Pure Cycle Corporation — Form 10-Q Summary
Reporting period: First fiscal quarter, three months ended November 30, 2012. The interim financial statements are unaudited. Pure Cycle provides wholesale water and wastewater services and manages agricultural land and water leases.
Financial performance and position
| Metric | Quarter ended Nov. 30, 2012 | Prior-year quarter |
|---|---|---|
| Revenue | $438,419 | $67,559 |
| Gross margin | $366,925 | $20,381 |
| Operating loss | $(526,606) | $(632,592) |
| Net loss | $(1,333,590), or $(0.06) per share | $(1,361,735), or $(0.06) per share |
| Cash used in operating activities | $(326,887) | $(432,574) |
| Cash and cash equivalents at period-end | $4,424,306 | $772,449 |
- Revenue increased principally because the company began recognizing farm lease income after taking over farm operations in August 2012. Farm operations generated $362,663 of quarterly revenue and $343,650 of gross profit.
- Water deliveries rose 16% to 8.7 million gallons; water revenue increased 12% to $46,618. Management attributed the increase to sales supporting oil and gas drilling and hydraulic fracturing. Water-delivery gross margin declined to 44% from 54%, reflecting higher costs associated with the ECCV system and increased demand.
- Wastewater revenue decreased 10% to $10,758, primarily due to lower demand from the company’s sole wastewater customer. General and administrative expense increased 40% to $838,064, including higher property taxes, legal/professional fees, and $110,000 of pledged-share sale costs.
- Cash and marketable securities totaled approximately $5.34 million at quarter-end. Working capital was approximately $5.9 million. Management said available working capital was sufficient to fund operations for the next fiscal year; an effective shelf registration allowed potential additional stock sales of up to $4.45 million.
- Total assets were $110.9 million and total liabilities were $82.1 million. Promissory notes payable totaled approximately $9.13 million, including current and long-term portions. The $69.16 million Tap Participation Fee liability is a major long-term obligation; it is an estimated discounted value, not a scheduled near-term cash payment.
- Investing cash flow was positive $3.60 million, primarily reflecting $3.525 million of proceeds from the foreclosure sale of pledged shares. Financing cash flow was negative $472,050, including approximately $492,000 paid to acquire defaulted HP A&M notes. Cash increased by $2.80 million during the quarter.
Material changes and developments
- Following HP A&M’s defaults on notes secured by company property and water rights, Pure Cycle terminated its farm property-management agreement and assumed farm operations and lease income. It foreclosed on 1.5 million pledged Pure Cycle shares; the September 2012 auction yielded approximately $3.42 million net of fees.
- Pure Cycle had acquired $5.0 million of the defaulted third-party notes by November 30 and bought an additional $816,600 after quarter-end. The underlying notes were reported at approximately $9.1 million, including accrued interest, at quarter-end. The company said it was not legally responsible for the notes but could cure defaults to protect collateral; failure to do so could result in loss of property and water rights.
- The Tap Participation Fee covers 20% of proceeds, or the equivalent, from the next 19,427 water taps. No taps were sold in the quarter, and the company recorded $894,648 of noncash imputed interest expense on this liability. Management reported no material change in the valuation assumptions.
- Farm income was newly reported as a separate operating segment. No significant changes to water rights or water and wastewater service agreements were reported for the quarter.
Outlook, risks, and contingencies
- Management’s stated liquidity outlook was that working capital would support operations for the next fiscal year; the filing does not provide specific revenue or earnings guidance.
- Results and asset valuations depend on uncertain development timing, housing and population growth, future tap fees, water demand, and operating costs. Management warned that actual outcomes could differ materially from assumptions used to value water assets and the Tap Participation Fee.
- Pure Cycle and the Rangeview Metropolitan District are litigating against the Colorado Land Board over alleged breaches affecting exclusive water-service rights at the Lowry Range. HP A&M separately sued Pure Cycle, alleging breaches related to the Arkansas River Agreement; Pure Cycle said it considered the allegations without merit. The company recorded no litigation accrual because losses were not deemed reasonably estimable or reasonably likely.
- One governmental customer accounted for 64% of total quarterly revenue, and the company identified concentration in the wholesale water and wastewater business. The filing also notes risks from customer demand, development delays, weather, regulation, litigation outcomes, and access to capital.
- The company may pursue remedies against HP A&M, including a reduction of the Tap Participation Fee and recovery of damages, but it could not estimate any potential reduction. The Tap Participation Fee may be accelerated in certain transactions or insolvency events.
- Disclosure controls were assessed as effective at quarter-end; the company reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Collection and recoverability of the HP A&M receivable, and the company’s exposure to remaining defaulted notes and collateral foreclosure risk.
- Any progress or settlement in the Land Board and HP A&M litigation, and whether Pure Cycle obtains a Tap Participation Fee reduction or damages.
- Assumptions behind the $69.16 million Tap Participation Fee estimate, including projected development, tap prices, and the 5.3% implied discount rate.
- Whether oil-and-gas-related water demand continues and whether the resulting water-service margins cover the higher system costs.
- Farm lease collections, property-tax and canal-assessment costs, and completion and proceeds of contracted sales of land and water shares held for sale.