PURE CYCLE CORP quarterly report, Q3 FY2016

Pure Cycle Corporation — Q3 FY2016 Form 10-Q

Reporting period: Quarter and nine months ended May 31, 2016; comparative periods ended May 31, 2015. The interim financial statements are unaudited. Pure Cycle is primarily a wholesale water and wastewater provider in Colorado; its agricultural operations were sold in August 2015 and are reported as discontinued operations.

Financial performance

Metric	Three months ended May 31, 2016	Three months ended May 31, 2015	Nine months ended May 31, 2016	Nine months ended May 31, 2015
Total revenue	$100,852	$120,360	$303,204	$1,062,312
Operating loss	$(532,894)	$(448,431)	$(1,562,118)	$(724,733)
Net income (loss)	$(422,270)	$30,247	$(790,510)	$(45,440)
Net loss per common share	$(0.02)	Less than $0.01 per share	$(0.03)	Less than $0.01 per share

Gross loss was $34,000 for the quarter and $84,500 for the nine months, compared with a gross loss of $19,400 and gross profit of $570,600, respectively, in the prior-year periods. The filing does not present an overall gross margin percentage.

Water demand and revenue: Water deliveries fell 42% in the quarter and 82% for the nine months year over year. Metered water revenue declined 51% to $35,700 and 87% to $119,800, respectively. The company reported no fracking-water sales in 2016.
Other operating revenue: Wastewater fees were $10,500 for the quarter and $31,500 for the nine months, down 15% in each comparison. Other revenue was $40,700 and $110,000, respectively. Tap and special-facility revenue recognized was unchanged year over year.
Other income: Nine-month oil and gas lease income was $354,800, down 27%; royalty income was $271,000, slightly above the prior-year $262,100. Interest income rose to $175,400 from $11,600, principally due to investing proceeds from the farm-asset sale.

Cash, liquidity and obligations

At May 31, 2016, cash and cash equivalents were $5.1 million, short-term investments $23.1 million, and long-term investments $7.0 million. Working capital was $29.3 million, including $28.3 million of cash and short-term investments.
Total assets were $71.1 million; total liabilities were $1.7 million; shareholders’ equity was $69.4 million. The filing reports no conventional borrowings outstanding at period end. Recorded participating interests in Export Water Supply were $344,400.
The company disclosed an additional contingent CAA obligation of approximately $678,300, payable only from future Export Water sales and not recorded as a balance-sheet liability. Total potential third-party obligation was approximately $1.02 million.
For the nine months, operating cash outflow was $215,000, including $1.47 million used by continuing operations and $1.25 million provided by discontinued operations. Investing cash outflow was $31.76 million, largely reflecting purchases of short- and long-term investments; financing cash outflow was $1,600. Cash declined by $31.97 million from August 31, 2015.
The company sold agricultural assets for approximately $45.8 million in August 2015 and received about $1.3 million of escrow proceeds during the quarter. Management stated that available working capital was sufficient to fund operations for the next fiscal year.

Changes and management outlook

The steep year-over-year decline in water sales reflected reduced oil-and-gas drilling activity and the resulting loss of fracking-water demand, which management attributed to lower oil prices. Management said it was not then selling water to the oil and gas industry.
Management expects to spend approximately $5 million over the next 12 months on about seven miles of pipeline connecting the Lowry and Sky Ranch systems. It also anticipates funding the District’s WISE participation at approximately $1.2 million annually for five years; the disclosed projected total is approximately $5.8 million. WISE is expected to be completed in 2021.
The ECCV system costs approximately $8,500 per month to maintain without production, and had not produced water since November 2014. Management expects this to continue weighing on water gross margin until capacity is used for future sales.
The company anticipates expenses related to discontinued agricultural operations through the end of calendar 2016 and intends to sell the remaining 700 acres acquired to resolve dry-up covenant issues.
An effective shelf registration statement permitted up to $15 million of stock sales and was scheduled to expire in August 2016. Management stated it could elect to use it; no sale was reported in this filing.

Risks, contingencies and other notable items

Revenue and receivables are concentrated: the Rangeview Metropolitan District accounted for 77% of water and wastewater revenue for the nine months, and its largest end customer accounted for 66%. The District represented 88% of wholesale water and wastewater trade receivables at May 31, 2016.
Development timing, population and economic growth, water demand and pricing, oil and gas activity, permits, construction costs, water-court outcomes, weather, and access to capital could affect results. Water-asset impairment estimates depend on uncertain future development and tap sales; management reported no impairment identified in its latest analysis.
The company expects approximately 2,300 new water connections, based on current tap fees and estimated margins, to recover the carrying cost of its Rangeview water assets; actual development and costs could differ materially.
The filing describes ordinary-course litigation and contingencies but does not identify a specific material pending claim or a clear quantified loss exposure.
Management reported effective disclosure controls as of May 31, 2016 and no material change in internal control over financial reporting during the quarter.

Investor verification priorities

Verify the source and sustainability of future water demand given the absence of fracking-water sales and the sharp decline in deliveries.
Assess the customer concentration, including the District and its major end customer, and the related-party receivables and funding arrangements.
Track pipeline and WISE capital commitments against available liquidity and confirm whether the shelf registration was used or renewed after August 2016.
Review the CAA’s recorded and contingent obligations, payment priority, and dependence on future Export Water sales.
Confirm disposition of the remaining agricultural land, collection of discontinued-operation receivables, and remaining post-sale costs.