 31, 2003. In September 2003,
the Company reached a settlement with PW&SD, and the settlement was
entered as a final rule and order of the Court terminating the
condemnation action. Under the settlement, the parties agreed to total
valuation (including costs of condemnation) of $700,000. Thus, PW&SD
supplemented the preliminary deposit with a further payment to the
Company of $405,866. The Company collected the supplemental payment in
October 2003, and recorded a gain of $405,866 as a result of completing
the settlement. In December 2003, the Company sold Byington Ranch, a rice farm in Yuba
County, California. The sale provided cash proceeds of $1,170,000,
allowed the Company to retire from such proceeds a short-term loan
secured by its Yuba County properties, and resulted in a gain of
$207,830. In March 2004, the Company sold Magnolia Ranch, a rice farm in Yuba
County, California. The sale provided cash proceeds of $1,916,036 and
resulted in a gain of $455,886. See also Note 24, Subsequent Events, for information on the sale of
assets that occurred after March 31, 2004. In October 2002, the Company sold its remaining Mojave water rights in
San Bernardino County, California to two municipalities resulting in a
gain of approximately $964,000. Cash proceeds from the sales were
received in four installments totaling approximately $2,632,000 by March
31, 2003. In July 2002, the Company entered into condemnation proceedings
concerning its Vessel Parcel of land at the Project and received a
preliminary deposit of approximately $294,000 from PW&SD pending a court
proceeding to establish the final value of the property. The Company
recorded a gain on the disposition of assets of approximately $11,000
during fiscal 2003 which included the carrying value of the condemned
parcel of land. The condemnation proceedings were concluded in fiscal
2004 as described above. During fiscal 2002, the Company sold certain parcels of land in San
Bernardino County, California for a gain of $16,747. F-13




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) Note 10. Fair Value of Financial Instruments: SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires the disclosure of the fair value of the Companys financial
instruments. The carrying amount of cash and cash equivalents, accounts
receivable  trade, other current assets, accounts payable, and accrued
expenses and other liabilities are reasonable estimates of their fair
values due to the short-term nature of those instruments. The carrying amount of the notes receivable is a reasonable estimate of
fair value based on managements belief that the terms are not materially
different than the terms that would be offered to land buyers with
similar credit ratings. The carrying amount of the Debentures is based on the principal amount
owed, and does not represent managements estimate that the interest
rates or terms of the debt represent rates and terms that are available
to the Company in todays marketplace for similar instruments. During
the fiscal years ended March 31, 2003 and 2002, the Company repurchased
Debentures in unrelated voluntary transactions between the Company and
individual Debenture holders at prices ranging from 50 to 55 cents per
dollar of face amount. No Debentures were repurchased during the fiscal
year ended March 31, 2004. At the times consummated, each of these
repurchase transactions represented the fair value of the Debentures.
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 additional Debentures or at what price such
purchases could be consummated. The carrying amount of the Note Payable to Series C Preferred
Stockholders is a reasonable estimate of fair value based upon
managements belief that the terms are not materially different that the
terms that would be obtainable for a similarly secured borrowing of
consistent maturity. Note 11. Accrued Expenses and Other Liabilities: Accrued expenses and other liabilities at March 31, 2004 and 2003
consisted of the following. 2004
    
    2003Professional fees
    
    $
    83,600
    
    
    $
    8,000Annual reporting costs
    
    
    55,000
    
    
    
    31,800Vacation and benefits
    
    
    36,632
    
    
    
    20,900Other
    
    
    34,896
    
    
    
    21,528$
    210,128
    
    
    $
    82,228
 Note 12. Long-Term Debt: Long-term debt at March 31, 2004 consisted of the loan to the Company
made by the Series C Preferred Stock holders, secured by the assets
representing the Project. Long-term debt at March 31, 2003 consisted of
the note secured by a rice farm in Yuba County, California which note was
retired with the proceeds of a short-term, secured loan arranged during
the fiscal year and repaid from the proceeds of the sale of the farm in
fiscal 2004 (Note 9). On March 16, 2004, the Board of Directors of the Company declared and
paid a dividend to the holders of the Series C Preferred Stock. The
Certificate of Designations of the Series C Preferred Stock provides that
the holders of the outstanding Series C Preferred Stock are entitled to
receive, when, as and if declared by the Board of Directors, dividends at
the annual rate of 7.25% of the stated value per share of Series C
Preferred Stock. The Certificate of Designations further provides that
the dividends shall be payable semi-annually on the 15th day of January
and the 15th day of July. The Board of Directors of the Company did not
declare dividends due on either July 15, 2003 or January 15, 2004 on a
timely basis. The dividend that was declared on March 16, 2004, in the
amount of $558,857, represents the aggregation of the semi-annual
dividends due on July 15, 2003 and January 15, 2004. In connection with the declaration of the dividend on March 16, 2004, the
Company and each of the holders of the Series C Preferred Stock entered
into the Loan Agreement, pursuant to which the holders of the Series C
Preferred Stock agreed to (i) lend to the Company an amount equal to the
entire $558,857 proceeds of the March 16 dividend and (ii) lend to the
Company an amount equal to any and all dividends that the Company may
declare on the Series C Preferred Stock with respect to the semi-annual
periods ending July 15, 2004, January 15, 2005 and July 15, 2005. The
foregoing $558,857 loan is evidenced by the Note. The Note bears interest
at the rate of eight percent (8%) per annum from inception, compounded
semi-annually on July 15th and January 15th and computed on a 360-day
year of twelve 30-day months until paid. There is no prepayment penalty F-14




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) on the Note. The entire principal balance plus all accrued and unpaid
interest on the Note is due and payable on August 31, 2005. In order to
secure the repayment of the Note and the performance of the Companys
obligations under the Loan Agreement, the Company granted to the holders
of the Note a security interest in all of the assets, property and
property rights owned by the Company in Douglas County, Colorado, which
assets and property essentially constitute the Project. The balance of long-term debt as of March 31, 2004 and 2003,
respectively, follows. 2004
    
    2003Note to Series C Redeemable Preferred StockholdersPromissory note payable, bearing interest at 8%
per annum. Principal and accrued interest payable
in full on August 31, 2005. Interest compounded
semi-annually on July 15th and January 15th.
    
    $
    558,857
    
    
    
    Note Secured by RiceFarmMortgage note payable bearing interest at 9%.
Principal and interest were payable in annual
installments of $39,786. Balance was due July
2007. The note was paid in full in October, 2003,
from the proceeds of a short-term, secured loan
which, in turn, was repaid from the proceeds of
the sale of a portion of the secured property in
December 2003.
    
    
    
    
    
    $
    154,755558,857
    
    
    
    154,755Less current maturities of long-term obligations
    
    
    
    
    
    
    (25,858
    )$
    558,857
    
    
    $
    128,897
 Each of the real estate notes payable above is (or was) collateralized by
the related individual property. As of March 31, 2004, the carrying
value of the collateral for the Note was $12,250,000 and as of March 31,
2003, the value of the collateral for the real estate note payable was
approximately $902,000. Aggregate principal maturities on long-term debt at March 31, 2004 were
as follows. Years ending March 31,2005
    
    
    2006
    
    $
    558,8572007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    Total
    
    $
    558,857
 Note 13. 9% Convertible Subordinated Debentures: On September 22, 1995 the Company issued $15,000,000 of the Debentures,
due in September 2005. The Debentures are unsecured and subordinate to
all secured debt. Interest accrues at 9% per annum and is payable
semi-annually on September 30 and March 31. The Debentures are initially convertible into shares of the Companys
common stock at a conversion price of $15.86 per share (after the effect
of the March 28, 1996 stock dividend). Effective October 1, 1997, the
Company may redeem the Debentures at a cash redemption price equal to
100% of the principal amount redeemed (plus accrued and unpaid interest
thereon) if the trading price of the common stock was 150% of the
conversion price for the 20 preceding trading days. Based upon the
market value of the Companys common stock and the Companys financial
and operating condition at March 31, 2004, the Company does not expect to
gain the right to redeem the Debentures prior to maturity. During the year ended March 31, 2003, the Company repurchased $500,000 of
its outstanding Debentures, plus accrued interest of $20,836 for $295,836
in cash. After reducing deferred debt costs of $27,000, net of
accumulated amortization of $21,000, the Company recognized a $219,000
gain on the early extinguishment of debt. During the year ended March
31, 2002, the Company repurchased $13,334 of its outstanding Debentures,
for $7,409 in cash. Amortization expense on the deferred debt F-15




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) costs was $48,211 during each of the years ended March 31, 2004, 2003 and
2002. Accumulated amortization of deferred debt costs as of March 31,
2004 and 2003 was $390,435 and $342,224, respectively. Note 14. Preferred Stock: Series B and Series C Preferred Stock
On February 26, 1997, the Company privately placed $4,000,000 of Series B
Convertible Redeemable Preferred Stock (Series B Preferred Stock) which
was non-participating. Each share of Series B Preferred Stock had a
stated value of $1,000, a par value of $.001, and was convertible at any
time, at the option of the holder, into shares of common stock at an
initial conversion price of $16.62 per share. The holders of Series B
Preferred Stock were 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 16 of each year. On April 21, 1997, the Company issued 9,000 shares of Series C Preferred
Stock in a private offering. Each share of Series C Preferred Stock has
a stated value of $1,000, a par value of $.001, and is convertible at any
time at the option of the holder into shares of common stock at a
conversion price of $16.62 per share. The conversion price, and therefore
the number of shares of common stock issuable upon the conversion of the
Series C Preferred Stock, is subject to adjustment in certain events to
prevent dilution. The Series C Preferred Stock offering consisted of the
sale of 5,000 of the newly-issued shares of Series C Preferred Stock, for
which the Company received $1,000 per share (less the placement fee) in
cash and incurred costs of issue amounting to $255,212. The remaining
4,000 shares of Series C Preferred Stock were issued in exchange for the
surrender of the previously-issued Series B Preferred Stock. Upon such
surrender, the Company cancelled all the Series B Preferred Stock. The Series C Preferred Stock was recorded at fair value on the date of
issuance (the liquidation preference less the placement discount of
$447,695) less costs of issue of $255,212. The placement discount is
being accreted ratably by periodic charges to accumulated deficit until
the redemption date in April 2007. The holders of Series C Preferred Stock are entitled to vote on all
matters presented to the stockholders, together with the holders of
common stock as one class, except as otherwise required by law. Each
share of Series C Preferred Stock is entitled to the number of votes
equal to the number of shares of common stock into which such share of
Series C Preferred Stock would have been convertible, if such conversion
had taken place on the record date set for determining stockholders
entitled to vote at a meeting or the date of the consent of stockholders
if action is being taken by written consent. The holders of Series C
Preferred Stock are entitled to receive, when, and if declared, annual
dividends in the amount of $72.50 per share (representing a rate of 7.25%
per annum), payable semi-annually on January 15 and July 15. In the event that the Company fails to pay two or more semi-annual
dividends, the holders of the Series C Preferred Stock have the right,
voting as a class, to elect a majority of the directors of the Company,
and the holders of the common stock would have the right to elect the
remaining directors. In such event, the right of the holders to elect a
majority of the directors of the Company continues until dividends are
paid for at least two consecutive semi-annual periods, after which the
right to elect directors reverts to the common stock and the Series C
Preferred Stock, voting as a single class. The Board of Directors of the
Company did not declare the dividends due on either July 15, 2003 or
January 15, 2004 on a timely basis. The Board of Directors of the Company
declared a dividend on March 16, 2004, in the amount of $558,857, which
represented the aggregation of the previously undeclared semi-annual
dividends for July 15, 2003 and January 15, 2004. In connection with the
declaration of the dividend of $558,857, the Company and each of the
holders of the Series C Preferred Stock entered into the Loan Agreement,
pursuant to which the holders of the Series C Preferred Stock agreed to
(i) lend to the Company an amount equal to the entire $558,857 proceeds
of the March 16 dividend and (ii) lend to the Company an amount equal to
any and all dividends that the Company may declare on the Series C
Preferred Stock with respect to the semi-annual periods ending July 15,
2004, January 15, 2005 and July 15, 2005. The foregoing $558,857 loan is
evidenced by the Note, and any future loans are to be evidenced by the
Notes. The Notes bear interest at the rate of eight percent (8%) per
annum from inception, compounded semi-annually on July 15th and January
15th and computed on a 360-day year of twelve 30-day months until paid.
There is no prepayment penalty on the Notes. The entire principal
balance plus all accrued and unpaid interest on the Notes is due and
payable on August 31, 2005. In order to secure the repayment of the
Notes and the performance of the Companys obligations under the Loan
Agreement, the Company granted to the holders of the Notes a security
interest in all of the assets, property and property rights owned by the
Company in Douglas County, Colorado, which assets and property
essentially constitute the Project (see Note 12). During the fiscal years
ended March 31, 2004, 2003 and 2002, the Company paid dividends on the
Series C Preferred Stock in the amounts of $838,285, $279,486, and
$838,285, respectively. Of the Series C Preferred Stock dividends paid
in fiscal 2004, $558,857 was paid using the proceeds of the loan
described above. F-16




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) The Company may, upon 30 days written notice to the holders, redeem all
or any portion of the Series C Preferred Stock at any time after April l,
1999 at a cash redemption price of $1,000 per share plus accrued but
unpaid dividends. However, the Company may redeem the Series C Preferred
Stock only if the average closing price of the Common Stock during the 20
consecutive trading days prior to the notice of redemption is not less
than 150% of the conversion price (initially $16.62 per share, subject to
adjustment). Based upon the market value of the Companys common stock
and the Companys financial and operating condition, the Company does not
expect to gain the right to redeem its preferred stock prior to its
mandatory redemption date. Commencing on April 1, 2006 and continuing until March 31, 2007, each
holder of the Series C Preferred Stock may, from time to time during such
period, at such holders option, cause the Company to redeem for cash,
out of funds legally available, up to an aggregate of one-half of all
shares of Series C Preferred Stock owned by such holder on April 1, 2006.
Commencing on April 1, 2007, each holder of Series C Preferred Stock
may, from time to time thereafter, at such holders option, cause the
Company to redeem for cash, out of funds legally available, some or all
of such holders shares of Series C Preferred Stock. The redemption
price for each share of Series C Preferred Stock shall be $1,000 per
share, plus, in each case, all declared and unpaid dividends, if any. The Series C Preferred Stock has a preference in liquidation over the
holders of common stock of $1,000 per share plus accrued and unpaid
dividends. During the fiscal year ended March 31, 2001, the Company voluntarily
purchased 2,456.5124 shares of its Series C Preferred Stock at a purchase
price of $180 per share for a total purchase consideration of $442,171
which was paid in cash. The net carrying value of such shares was
$2,376,911 net of related private placement costs of $79,600. The excess
of the Series C Preferred Stock net carrying value over the consideration
paid by the Company was $1,934,740 and has been credited to accumulated
deficit in the 2001 consolidated financial statements. Solely for
earnings per share purposes in the year ended March 31, 2001, such excess
was included in the computation of earnings applicable to common
stockholders for the applicable period. The carrying amount of the
Series C Preferred Stock is based on the liquidation preference accorded
such stock and on the Companys obligation to redeem such stock for cash
at the liquidation value at a future date certain. Therefore, the
carrying value of the Series C Preferred Stock does not represent
managements belief that the dividend rates, conversion price and other
terms of such stock are comparable to those commercially available to the
Company in the marketplace for similar instruments. Series D and Series F Preferred Stock
On October 27, 1998, the Company sold $10,000,000 of its Series D
Convertible Redeemable Preferred Stock (Series D Preferred Stock) to
Interagua, Servicios Intregrales del Agua, S..A. (Interagua), an
affiliate of Sociedad General de Aguas de Barcelona, S. A. (Agbar).
Each share of Series D Preferred Stock had a stated value of $1,000, had
a dividend rate of 7.5% of its stated value, and was convertible at any
time at the option of the holder into the number of shares of common
stock determined by dividing the amount of the liquidation preference on
the conversion date by the conversion price of such shares in effect on
the conversion date. The conversion price was $8.99 per share (the
Conversion Price) and was subject to adjustment in certain events to
prevent dilution. On March 16, 2001, the Company entered into an Investment Restructure
Agreement (the Agreement) with Agbar and its affiliate for the early
redemption and retirement of the entire $10,000,000 of issued and
outstanding Series D Preferred Stock. In consideration of that
redemption and retirement, the Company (1) declared and paid to Interagua
the December 15, 2000 scheduled dividend of $187,500; (2) returned to
Interagua the remaining restricted cash balance (after giving effect to
the reduction of such balance resulting from the aforementioned dividend)
of $3,853,643; (3) issued 175,000 unregistered shares of the Companys
Common Stock to Interagua; and (4) issued to Interagua 2,000 shares of
its newly authorized Series F Preferred Stock , which shares have an
aggregate stated value of $2,000,000 with a fair value at issue date of
$364,000, according to an independent third-party valuation. In
addition, under the Agreement, the Strategic Relationship Agreement
(SRA) was cancelled, and the parties thereto agreed to consider
cooperating in the potential joint development of future water
infrastructure and water utility projects. Also, with the cancellation
of the SRA, Interagua no longer has the right to appoint Directors to the
Board of the Company. The excess of the Series D Preferred Stock carrying value over fair value
of the consideration paid by the Company to retire the Series D Preferred
Stock was $5,743,857 and has been credited to accumulated deficit in the
2001 consolidated financial statements. Solely for earnings per share
purposes in the year ended March 31, 2001, such excess has been included
in the F-17




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) computation of earnings applicable to common stockholders. The carrying
amount of the Series D Preferred Stock was based on the liquidation
preference accorded such stock and on the Companys obligation to redeem
such stock for cash at the liquidation value at a future date certain,
and did not represent managements belief that the interest rates,
conversion price and other terms of such stock were comparable to those
commercially available to the Company in the marketplace for similar
instruments. As described in the Certificate of Designations for the Series F
Preferred Stock, each share of Series F Preferred Stock has a stated
value of $1,000, a dividend rate of 6.0% per annum of its stated value,
and is convertible at any time at the option of the holder into the
number of shares of common stock determined by dividing the amount of the
stated value of the shares of Series F Preferred Stock by the conversion
price of such shares in effect on the conversion date. The conversion
price is initially $5.60 per share and is subject to adjustment in
certain events to prevent dilution. Dividends shall be fully cumulative,
and shall be paid semi-annually in arrears, out of funds legally
available for the payment of dividends, on January 15 and July 15.
Dividends may be paid in additional shares of Series F Preferred Stock,
or in cash, at the Companys option. During the year ended March 31,
2004 and 2003, the Company declared and issued 137.087 and 129.218
additional shares, respectively, of Series F Preferred Stock in
satisfaction of these dividend requirements. The Series F Preferred
Stock is subject to full redemption at its stated value plus accrued
dividends, at the option of the holder, from cash of the Company legally
available for such purpose, beginning in 2010, or earlier, at the option
of the Company, subject to certain conditions being met. Based upon the
market value of the Companys Common Stock and the Companys financial
and operating condition at March 31, 2004, the Company does not expect to
gain the right to redeem the Series F Preferred Stock prior to its
mandatory redemption date. Note 15. Treasury stock: In November 1998, the Companys Board of Directors authorized the
repurchase of up to 500,000 shares of the Companys common stock in the
open market. As of March 31, 2004 and 2003, the Company had repurchased
341,200 shares of common stock at a cost of $1,374,870. None of such
repurchases occurred within the last three fiscal years. The purchase of
treasury shares was recorded using the cost method. Note 16. Income Taxes: Total income taxes for the years ended March 31, 2004, 2003 and 2002,
were allocated to continuing operations. Income tax expense attributable
to income (loss) from continuing operations consisted of the following. Current
    
    Deferred
    
    TotalYear ended March 31, 2004 (State):
    
    $
    4,800
    
    
    
    
    
    
    $
    4,800Year ended March 31, 2003 (State):
    
    $
    3,200
    
    
    
    
    
    
    $
    3,200Year ended March 31, 2002 (State):
    
    $
    3,200
    
    
    
    
    
    
    $
    3,200
 Income tax expense was $4,800 for the year ended March 31, 2004, and
$3,200 for each of the years ended March 31, 2003, and 2002. Income tax
attributable to the net loss differed from the amounts computed by
applying the U.S. federal and state income tax rate of 34% to pretax net
loss as a result of the following. 2004
    
    2003
    
    2002Tax benefit computed at Federal statutory rate
    
    $
    (824,000
    )
    
    $
    (729,000
    )
    
    $
    (1,114,000
    )Permanent Differences  tax effected
    
    
    168,000
    
    
    
    56,000
    
    
    
    110,000Valuation allowance
    
    
    656,000
    
    
    
    673,000
    
    
    
    1,004,000State income taxes
    
    
    4,800
    
    
    
    3,200
    
    
    
    3,200$
    4,800
    
    
    $
    3,200
    
    
    $
    3,200
 The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at March
31, 2004 and 2003 are presented below. 2004
    
    2003Deferred tax assets:Allowance for water projects
    
    $
    3,000
    
    
    $
    4,000Property and equipment
    
    
    
    
    
    
    1,000Deferred revenue
    
    
    65,000
    
    
    
    72,000Net operating loss carry-forwards
    
    
    13,007,000
    
    
    
    12,370,000
 F-18




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WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (Continued) 2004
    
    2003Total gross deferred tax assets
    
    
    13,075,000
    
    
    
    12,447,000Less valuation allowance
    
    
    (12,669,000
    )
    
    
    (12,013,000
    )Net deferred tax assets
    
    
    406,000
    
    
    
    434,000Deferred tax liabilities:Land and water rights, principally due to
differences in capitalized interest
    
    
    (379,000
    )
    
    
    (434,000
    )Property and equipment
    
    
    (27,000
    )
    
    
    Net deferred tax asset
    
    
    
    
    
    
    
 The net change in the total valuation allowances for the fiscal years
ended March 31, 2004 and 2003 were net increases of $656,000 and
$673,000, respectively, which were primarily due to the respective
current year additions to net operating loss carryforwards partially
offset by the write-off of net operating loss carryforwards which expired
unused. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization
of deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies
in making this assessment. During the years ended March 31, 2004, 2003
and 2002, the valuation allowance was increased as a result of the
current years net operating loss carry-forward. At March 31, 2004, the Company had net operating loss carry-forwards for
federal income tax purposes which are available to offset future federal
taxable income, if any, as follows. 2005
    
    $
    400,0002006
    
    
    1,900,0002007
    
    
    1,600,0002008
    
    
    1,800,0002009
    
    
    400,0002010
    
    
    1,300,0002011
    
    
    1,800,0002012
    
    
    4,900,0002013
    
    
    2,400,0002019
    
    
    4,800,0002020
    
    
    3,000,0002021
    
    
    2,700,0002022
    
    
    3,300,0002023
    
    
    2,800,0002024
    
    
    2,400,000$
    35,500,000
 The Internal Revenue Code limits the future availability of net
operating loss and tax credit carryforwards that arose prior to certain
cumulative changes in a corporations ownership resulting in a change of
control of the Company. A detailed analysis of historic ownership changes
pursuant to IRC Section 382 has not yet been performed; however, it is
possible that some of the net operating loss carryforwards may be limited
in their use by the provisions of IRC Section 382. The extent and impact
of such limitation has not been determined at this time. Note 17. Quasi-Reorganization: The Companys Board of Directors authorized management to effect
a quasi-reorganization as of October 1, 1994. Such
reorganization was ratified by the Companys stockholders in
March 1995, and accordingly, the assets and liabilities have been
restated to their current values as of the date of the
reorganization. The amount of increases, however, is limited to
the amount of decreases in other assets. In this regard,
effective October 1, 1994 the Company recognized a write-down in
the value of the silica plant of $1,830,914, which was
subsequently sold. This write-down was offset by a corresponding
write-up of a like amount which was allocated proportionately,
based on the relative excess of fair market value of each asset
over historic book basis, to land held for sale of $454,604, to
water rights of $1,038,268, and to other water assets of
$338,042. Further, the accumulated deficit of $14,405,252, most
of which was due to the Companys prior and now discontinued
operation, was F-19




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) eliminated by a corresponding decrease in the Companys additional
paid-in capital. Accumulated deficit is dated to reflect only results of
operations subsequent to October 1, 1994. Any future tax benefits from
deductible temporary differences and net operating loss carry-forwards
that existed at the date of the quasi-reorganization will be reported as
a direct credit to paid-in capital. Note 18. Stock Options: Under the Companys 1997 and 1993 stock option plans (the Plans), the
Company may grant options to purchase up to 2,200,000 shares of common
stock to officers, directors, key employees and others providing
significant services to the Company. The Companys 1990 stock option
plan, which provided for the grant of up to 800,000 options, terminated
during the fiscal year ended March 31, 2001. Stock options are generally
granted at an exercise price no less than fair value of the Companys
common stock on the date of grant. There were 820,833 options available
for grant at March 31, 2004. Stock option activity during the periods indicated was as follows. Weighted-AverageNumber of Shares
    
    Exercise PriceBalance at March 31, 2001
    
    
    1,430,375
    
    
    $
    3.17Granted
    
    
    188,500
    
    
    
    .59Exercised
    
    
    
    
    
    
    Cancelled/forfeited/expired
    
    
    (72,709
    )
    
    
    10.70Balance at March 31, 2002
    
    
    1,546,166
    
    
    
    2.55Granted
    
    
    217,000
    
    
    
    .86Exercised
    
    
    
    
    
    
    Cancelled/forfeited/expired
    
    
    (163,500
    )
    
    
    8.86Balance at March 31, 2003
    
    
    1,599,666
    
    
    
    1.54Granted
    
    
    236,000
    
    
    
    .22Exercised
    
    
    Cancelled/forfeited/expired
    
    
    (456,499
    )
    
    
    3.94Balance at March 31, 2004
    
    
    1,379,167
    
    
    $
    .43
 The following table summarizes information about stock options
outstanding at March 31, 2004. Weighted
    
    
    
    
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    
    
    
    
    averageNumber of
    
    remaining
    
    Weighted
    
    Number of
    
    exercise priceRange of
    
    options
    
    contractual life
    
    average
    
    options
    
    of exercisableexercise price
    
    outstanding
    
    (years)
    
    exercise price
    
    exercisable
    
    options$.10-.86
    
    
    1,379,167
    
    
    
    6.3
    
    
    $
    .43
    
    
    
    1,192,763
    
    
    $
    .45
 At March 31, 2003 and 2002, the number of options exercisable was 908,999
and 673,666, respectively, and the weighted-average exercise price of
those options was $2.23 and $5.29, respectively. During the fiscal year ended March 31, 2001 the exercise price of options
to purchase 600,000 shares of common stock was lowered to the
then-current market price of the Companys common stock. This
modification of the exercise price required the modified stock options to
be accounted for following variable plan accounting until such options
are exercised, are cancelled, or expire unexercised. The Company
recorded no options-related compensation expense for these options in the
fiscal year ended March 31, 2004. For fiscal years ended March 31, 2003
and 2002, the Company recorded options-related compensation expense
associated with these options of $(145,740) and $145,740, respectively. F-20




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 19. General and Administrative Expenses: General and administrative expenses for the years ended March 31, 2004,
2003 and 2002 consisted of the following. 2004
    
    2003
    
    2002Payroll, severance and related expense
    
    $
    1,532,079
    
    
    $
    1,488,443
    
    
    $
    1,621,838Legal and accounting
    
    
    684,106
    
    
    
    368,260
    
    
    
    333,453Consulting and engineering
    
    
    166,105
    
    
    
    260,691
    
    
    
    340,621Travel
    
    
    63,118
    
    
    
    62,721
    
    
    
    99,093Other corporate expenses
    
    
    692,029
    
    
    
    900,695
    
    
    
    680,604$
    3,137,437
    
    
    $
    3,080,810
    
    
    $
    3,075,609
 Note 20. Employee Benefit Plan: The Company has a 401(k) Plan for all employees. Employer contributions
by the Company are discretionary. In the three most recent fiscal years,
the Company has matched a percentage of the contributions of
participating employees. Company matching contributions for the years
ended March 31, 2004, 2003 and 2002 amounted to $7,000, $9,731, and
$10,000, respectively. Note 21. Segment Information: 2004
    
    2003
    
    2002Segment revenue:California
    
    $
    754,283
    
    
    $
    1,519,163
    
    
    $
    1,464,200Colorado
    
    
    149,665
    
    
    
    10,072
    
    
    
    $
    903,948
    
    
    $
    1,529,235
    
    
    $
    1,464,200Interest income:California
    
    $
    3,760
    
    
    
    
    
    
    
    Colorado
    
    
    
    
    
    
    
    
    
    
    Non-segment
    
    
    12,062
    
    
    $
    90,508
    
    
    $
    170,006$
    15,822
    
    
    $
    90,508
    
    
    $
    170,006Interest expense:California
    
    $
    26,884
    
    
    $
    58,449
    
    
    $
    83,952Colorado
    
    
    
    
    
    
    
    
    
    
    Non-segment
    
    
    748,600
    
    
    
    798,153
    
    
    
    775,747$
    775,484
    
    
    $
    856,602
    
    
    $
    859,669Depreciation and amortization expense:California
    
    $
    467,915
    
    
    $
    985,892
    
    
    
    970,452Colorado
    
    
    932
    
    
    
    
    
    
    
    Non-segment
    
    
    92,431
    
    
    
    73,680
    
    
    
    63,926$
    561,278
    
    
    $
    1,059,672
    
    
    $
    1,034,378Net income (loss):California
    
    $
    286,368
    
    
    $
    (565,831
    )
    
    $
    (571,515
    )Colorado
    
    
    123,696
    
    
    
    9,708
    
    
    
    Non-segment
    
    
    (2,837,867
    )
    
    
    (1,590,078
    )
    
    
    (2,708,879
    )$
    (2,427,803
    )
    
    $
    (2,146,201
    )
    
    $
    (3,280,394
    )Assets:California
    
    $
    2,632,776
    
    
    $
    6,077,753
    
    
    
    8,282,294Colorado
    
    
    12,252,069
    
    
    
    12,261,651
    
    
    
    12,057,131Non-segment
    
    
    1,975,473
    
    
    
    1,574,793
    
    
    
    3,885,466$
    16,860,318
    
    
    $
    19,914,197
    
    
    $
    24,224,891
 F-21




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the years ended March 31, 2004, 2003 and 2002, the Company recognized
revenue of $641,330, $1,282,661, and $1,305,809, respectively, from 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
responsible 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 net income (loss) includes general and
administrative expenses. The non-segment amount under depreciation and
amortization includes depreciation of the non-segment property and
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. Note 22. Commitments and Contingencies: The Company has several non-cancelable office equipment and office leases
that expire over the next four years. These leases generally contain
renewal options for periods ranging from three to five years and require
the Company to pay all executory costs such as maintenance and insurance.
Rental expense for operating leases was $76,538, $89,526, and $121,070,
for the years ended March 31, 2004, 2003 and 2002, respectively. In addition, the Company entered into a pumping rights lease and a water
sale agreement with the City of Inglewood in September 1998. In order to
secure a portion of the water that the Company agreed to sell to
Inglewood, the Company entered into a five-year water rights lease and a
fifteen-year water rights lease. The five-year water rights provided
1,008 acre-feet per year for a payment of $150 per acre-foot in the first
year. This amount escalated over the remaining four-year period at $7.50
per acre-foot per year. This lease expired in September 2003. The
fifteen-year water rights lease is expected to provide 250 acre-feet per
year for a payment of $135 per acre-foot in the first year. The fees for
subsequent years are to be determined by multiplying the fee for the
first year by the ratio of the index price for each subsequent year
divided by the index price for the first year. The index price is the
sum of the price established by the Metropolitan Water District (MWD)
for full service untreated water and the price components established by
the West Basin Municipal Water District for MWD readiness-to-serve charge
and the West Basin surcharge for basic non-interruptible water. Future minimum leases payments under non-cancelable operating leases
(with initial or remaining lease terms in excess of one year) as of March
31, 2004 were as follows. Year ending March 31,2005
    
    $
    33,7502006
    
    
    33,7502007
    
    
    33,7502008
    
    
    33,7502009
    
    
    33,750Thereafter
    
    
    151,833Total minimum lease payments
    
    $
    320,583
 In May 1999, the Company entered into an agreement with the Norte-Sur
Water Company (NSWC) for the purchase of 14,000 acre-feet of water from
NSWC for $50 per acre-foot. In accordance with the agreement, the
Company paid a deposit of $350,000. In December 1999, the Company
entered into an agreement with the Westlands Water District (WWD) to
deliver up to 14,000 acre-feet to WWD at a price of $75 per acre foot.Pursuant
to the agreement, WWD made a series of payments ending in December, 2001
in which WWD paid the entire purchase price of $1,050,000 to the Company.
During the year ended March 31, 2001 the Company had purchased 2,000
acre-feet of water from NSWC and delivered it to WWD. The remaining
12,000 acre-feet cannot currently be delivered to WWD due to disputes
between WWD and certain other water districts in the F-22




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) area that will not convey the water to WWD. In March 2003, the Company
purchased the remaining water from NSWC with the payment to NSWC of the
remaining $300,000, plus accrued interest of $19,000. In September 2003, the Company discovered that a portion of a seven-acre
parcel of its property in Northern California had historically been used
as a domestic disposal site. The site is located in a remote section of
property which was deeded to the Company by its predecessor in 1990.
Based on a recent inspection and preliminary inquiry, use of the parcel
as a domestic disposal site appears to have been abandoned for roughly 40
years. It is not known what materials were disposed at the site. The
Company has not been notified of any potential liability with respect to
the abandoned disposal site, and no claims have been made against the
Company regarding the site. As of March 31, 2004, the Company was
proceeding with an evaluation of the site, but had made no provision for
the possible costs associated with cleanup of the site. Subsequent to
March 31, 2004 the Company arranged for collection and laboratory
analysis of soil samples at the former dump site. Results of the analysis
showed no material contamination. The Company is subject to claims and legal proceedings arising in the
ordinary course of business. While complete assurance cannot be given as
to the outcome of any pending or threatened legal actions, the Company,
upon advice of its legal counsel, believes that any financial impact
would not be material to its financial position, annual operating results
or cash flows. Note 23. Quarterly Financial Data (Unaudited): The following is a summary of quarterly results for the fiscal years ended March 31, 2004, 2003 and 2002. Fiscal 2004 quarters ended:
    
    June 30
    
    September 30
    
    December 31
    
    March 31Revenue
    
    $
    428,072
    
    
    $
    367,183
    
    
    $
    43,758
    
    
    $
    64,935Operating loss
    
    
    (457,254
    )
    
    
    (311,595
    )
    
    
    (686,055
    )
    
    
    (129,839
    )Net loss
    
    $
    (759,138
    )
    
    $
    (526,206
    )
    
    $
    (848,006
    )
    
    $
    (294,453
    )Net loss applicable to
common stockholders
    
    $
    (1,075,402
    )
    
    $
    (578,104
    )
    
    $
    (888,789
    )
    
    $
    (930,337
    )Loss per share -Basic and diluted:
    
    $
    (0.13
    )
    
    $
    (0.07
    )
    
    $
    (0.11
    )
    
    
    (0.12
    )Weighted average shares -Basic and diluted:
    
    
    8,069,012
    
    
    
    8,069,012
    
    
    
    8,069,012
    
    
    
    8,069,012
 Fiscal 2003 quarters ended:
    
    June 30
    
    September 30
    
    December 31
    
    March 31Revenue
    
    $
    420,091
    
    
    $
    472,852
    
    
    $
    326,084
    
    
    $
    310,208Operating income (loss) (1)
    
    
    (540,330
    )
    
    
    (477,440
    )
    
    
    234,035
    
    
    
    (831,175
    )Net income (loss)
    
    $
    (806,116
    )
    
    $
    (682,244
    )
    
    $
    125,738
    
    
    $
    (783,579
    )Net income (loss)
applicable to common
stockholders
    
    $
    (836,485
    )
    
    $
    (1,004,805
    )
    
    $
    92,299
    
    
    $
    (831,379
    )Earnings (loss) per share -Basic and diluted:
    
    $
    (.10
    )
    
    
    (.13
    )
    
    
    .01
    
    
    
    (.10
    )Weighted average shares -Basic and diluted:
    
    
    8,069,012
    
    
    
    8,069,012
    
    
    
    8,069,012
    
    
    
    8,069,012
  (1)    Operating income (loss) in 2003 reflects the reclassification of Gain
on Disposition of Assets from an element of Other Income Expense to an
element of Operating Income in order to be consistent with presentation
in the 2004 fiscal year. Note 24. Subsequent Events: On May 20, 2004, the Company sold Loma Rica Ranch, a rice farm in Yuba
County, California, which is included in Assets Held for Sale. The sale
provided cash proceeds of approximately $599,000 and resulted in a gain
of approximately $85,000. F-23




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##### Table of Contents



WESTERN WATER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) On June 7, 2004, the Company sold Cardozo Ranch, a former dairy farm in
San Bernardino County, California, which is included in Assets Held for
Sale as of March 31, 2004. The sale provided cash proceeds of
approximately $454,000 and resulted in a gain of approximately $2,000. On July 15, 2004, the Board of Directors declared a dividend on the
Series C Preferred Stock in the amount of approximately $279,000.
Simultaneously, the Company borrowed $279,000 from the Series C Preferred
Stock holders in order to fund the July 15, 2004 dividend. As of July 15,
2004, the balance of the Companys notes payable to the Series C
Preferred Stock holders was approximately $853,000, consisting of
approximately $838,000 in principal, plus approximately $15,000 in
accrued interest. On July 15, 2004, the Board of Directors declared a semi-annual dividend
on the Series F Preferred Stock at the semi-annual rate of 3%. The
dividend was paid in additional shares and, accordingly, the Company
issued 71.643 additional shares of Series F Preferred Stock in
satisfaction of the dividend requirement. On July 26, 2004, the Company sold Lewis Ranch, an unimproved 80-acre
parcel of land in San Bernardino County California, to an unaffiliated
purchaser for the purchase price of $250,000 for which the Company
received $30,000 in cash and a long-term amortizing purchase note in the
amount of $220,000. The property, with a book value of $101,015 is
included in Assets Held for Sale as of March 31, 2004, and the
transaction is being recorded as an installment sale. On August 24, 2004, Empire Insurance Company, a holder of $3 million of
the Companys 9% Convertible Subordinated Debentures, due September 30,
2005 filed suit against the Company, its directors and some of the
holders of Series C Convertible Redeemable Preferred Stock in the Court
of Chancery for the State of Delaware. The complaint challenges the
March 16, 2004 decisions of the Companys Board of Directors to declare
and pay a dividend on the Series C Preferred Stock and to take other
related actions (see Notes 2 and 14). The complaint seeks equitable
relief including rescission of the dividend, voidance of the loan with
which the dividend was funded, cancellation of the security for the loan,
injunction against the declaration of future dividends in favor of the
Series C Preferred Stock and other unspecified damages. The Company
believes that the outcome of the litigation is unlikely to have a
material effect on the Companys financial position, except for the cost
of responding to and defending against the allegations in the complaint. F-24