PURE CYCLE CORPORATION — Form 10-Q Summary
Reporting period: Third quarter and nine months ended May 31, 2012; interim financial statements are unaudited. Pure Cycle provides wholesale water and wastewater services in the greater Denver area and holds water rights and related land assets.
Financial results and position
| Metric | Three months ended May 31, 2012 | Nine months ended May 31, 2012 |
|---|---|---|
| Total revenue | $57,567 | $175,098 |
| Gross margin | $13,245 | $44,354 |
| Operating loss | $663,572 | $1,924,186 |
| Net loss | $1,419,926 ($0.06 per share) | $4,145,260 ($0.17 per share) |
| Operating cash flow | Not separately reported for the quarter | $(1,594,418) |
- For the nine months, water and wastewater service revenues were $98,301 and $34,944, respectively. Revenue also included ratable recognition of previously received facility funding and tap fees.
- At May 31, cash was $243,405 and marketable securities were $2.80 million; working capital was approximately $2.7 million. Total assets were $114.3 million and shareholders’ equity was $43.3 million.
- The company reported no debt obligations with contractual maturity dates. However, it recorded a $67.4 million Tap Participation Fee liability payable to HP A&M as eligible taps are sold; the liability is estimated using discounted projected cash flows. A further $2.26 million contingent obligation to Export Water participants was not recorded as a balance-sheet liability.
- Cash used in investing activities was $1.71 million provided, chiefly reflecting net sales and maturities of marketable securities. Financing activities provided $51,278.
Changes versus the prior comparable period
- Third-quarter revenue declined about 10% from $63,638; nine-month revenue declined about 7% from $188,579. Nine-month water revenue increased 5%, while wastewater revenue fell 34%, primarily after the wastewater customer’s billing changed from a fixed fee to a usage-based charge.
- Nine-month net loss improved by $459,350, or about 10%, from the prior-year loss of $4.60 million. Third-quarter net loss increased about 4% from $1.36 million.
- Nine-month operating cash use rose to $1.59 million from $151,229. Management attributed the increase principally to the prior-year receipt of a one-time $1.24 million oil-and-gas lease payment and higher legal fees in 2012.
- Water-delivery operating costs, excluding depreciation and depletion, increased 47% in both the quarter and nine-month period. Management cited higher pumping and energy costs related to short-term demand from oil and gas drilling and fracking. Reported water gross margin rates fell to 48% for the quarter and 51% for nine months, from 64% and 65%, respectively.
- General and administrative expense rose 29% in the quarter and 8% for nine months, with legal fees increasing in connection with two lawsuits. Nine-month imputed interest expense on the Tap Participation Fee declined to $2.59 million from $3.01 million.
Outlook, risks and unusual items
- Management stated that working capital was sufficient to fund operations for the next fiscal year. The company also had an effective shelf registration statement permitting potential sales of up to $4.45 million of stock; no specific operating guidance was provided.
- Subsequent to quarter-end, HP A&M defaulted on notes with approximately $2.73 million of principal and accrued interest then due. Approximately $9.4 million of HP A&M debt remained secured by properties and water rights acquired by Pure Cycle. Pure Cycle said it was not responsible for the debt, but could lose collateral properties and associated water rights if defaults are not resolved. The company said it lacked funds to cure all notes and was negotiating a settlement; possible responses include foreclosing on pledged shares or mineral rights, or selling shares or property. Management estimated that about 4,200 acres of farms and water could be sold to retire the $9.4 million outstanding.
- Pure Cycle and the Rangeview Metropolitan District sued the Colorado Land Board, alleging breach of agreements concerning the company’s water-service rights at the Lowry Range. HP A&M separately sued Pure Cycle over alleged breaches of representations in the Arkansas River Agreement. The company reported increased legal costs and litigation uncertainty.
- Revenue and asset recoverability depend on future development, tap sales and fees. Management’s $67.4 million Tap Participation Fee valuation is Level 3 and sensitive to estimates of housing growth, tap fees and development timing. The company also identified ongoing diligence requirements for its Paradise Water Supply; failure to satisfy them could result in loss and impairment of those rights.
- Customer concentration is substantial: the District generated 91% of water and wastewater revenue in the quarter and nine-month period; its largest end customer represented 78% and 74%, respectively. The District accounted for 94% of trade receivables at May 31.
- Management reported disclosure controls and procedures were effective as of May 31, 2012, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Progress and terms of settlement discussions with HP A&M, the status of the defaults, and potential effects on Pure Cycle’s properties, water rights and liquidity.
- Resolution and potential financial impact of the Land Board and HP A&M lawsuits.
- Cash runway, operating cash use and whether any shelf-registration stock sale is pursued.
- Assumptions underlying the Tap Participation Fee valuation and its future imputed-interest effect.
- Customer concentration, water-delivery cost trends, and development progress supporting water-asset recoverability and Paradise Water Supply diligence.