Pure Cycle Corp. 10-Q Summary: Period Ended May 31, 2011
Business Context and Reporting Period
Pure Cycle Corporation is a Colorado-based entity providing wholesale water and wastewater services to local governmental entities in the Denver metropolitan area. The company operates water systems, manages water rights, and develops land assets. This filing covers the quarterly period ended May 31, 2011, and the nine-month period ended on the same date. The company is classified as a smaller reporting company.
Key Financial Metrics
| Metric | Three Months Ended May 31, 2011 | Nine Months Ended May 31, 2011 |
|---|---|---|
| Total Revenues | $63,638 | $188,579 |
| Net Loss | $(1,362,839) | $(4,604,610) |
| Net Loss Per Share (Basic/Diluted) | $(0.06) | $(0.20) |
| Cash and Cash Equivalents | $541,697 | $541,697 (Balance Sheet) |
| Marketable Securities | $4,583,176 | $4,583,176 (Balance Sheet) |
| Total Assets | $116,616,451 | $116,616,451 (Balance Sheet) |
| Total Liabilities | $67,942,148 | $67,942,148 (Balance Sheet) |
| Working Capital | ~$4.84 million | ~$4.84 million |
Debt and Liquidity: The company holds significant long-term liabilities, primarily the "Tap Participation Fee" payable to High Plains A&M, LLC, valued at approximately $64.0 million. Current liabilities totaled $633,108. The company raised capital through a $5.2 million convertible note (converted to equity in January 2011) and a $5.5 million common stock offering.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 10% for the three months and 12% for the nine months compared to the prior year periods. This was driven by a 14% and 28% increase in water deliveries, respectively, due to lower precipitation and increased irrigation demand, alongside rate increases effective July 2010.
- Operating Expenses: General and administrative (G&A) expenses increased 24% (three months) and 26% (nine months). Increases were attributed to $180,000 in employee bonuses related to the Sky Ranch acquisition, higher professional fees, and accrued property taxes on new assets.
- Net Loss: Net loss increased slightly by 2% for the quarter and 12% for the nine months. The increase in the nine-month period was largely due to higher G&A expenses and interest expense on a convertible note prior to its conversion.
- Asset Acquisition: The company completed the acquisition of the Sky Ranch property (940 acres and water rights) for approximately $7.0 million, funded by the equity offering and convertible note.
- New Revenue Stream: The company entered an Oil and Gas Lease with Anadarko in March 2011, receiving a $1.24 million bonus payment (recognized ratably over three years), contributing $95,637 to other income for the period.
Guidance, Outlook, and Risks
- Liquidity Outlook: Management believes current working capital (~$4.8 million) and cash equivalents are sufficient to fund operations for the next fiscal year. An effective shelf registration statement allows for the sale of up to an additional $4.45 million in common stock.
- Tap Participation Fee: A significant contingent liability exists where the company must pay 10% of gross proceeds from the sale of the next 40,000 water taps to HP A&M. As of May 31, 2011, 38,937 taps remain subject to this fee. No taps were sold in the current period.
- Impairment Risks: The company monitors water assets for impairment. While no impairment was recorded, the valuation relies on estimates of future home development and tap fees in the Denver area. A significant downturn in the housing market could impact the recoverability of water asset costs.
- Regulatory Risks: The Paradise Water Supply is subject to a "reasonable diligence" review by the water court every six years. Failure to meet diligence requirements could result in the loss of these water rights.
- Related Party Obligations: HP A&M holds promissory notes totaling ~$10.6 million secured by properties acquired by Pure Cycle. While Pure Cycle is not responsible for payments, a default by HP A&M could result in the loss of the underlying properties and water rights.
Investor Verification Checklist
- Tap Participation Fee Valuation: Verify the assumptions used to value the $64 million liability, specifically the projected housing development rates and future tap fee increases in the Denver metro area.
- Sky Ranch Development: Assess the timeline and capital requirements for developing the newly acquired Sky Ranch property to generate revenue from water taps or land sales.
- Oil and Gas Lease Terms: Review the terms of the Anadarko lease, including the royalty rate (20% of gross proceeds) and the potential for additional bonus payments upon lease extension.
- HP A&M Solvency: Monitor the financial status of HP A&M regarding the $10.6 million in promissory notes secured by Pure Cycle's properties to assess the risk of foreclosure.
- Paradise Water Rights: Confirm the status of the "reasonable diligence" requirements for the Paradise Water Supply to ensure no risk of asset impairment or loss.