PCYO

Pure Cycle Corp. 10-Q Summary

Business Context and Reporting Period

Pure Cycle Corporation is a water and wastewater service provider operating in the Denver metropolitan area. This report covers the quarterly period ended February 28, 2011, and the six-month period ended on the same date. The company is classified as a smaller reporting company.

Key Financial Metrics

Note: The company reported a significant non-cash imputed interest expense of approximately $954,000 for the quarter and $1.89 million for the six months related to the Tap Participation Fee liability.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 11% for the quarter and 13% for the six months compared to the prior year periods, driven by a 59% increase in water deliveries (quarterly) due to lower precipitation and increased irrigation demand.
• Operating Loss: Operating loss widened to $(797,090) for the quarter and $(1,245,143) for the six months, compared to $(643,633) and $(1,058,692) in the prior year periods. This was primarily due to a 32% increase in General and Administrative (G&A) expenses.
• G&A Expenses: The increase in G&A expenses was largely attributable to $180,000 in bonuses paid to employees and management for the successful acquisition of Sky Ranch and completion of financing, as well as increased professional fees.
• Asset Acquisition: The company acquired the Sky Ranch property (approx. 940 acres and 820 acre-feet of water) for approximately $7.0 million during the period, funded by a convertible note and stock sale.
• Debt Conversion: A $5.2 million Convertible Note issued to a related party (PAR Investment Partners) was converted into 1,982,099 shares of restricted common stock in January 2011.

Outlook, Risks, and Unusual Items

• Subsequent Event (Oil & Gas Lease): On March 14, 2011, the company entered into an oil and gas lease with Anadarko E&P Company. The company expects to receive an upfront bonus payment of approximately $1.268 million by April 22, 2011, plus a 20% royalty on future production.
• Liquidity: Management believes current working capital (approx. $4.4 million) and the expected Anadarko payment are sufficient to fund operations for the next fiscal year. The company also has an effective shelf registration statement allowing for the sale of up to an additional $4.45 million of common stock.
• Tap Participation Fee Liability: A significant liability of approximately $63.0 million exists for a 10% participation fee on future water tap sales payable to High Plains A&M (HP A&M). This liability is valued using discounted cash flow models based on projected housing development, which carries estimation risk.
• Customer Concentration: One customer (Ridgeview Youth Services Center) accounted for approximately 64% of total revenues for the six months ended February 28, 2011.
• Regulatory Risk: The Paradise Water Supply is subject to a "reasonable diligence" review by the water court every six years; failure to meet stipulations could result in the loss of these water rights.

Investor Verification Checklist

• Verify the receipt of the $1.268 million bonus payment from Anadarko by April 22, 2011.
• Monitor the status of the Tap Participation Fee liability valuation and the underlying housing development assumptions in the Denver metro area.
• Review the progress of the "reasonable diligence" requirements for the Paradise Water Supply to ensure no impairment risk arises before the 2014 review.
• Assess the impact of the $180,000 one-time bonus on future G&A expense trends.
• Confirm the conversion of the Convertible Note and the issuance of restricted shares to PAR Investment Partners.