Pure Cycle Corporation — Form 10-Q
Reporting period: Quarter and six months ended February 28, 2014. The interim financial statements are unaudited. Pure Cycle provides wholesale water and wastewater services and leases land and water for farming.
Financial performance and position
- Revenue: Second-quarter revenue was $735,874, up 69% from $434,505 a year earlier. Six-month revenue was $1.314 million, up 51% from $872,923.
- Drivers and margins: Water revenue rose to $392,837 for the quarter and $714,410 for six months, chiefly on sales to oil-and-gas customers for hydraulic fracturing. Water-delivery gross margin rose to 72% for the quarter and 70% for six months, versus 50% and 48%, respectively. Total gross margin was $551,517 for the quarter and $949,572 for six months.
- Profitability: Operating loss was $140,894 for the quarter and $378,251 for six months. Net loss narrowed to $455,975 for the quarter from $914,692, and to $1.302 million for six months from $1.992 million. Six-month loss per share was $0.05, versus $0.08.
- Cash flow: Cash used in operations was $1.558 million for six months, compared with $816,792 a year earlier. Investing activities provided $650,120, including $1.172 million of farm-sale proceeds; financing used $1.251 million, mainly for note repayments. Cash fell by $2.159 million to $289,591.
- Liquidity and obligations: Current assets were $13.220 million and current liabilities $4.886 million, implying working capital of approximately $8.334 million. Promissory notes totaled approximately $6.654 million, including current maturities. Total liabilities were $35.670 million. The balance sheet also included a $24.632 million Tap Participation Fee (TPF) liability and a $1.188 million participating-interest liability.
Changes versus the prior comparable period
- Water deliveries for the quarter increased 239% to 34.6 million gallons; six-month deliveries increased 276% to 71.4 million gallons. Management attributed the increase primarily to fracking-water sales, which generated higher rates than typical tap-connected customer sales.
- Farm revenue was nearly flat for the quarter, but fell 21% for six months, partly because the prior-year six-month period included an additional month of recognized farm income.
- General and administrative expense rose 22% for the quarter and 14% for six months. Management cited higher legal and accounting fees, including increased litigation and foreclosure costs.
- Imputed TPF interest expense declined to $403,003 for the quarter and $1.060 million for six months, from $650,107 and $1.545 million, respectively, following reductions in the TPF obligation.
Outlook, risks, and unusual items
- Management stated that working capital and available financing were sufficient to fund operations for the next fiscal year. The company had an effective shelf registration allowing it to sell up to an additional $15 million of stock and had agreements to sell farms for approximately $4.6 million. This is management’s assessment, not formal earnings guidance.
- During the six months, foreclosure remedies reduced the reported TPF liability by $36.235 million as an equity transaction, rather than income. The TPF was valued using estimated future home development, tap sales, fees, and a 7.2% implied discount rate; actual outcomes may differ materially. At quarter-end, 7,126 taps remained subject to the fee.
- After quarter-end, additional foreclosures reduced taps subject to the TPF by 2,861 and the liability by approximately $9.9 million, leaving 4,265 taps. The company also reported a subsequent sale of five farms and related water shares for approximately $2.7 million.
- Liquidity depends in part on farm sales and cash generation. Oil-and-gas water sales accounted for 86% of water and wastewater revenue in the quarter and 87% for six months, creating customer and end-market concentration risk. Cash balances at times exceeded federally insured limits.
- Material legal matters include disputes with the Colorado Land Board, HP A&M litigation and appeal related to foreclosed properties, and arbitration matters whose timing and outcomes were uncertain. The company recorded no litigation loss accruals, stating losses were not reasonably estimable or deemed reasonably likely. Six properties remained subject to foreclosure proceedings at filing; they represented more than 12% of FLCC shares and approximately 16% of Arkansas River farmland.
- The company held a $7.002 million receivable from HP A&M related to defaulted notes and was pursuing recovery. The filing also describes approximately $6.6 million owed on outstanding notes secured by company property and water rights.
Important facts for investors to verify
- Whether farm-sale proceeds, the shelf registration, and operating cash flows are sufficient to support liquidity given quarter-end cash of $289,591.
- The sustainability of fracking-water demand and the extent of dependence on the concentrated oil-and-gas customer base.
- The assumptions and accounting treatment behind the TPF valuation and reductions, including subsequent foreclosures and any remaining obligations.
- The outcomes of HP A&M-related foreclosures, litigation, and recovery efforts, and the status of Land Board disputes and arbitration.
- The collectability and timing of the HP A&M receivable and the company’s exposure to the associated defaulted notes.