Business Context and Reporting Period
Company: Pure Cycle Corp (PCYO)
Filing Type: Form 10-K (Annual Report)
Period Ended: August 31, 2011
Business Overview: Pure Cycle is an investor-owned Colorado corporation providing wholesale water and wastewater services to local governmental entities, primarily the Rangeview Metropolitan District. The company owns water rights, infrastructure (wells, pipelines, treatment facilities), and land assets (including the Lowry Range, Sky Ranch, and Arkansas River Valley properties) to serve the Denver metropolitan area and the Colorado Front Range.
Key Financial Metrics
| Metric | Fiscal 2011 | Fiscal 2010 |
|---|---|---|
| Total Revenues | $282,134 | $264,107 |
| Net Loss | $(6,016,159) | $(5,391,262) |
| Loss Per Share (Basic & Diluted) | $(0.26) | $(0.27) |
| Working Capital | $4,407,338 | $1,648,314 |
| Cash & Cash Equivalents | $71,795 | $12,017 |
| Marketable Securities | $4,588,535 | $1,435,054 |
| Total Assets | $116,122,652 | $106,377,754 |
| Total Liabilities | $68,832,313 | $63,917,755 |
| Shareholders' Equity | $47,290,339 | $42,459,999 |
Revenue Composition: Revenues are derived from metered water usage ($157,497), wastewater treatment fees ($68,833), and recognized tap/construction fees ($55,804).
Major Expense: Imputed interest expense on the Tap Participation Fee payable to HP A&M was $3,847,000, accounting for approximately 64% of the net loss.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 6.8% to $282.1 million, driven by a 12% increase in water revenues due to higher usage (less precipitation) and fee increases effective July 2010.
- Net Loss Increase: Net loss widened by 11.6% to $6.0 million, primarily due to increased General and Administrative (G&A) expenses and higher imputed interest.
- Asset Acquisition: The company acquired 931 acres of undeveloped land known as "Sky Ranch" for approximately $7.0 million, funded by equity sales and a convertible note.
- Liquidity Improvement: Working capital increased significantly from $1.6 million to $4.4 million following the sale of 3.8 million shares of common stock for $10.8 million and the conversion of a $5.2 million convertible note.
- New Revenue Stream: Recognized $199,257 in oil and gas lease income from an agreement with Anadarko E&P Company, L.P., a new source of revenue not present in the prior year.
Guidance, Outlook, Risks, and Unusual Items
Outlook and Management Commentary
- Development Plans: Management anticipates drilling up to four new deep water wells at a cost of $2.4 million over the next 24 months to meet increased demand for water for oil and gas drilling (fracking) in the Niobrara Formation.
- Capital Needs: The company believes it has sufficient working capital to fund operations for the next fiscal year. However, long-term development of Arkansas River water for municipal use requires an estimated $500 million pipeline investment, which is not expected to occur in the near term.
- Regulatory Compliance: The company anticipates spending between $400,000 and $500,000 by 2014 for wastewater treatment facility improvements to comply with stricter ammonia-nitrogen and chlorine residual regulations.
Risks and Contingencies
- Tap Participation Fee: A significant contingent liability exists for 10% of tap fees from the next 38,937 water taps sold to HP A&M. Subsequent Event: Effective September 1, 2011, HP A&M elected to increase this fee to 20% while reducing the number of subject taps by 50% to 19,468. This requires a revaluation of the liability.
- HP A&M Promissory Notes: 60 properties acquired from HP A&M are subject to promissory notes totaling $10.0 million (with $5.5 million due within 12 months). While HP A&M is responsible, a default could cause Pure Cycle to lose these properties unless the company cures the default.
- Customer Concentration: 91% of revenues are derived from the Rangeview Metropolitan District, which in turn relies heavily on one customer (Ridgeview Youth Services Center) for 60% of total revenues.
- Water Rights Diligence: The Paradise Water Supply is subject to a "reasonable diligence" review by the water court every six years. Failure to meet stipulations by 2014 could result in the loss of these rights.
Investor Verification Checklist
- Tap Participation Fee Revaluation: Verify the impact of the September 1, 2011 change (20% fee on 19,468 taps) on future imputed interest expense and the liability balance.
- HP A&M Solvency: Monitor the financial status of HP A&M regarding the $10 million in promissory notes secured by Pure Cycle's Arkansas River properties.
- Customer Concentration: Assess the risk associated with the Ridgeview Youth Services Center, which accounts for 60% of total revenue, and the stability of the Rangeview Metropolitan District.
- Oil & Gas Revenue Sustainability: Evaluate the longevity of the new oil and gas lease revenue stream and the potential for future drilling contracts.
- Capital Expenditure Funding: Confirm the company's ability to fund the planned $2.4 million in new well drilling and future $500 million pipeline projects without excessive dilution.