PCYO

Pure Cycle Corp. 10-Q Summary (Period Ended May 31, 2009)

Business Context and Reporting Period

Pure Cycle Corporation is a water utility company providing water and wastewater services in the Denver metropolitan area, primarily through its "Rangeview Water Supply" and Arkansas River assets. This report covers the quarterly period ended May 31, 2009, and the nine-month period ended May 31, 2009. The company operates in a capital-intensive environment dependent on new residential development to sell water taps and generate revenue.

Key Financial Metrics

Key Liability Note: The balance sheet includes a significant "Tap Participation Fee payable to HP A&M" of approximately $56.7 million (net of discount), representing a contingent obligation to pay 10% of future water tap fees.

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased 7.5% for the three months and 7.0% for the nine months compared to the prior year periods. This was primarily driven by a 24% and 25% decrease in water deliveries, respectively, due to above-average precipitation in Colorado reducing customer demand.
• Net Loss Reduction: Despite lower revenues, the net loss decreased by 23% for the quarter and 16% for the nine months. This improvement was driven by a 23% reduction in General and Administrative (G&A) expenses and a gain on the sale of non-irrigated land ($22,172 for the quarter; $59,671 for the nine months).
• Cash Position: Cash and cash equivalents dropped significantly from $5.24 million at August 31, 2008, to $946,881 at May 31, 2009. This decrease was largely due to the purchase of $3.0 million in marketable securities (certificates of deposit) and net cash used in operating activities of $1.25 million.
• Imputed Interest: Imputed interest expense on the Tap Participation Fee decreased to $858,000 for the quarter and $2.86 million for the nine months, compared to $1.11 million and $3.26 million in the prior year periods, following a revaluation of the liability in February 2009.

Guidance, Outlook, and Risks

Management Commentary: Management believes current working capital and cash equivalents are sufficient to fund operations for the next year. However, long-term viability depends on the development of the Lowry Range and other Front Range areas to sell water taps. The company is actively seeking to change the use of its Arkansas River water rights from agricultural to municipal, a process that could take years and cost over $500 million.

Risks and Contingencies:

• Development Delays: The developer of the Lowry Range terminated its agreement with the Land Board in January 2009, creating uncertainty regarding future water sales in that area.
• Legal Disputes: While the Colorado Supreme Court recently upheld Pure Cycle's rights to certain reservoir sites against the City of Aurora, further legal action may be required to enforce these rights.
• Asset Impairment: The company must continue to demonstrate "reasonable diligence" to maintain its Paradise Water Supply rights; failure to do so could result in asset impairment.
• Tap Participation Fee: The company remains obligated to pay HP A&M 10% of gross proceeds from the sale of the next 40,000 water taps (38,937 remaining). Actual development and tap fees may vary significantly from estimates used to value this liability.

Investor Verification Checklist

• Cash Burn Rate: Verify the sustainability of the $1.25 million cash burn from operations over the next 12 months given the reduced cash balance of under $1 million.
• Lowry Range Status: Confirm if the Land Board has identified a new developer for the Lowry Range to replace the terminated agreement.
• Arkansas River Transfer: Assess the timeline and capital requirements for the "change of use" application to convert agricultural water rights to municipal use.
• Tap Participation Fee Valuation: Review the assumptions used in the discounted cash flow analysis for the $56.7 million liability, specifically regarding future housing growth and tap fee pricing.
• Related Party Notes: Monitor the status of the $12.4 million in promissory notes held by HP A&M on acquired properties, as a default could jeopardize the underlying assets.