Pure Cycle Corporation — FY2016 Form 10-K
Reporting period: Fiscal year ended August 31, 2016. This is an annual filing, not a quarterly report; the filing also presents unaudited quarterly data. Pure Cycle provides wholesale water and wastewater services, primarily in the Denver area, and is developing water assets and the 931-acre Sky Ranch property.
Financial performance and position
- Revenue: $452,000, down 62% from $1.197 million in FY2015. Metered water revenue fell 77% to $221,000; wastewater fees declined 13% to $43,700. No water or wastewater taps were sold in FY2016.
- Profitability: Gross loss was $76,600 versus gross profit of $437,200 in FY2015. Operating loss widened to $2.180 million from $1.677 million. Net loss was $1.311 million, compared with $23.128 million in FY2015; the prior-year loss included a $22.1 million loss on the farm-asset sale. FY2016 basic and diluted loss per share was $0.06.
- Margins and cost drivers: Water-delivery gross margin, excluding depletion, was negative 20%, versus positive 52% in FY2015, as much lower fracking-related deliveries left system costs less covered. Wastewater gross margin improved to 33% from negative 33%.
- Cash flow: Operating activities used $271,000 of cash, versus $974,000 used in FY2015. Investing activities used $32.119 million, largely reflecting purchases of securities; financing activities used $2,000. Cash and cash equivalents fell to $4.697 million from $37.089 million.
- Liquidity and debt: Working capital was $28.6 million. Current and long-term investments totaled approximately $30.0 million, in addition to cash. Total liabilities were $1.882 million; the company reported no debt at year-end.
- Other balance-sheet items: Water and water-system investments, net, were $28.322 million; total assets were $70.880 million and equity was $68.998 million. The company recorded $343,600 in oil and gas royalties and $241,300 in interest income.
Material changes versus the prior comparable period
- Water deliveries dropped 65% to 33.9 million gallons, and water revenue fell 77%. Management attributed the decline primarily to curtailed oil and gas drilling as oil prices weakened; the filing says water sales to the oil and gas industry had ceased as of the report date.
- FY2015 included the sale of the Arkansas River farm portfolio for approximately $45.8 million and a $22.1 million loss on that sale. The agricultural business is reported as discontinued operations; FY2016 discontinued-operation loss was $80,000.
- Cash balances declined substantially as proceeds from the farm sale were shifted into short- and long-term investments and used for investments and operations. General and administrative expense decreased 5% to $1.850 million, but the operating loss increased as revenue and gross margin weakened.
Outlook, risks and unusual items
- Management outlook: Management stated that working capital and financing sources were sufficient to fund operations for at least the next fiscal year. It anticipated $4.5–$5.0 million of FY2017 pipeline investment to connect the Rangeview, WISE and Sky Ranch systems, and approximately $650,000 of FY2017 WISE spending. These are plans and estimates, not guaranteed outcomes.
- WISE and Sky Ranch: WISE was expected to provide about 500 acre-feet of water annually and three million gallons per day of transmission capacity after infrastructure completion, then anticipated in 2017. Sky Ranch’s first phase was expected to begin in the second half of calendar 2017, subject to approvals and final design. Management estimated full Sky Ranch development could generate more than $145 million in tap fees and about $7.5 million of annual service-fee revenue, based on current fees and charges.
- Concentration and execution risks: The business depends on a small customer base, housing and development activity, water availability, regulatory approvals, construction execution and access to capital. A single customer, Ridgeview Youth Services Center, accounted for 55% of FY2016 water revenue. Fracking-related sales have been highly volatile.
- Contract and regulatory exposure: Lowry Range rates are constrained by comparisons with nearby providers, while construction and operating costs may rise faster. Surface-water decrees require a water-court diligence finding, with the next review due in February 2018. Environmental compliance, water contamination, drought, political decisions and possible disputes over the long-term Lowry Range lease are also risks.
- Contingencies and unusual items: The company disclosed $677,500 of contingent CAA obligations off balance sheet, payable only upon Export Water sales; recorded participating-interest liability was $344,000. Approximately 42% of total assets consisted of proceeds invested in securities, creating a disclosed risk that the company could be viewed as an investment company under federal law. Related-party loans to the District and Sky Ranch District totaled about $800,400, including accrued interest.
- Capital return and controls: The company has never paid common dividends and expects to retain capital for development. The auditor issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Whether customer demand, especially residential development and non-fracking water sales, can grow enough to support operating costs and planned capital spending.
- Whether the WISE schedule, projected cost obligations and expected water availability remain on track.
- Whether Sky Ranch obtains approvals and financing and proceeds on management’s expected timetable.
- The liquidity, maturity profile and regulatory implications of the company’s securities portfolio, including the disclosed investment-company risk.
- The collectability and repayment terms of related-party receivables, and the timing and amount of CAA payments if Export Water is sold.
- How management reconciles its stated estimated service capacity of approximately 60,000 SFEs with another filing estimate of approximately 57,800 SFEs.