Pure Cycle Corporation — Q1 FY2014 Form 10-Q
Reporting period: Three months ended November 30, 2013; comparative period ended November 30, 2012. Interim financial statements are unaudited. Pure Cycle provides wholesale water and wastewater services and leases agricultural land and water.
Key financial results
| Metric | Q1 FY2014 | Q1 FY2013 |
|---|---|---|
| Revenue | $578,503 | $438,419 |
| Gross margin | $398,055; 68.8% of revenue | $366,925; 83.7% of revenue |
| Operating loss | $237,357 | $526,606 |
| Net loss | $846,502 | $1,333,590 |
| Net loss per share | $0.04 | $0.06 |
| Cash used in operating activities | $120,851 | $326,887 |
Water revenue rose to $321,573 from $46,618, principally because of sales for oil and gas fracking. Deliveries increased 298% to 34.6 million gallons; fracking supplied 29.2 million gallons and $290,300 of sales. Farm revenue fell 39% to $220,269, largely because the prior-year quarter included four months of farm lease income after the company assumed management. General and administrative expense declined 26% to $619,924. Gross margin percentage fell as cost of revenues grew faster than revenue.
Cash and cash equivalents were $1.48 million at November 30, down from $2.45 million at August 31, 2013. Working capital was $3.6 million. Total assets were $108.3 million and total liabilities were $59.3 million. Promissory notes payable totaled approximately $7.50 million, including $4.65 million current. The $48.43 million Tap Participation Fee (TPF) liability is a major obligation, payable as taps are sold and potentially accelerated in specified transactions or insolvency events. The filing reports a $6.84 million receivable from related party HP A&M.
Material changes and unusual items
- The company used $399,552 in investing activities, primarily for water and water-system investments, and $446,967 in financing activities, primarily note payments. Cash declined by $967,370 during the quarter.
- Foreclosures under the Arkansas River Agreement reduced taps subject to the TPF from 17,194 at August 31 to 13,830 at November 30. The company recorded a $12.03 million reduction in the TPF liability as an equity transaction, not income. The reported liability fell from $59.81 million to $48.43 million; the gross estimated future payments and discount are management estimates. Subsequent to quarter-end, additional foreclosures reduced the affected taps to 12,577, with an estimated further $4.4 million TPF reduction.
- Noncash imputed TPF interest expense was $657,235, compared with $894,648 in the prior-year quarter. Interest expense on promissory notes rose to $64,102 from $26,873.
- The company reported no water or wastewater tap sales in either comparative quarter. District water and wastewater tap fees increased effective December 31, 2013.
Outlook, risks and contingencies
Management stated that available working capital was sufficient to fund operations for the next fiscal year. Potential funding sources include an effective shelf registration statement allowing up to $15 million of additional stock sales and agreements to sell certain farms for $5.7 million. These are available or anticipated sources, not assured proceeds. The filing provides no formal revenue or earnings guidance.
- Water-sales growth depended heavily on fracking demand: revenues indirectly related to ConocoPhillips represented 87% of water and wastewater revenue, versus 7% a year earlier. Demand, customer concentration and energy-sector activity are material risks.
- The TPF fair value depends on management estimates of future development, tap sales, tap fees and discounting; actual outcomes could materially differ. Water-asset recoverability also depends on long-term development assumptions.
- HP A&M defaulted on notes secured by company land and water rights. The company acquired or is pursuing acquisition of defaulted notes and is pursuing remedies against HP A&M; collection and foreclosure outcomes remain uncertain.
- HP A&M appealed a ruling favoring the company in a dispute over four foreclosed farms. The company said an adverse appeal could result in loss of those properties, subject to its remedies under the Arkansas River Agreement.
- Litigation with the Colorado Land Board and related binding arbitration over royalties, wastewater rights-of-way and water blending remain unresolved. HP A&M’s separate lawsuit is stayed pending resolution of the Land Board dispute. No loss accruals were recorded because losses were not considered reasonably estimable or likely.
- Cash balances at times exceeded federal deposit-insurance limits. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Verify the sustainability and customer concentration of fracking-related water sales, including the relationship to ConocoPhillips.
- Review subsequent foreclosure developments, the appeal, and the resulting number of taps and estimated TPF liability.
- Assess the assumptions behind TPF valuation, future tap sales and water-asset impairment recoverability.
- Track the HP A&M receivable, defaulted-note exposure and the collectability of amounts spent to protect land and water rights.
- Confirm liquidity against operating needs, scheduled note payments, expected farm-sale proceeds and any planned use of the equity shelf.
- Follow the Land Board litigation and arbitration for potential effects on royalties, service rights and operating economics.