Pure Cycle Corp (PCYO) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fiscal Year-end August 31 Year-End Conference Call. My name is Audria and I will be your coordinator for today. At this time all participants are in a listen-only mode, we will be facilitating a question and answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS)

I would now like to turn the presentation to your host for today, Mr. Mark Harding, President and CEO. Please proceed, sir.

Thank you. I would like to welcome you all to our year-end earnings call. As we have done with all of our calls, we have access to some PowerPoint slides that you can get to. You will have to advance those slides yourself on your computers. So, I will try and note the transitions as we move through the presentation, and what I would like to do is present a brief overview of the year-end and follow it up by some financial highlights. And then, what we will do is open it up to some questions and answers.

As we start, one of the first things that we always do is talk about our Safe Harbor statement. Most of you are familiar with the Safe Harbor statement, but our statements are purely historical information and results could materially differ from actual presentation.

With that, what I want to do is really highlight some of the significant events. So, if you can advance to our first text slide. And, we will highlight some of the significant events that happened in 2007. Most notably in those recently, the Company completed a $9 million registered offering in July of this year. And, what the Company had done was we sold an additional 1.2 million shares into the market for $7.75 a share.

Those shares were sold pursuant to a $15 million registration statement that we filed in July as well. In addition to the Company shares, we also sold about 2.4 million shares of selling stockholder shares. These shares were primarily held by some early stage financial partners of the Company dating back to the early 1990's and this is really the last remaining component of that sort of early stage financing partners exit. We've orderly placed those shares into the markets with the registered offering as well.

One of the key components of this source of use funds in there is the Company was able to repurchase about $10.5 million of the CAA interests. And, as you are familiar with, the Company has this contingent obligation that is payable from proceeds from a portion of the Company's water assets that we have. We repurchased those interests for a cash payment of about $2.6 million. So, of the $9 million in proceeds, $2.6 million went to reacquire those interests.

Directly as a result of that, we reported a gain of about $1 million, of this approximately $765,000 was contributed as a capital gain because certain CAA parties were deemed to be related parties of the Company, either by virtue of their stock ownership interests or their board memberships. As of August 31, 2007, the remaining CAA interest that were held by third parties is about 8.2 million, and as you can recall how that is accounted for in the Company's financial statements, roughly one third of that, or about 2.9 million, is reflected on the balance sheet, with the remaining portion of that [contingent] obligation in the notes.

Subsequent to that, later in the year, the Company reacquired another 4.7 million of the 8.2 million of those CAA interests with the issuance of about another 200,000 shares of restricted stock. And so, that really took down the CAA interest to about $3.5 million. And, that transaction will be reflected in our first quarter 2008, and you will see the reduction of that, not only on the balance sheet, but also in the aggregate account.

Continuing to the next slide, some of the other significant events that occurred in the fiscal year, the Company continues to develop some technology that we hope to approve well yields from our groundwater supply. That is through the development of some proprietary technology that we have in being able to use some oil technology to hydro-frack some of the wells that we have in the Denver Basin Aquifer.

We invest about $40,000 into an entity known as Well Enhancement and Recovery Systems, where the Company is a one third owner. The other two thirds owner are going to be one of the most significant well drilling companies here in the Denver area that helps us in drilling, actually drills the deep water wells that we have, as well as Ryan Clark who is a significant stockholder of the Company, he is a one third owner as well. We have expensed about $35,000, which is our ratable share of the losses of the LLC. And, we are accounting for this under the equity method of accounting.

Another significant event in the year is that we reached an agreement with the objectors in our Paradise Water review case, that is our west slope asset where we have 70,000 acre feet of conditionally decreed Colorado River water, and we worked through the objectors that were in that case to take a look at the diligence and how the Company continues to develop that asset on the west slope. We have filed those stipulations with the water court, and we will await water court ruling on that within the next three to six months on that.

Additionally, I want to update you to activities on the Lowry Range, both in terms of the development, the conservation and the water resource proposals. I have a separate slide on that that we will discuss that in a little bit more detail in the presentation. And, also want to update the area -- the fiscal year for water-- our water year this year, an overview of what happened.

We had a bit more average year, this year in 2007, providing some recovery against several years of drought. And, this resulted in a little lower year-over-year water usages, which I will go over in the financial portion of the presentation to give you an idea of what we are looking at in terms of water deliveries revenues, and what the water outlook is going to be -- what the water outlook was for the previous year.

Continuing on to the next slide, financial summary for 2007, net loss -- let me just summarize some of the highlights area. Net loss for fiscal year 2007 was about $6.9 million. This compares to about $800,000 in 2006. The main attributes to that, there is about $4.7 million of imputed interest and that is associated with the Tap Participation Fee obligation that we have on our balance sheet, relating to the Arkansas asset acquisition. It is a non-cash accrual that we have that we continue imput interest on that. So, you will see that going forward. There will be a recurring imputed interest component to that liability account.

And then, we had two amendments to our 2006 form 10-K, and those were really to clarify some of the accounting methodologies that we had on the Arkansas acquisition. And also, to clarify certain wording on the Company's reporting on internal controls. The other component to that $7 million loss component was about another $366,000 of depreciation towards assets that we have acquired, not only from the High Plains A&M acquisition on the Arkansas, but also assets that the Company has placed in service for water deliveries.

So, of that $6.9 million about $5.4 million of that is the non-cash portion of that. We have about another $0.5 million of increased general one-time overhead associated with the Arkansas River acquisition, whether that was relating to $256,000 of water assessments from the Fort Lyon Canal, and that is going to be a recurring element for the Company as well. We are responsible for the water assessment payments to the Fort Lyon ditch system. And then, about $200,000 legal accounting fees related to the High Plains acquisition, and that is probably a non-recurring element.

Moving to the next slide, let me give you a brief update on the Arkansas acquisition. One of the things that we had looked at doing was divesting ourselves of non-strategic related water assets, and we acquired a number of things pursuant to that acquisition, not only land, not only the acquisitions of the Fort Lyon interest, but also other water interests that were associated with that that are not available for us to transfer to municipal industrial uses, and so what we did was we had a disposition of the lion's share of those, about 509 shares of the lower Arkansas water management association shares.

That resulted in revenues of about $850,000 and pursuant to our agreement with the High Plains A&M, those payables were to High Plains A&M, and then we were able to take a dollar for dollar reduction to the Tap Participation Fee liability that we have on our balance sheet. So, you will see the Tap Participation Fees decrease by 505 taps associated with that transaction. We have a small amount of shares of that system remaining, about 45,000 shares that are available for sale and we will sale those in an orderly disposition basis.

Also, in January 2007, we sold a small amount of acreage which was non-irrigated land acreages to one of the tenant farmers. That was not subject to the Tap Participation Fee. The Company recognized a gain of about $18,000 off of that transaction. And, one of the things that we continue to work towards in this Arkansas asset acquisition is that we continue to work with both regional and statewide interests in the development of these Arkansas systems.

We want to make sure that we continue to provide water for agriculture uses and explore ways that we can take advantage of various revolving systems for transferring agriculture rights to municipal rights, such as rotational fallowing, or alternate crop management or a host of other alternative methods that allow for us to have a continued agricultural presence in the region, as well as freeing up additional water for municipal, industrial and urban uses along the front [range]. So, we continue to work with the local interests, we continue to work with the region-wide interests and statewide interests in developing that project in a combined collective fashion.

If you want to advance to the next slide, what we want to talk about is -- give you an activity update, talk a little about Sky Ranch, talk a little bit about what is happening on the Lowry Range. Focusing specifically on Sky Ranch, we have had no development on Sky Ranch, no change of status throughout the fiscal year. The development continues to occur along the borders of the property, but from the development itself Sky Ranch has really not advanced at all.

We have certain installment purchase contract where we are purchasing a portion of the water beneath the property. We have made two other additional incremental payments to them. We have not received the title or groundwater deeds from those purchases. Technically they are in default of our groundwater purchase agreement. One of the things that they risk losing is, we continue to provide -- have the obligation to provide service to the property and there are various thresholds that we can and can't provide service to that property based on the number of single family equivalents.

So, one of the things that we have become aware of in recently is that the homebuilder that was going to be associated with this project, a group out of Chicago known as Neumann Homes, did file for bankruptcy protection in November. Near as we can tell, this particular property -- because the property interest was held into a particular LLC company, has not been identified as part of that overall home building group's bankruptcy filing.

So, we are working with the developer, not only Neumann, but also the other minority interest developer interest out there, to find out a reconfiguration of the property and settle that property so that it has the opportunity to come back to market on a development plan as they choose to time that into the market interest.

Moving on to the next slide, I want to give you an update into some of the activities out at Lowry. In June of this year, the State Land Board who is our development partner on the Lowry project on the water assets, signed an agreement with a company out of Australia, known as Lend Lease Communities. Lend Lease executed that contract in June for Development Management Services agreement.

They are in the investigatory stage of that project and they will be looking at all of the relative project attributes during this investigatory period. We are working closely with the state, with Lend Lease and with the surrounding communities to make sure that the project has all of the various attributes that it is going to need in order to be able to move forward.

In taking a look at that, I want to sort of break that down into the various components of the overall proposal. For those of you who are new to -- review of the Company, in taking a look at the slide, the textured box covers two square miles, two sections of ground about 1,200 acres that is incorporated into the development RFP and that is the area that is going to be covered under our relationship with the State Land Board on water resources out there.

The additional four sections, which is going to be the salmon colored area directly adjacent to that is an additional four sections that also is included in the development RFP, and we are working with the various parties on water alternatives for those properties as well. The blue colored area is going to be the section of ground that the State Land Board is looking at working with conservation interests in finding conservation proposals on that piece of property.

And then, the water resource area is going to be that in the dashed red area, and those are an opportunity for us to develop water resources and water storage opportunities, not only for our needs and the states needs relative to the property, but also taking a look at some region wide interests out there.

Advancing to the next slide, what we tried to do is give you a flavor for what the price of water tappings have done in the region. This is sort of a five-year view of what those have seen over the recent years. 2006 to 2007 saw another significant jump in water rates, up to $20,000 per tap. So, each individual water tap is at that threshold for our customers. And again, our water taps are based on a market driven principle where we are setting our rates based on three surrounding water providers in the region.

The trend continues to grow in terms of water tap fees. I do believe that the trend will [soften] and I don't think that we are going to see such significant increases going forward. We are going to see a little bit more normalized rates and charges. Typically, our rate based districts rate their -- assess their rates at year-end. We review those at year-end and we take a look at those, make our announcements in March and typically adjust our rates in July of each year.

Let me move to the next slide and talk about some of the issues for the local housing market. One of the things we do is track housing markets and provide comparative matrix on the local housing related issues. The Denver housing -- Colorado housing market continues to contract similar to the national trend. Foreclosures are still a relevant fact here in the local market. The highest percentage of foreclosures is still in the entry level market. Colorado is ranked, I think our matrix here said, eighth, and we are somewhere in the 12th in the country for foreclosures. That is probably down from where we were leading the nation in terms of foreclosures.

There is really some debate about how the statistic is tracked because of the inaccuracies in terms of how Colorado reports those foreclosures. But notwithstanding, foreclosures still are a significant component of the local and national housing picture here. One of the statistics that we continue to try and track is to understand where rental vacancy rates go, and as September 2007 in a year-over-year comparison, the metro area -- the Denver metro area, rental housing vacancies are down to 5.3% compared to 6.7% in the same period in 2006. And then, even more specific into our target sub areas, Arapahoe County vacancy rates are around 5%. So, we've got a very full rental market segment here.

Moving on to the next slide, one of the things that we try and also take a good inventory of is housing starts. So we have three data sets for you here that will give you both a front range assessment on how the region looks like on the 11 county front range, year-to-date about 17,000 starts, compared to around 24,500 year-over-year.

Denver metro housing starts are about 11,000, compared to 15,700 so about a 30% increase, across the board both in terms of the front range, the Denver and also the local housing starts in Arapahoe County. So, we are soft. I think it tracks comparatively to national trends. Denver seems to be -- it is more of a sustainable market but we are still not immune from the market forces in housing in the aggregate picture.

Moving on to a general picture of the overall economy. We show a very good economy in Colorado, in the Denver market in particular. Take a look at very strong growth in jobs and very low unemployment rates. Colorado added over 40,000 jobs in September over September 2006 to 2007. The Denver metro area added around 23,000 of those jobs. Unemployment in the region, Denver's unemployment is a very low 3.8%, Colorado even lower yet at 3.7% compared to national average around 4.7%.

Some of the continuing statistics, the forecast and leading indicators for the Southwest region continue to be one of those areas of focus for continued growth through 2020. Colorado's inflation adjusted growth rate continues to be among the top in the nation, eighth in the nation. So, it is kind of an overview of where the key projects are and some of the matrices that we follow for you year-over-year and tracking housing starts and overall economy starts.

Let me talk a little bit about the Company's financial results for 2007. Moving into the first slide of the financial results, as I mentioned, we have seasonally adjusted water deliveries which were a more average year water cycle. So, we see water deliveries down about 22%, 44 million gallons versus 56 million gallons. That resulted in lower water usage fees, decreases of about 9%.

The decrease differential between water deliveries and usage fees is really going to be a measure of a blocked tiered pricing structure, so it kind of depends on when those water deliveries occur. What you will see is that you might get a decrease in water deliveries but some of those water deliveries on the decrease may not be at the right time of year where it may be a seasonally hot month in a particular summer irrigation season which bumps those block water deliveries up and generates a revenue stream which may be out of sync. It generally tries to track, but it is slightly out of sync with what water deliveries are.

Then you look at total revenues. Total revenues are down just slightly, about 2%, and that is probably related to non-water related revenues. So, there are some small non-recurring revenues that sort of adjusted out some of the decrease in water delivery revenues.

Then the following slide really takes a look at the Company's G&A expenses through 2006. And, those were up significantly. We are about $1 million more than previous year, about $2.4 million, compared to about $1.55 million in previous year. And, those are -- that $1 million is really made up of three or four different components. One is going to be the continuing charges, the $250,000 in water assessments from the Fort Lyon Canal.

One of those is going to be in some Delaware franchise fees. We have increased franchise fees from the state of Delaware; the non-recurring professional service fees; about $200,000 in legal and accounting fees associated with [our] Arkansas acquisition; and salaries and overhead are about $300,000. So, all three of those collectively really accounted for that $1 million differential. Going forward, we are forecasting approximately about $1.5 million a year in salaries and overhead and G&A expenses.

Continuing on to the next slide, taking a look at the net loss that we talked about a little bit earlier. We have about $7 million net loss, that is $6 million increase over 2006. $5 million of that is going to be non-cash relating to the imputed interest on the Tap Fees payable to High Plains A&M, as well as depreciation charges associated with those assets, and then the $1 million G&A as explained in the previous slide.

So, that really gives you the picture on where the net loss is. It looks like a horrible number year-over-year comparison statistic, but a good portion of that statistic is going to be that non-cash accrual on interest expense. Continuing on to current assets, current assets are up predominantly because of the registered offering. We have cash and cash equivalents of about $7.3 million, and that compares to 2006 of about $3.2 million.

Moving on to investments in water and water systems, those are going to be in line, slight decrease mostly due to depreciation. We have an offset against the additional asset allocations from the offering against some of the depreciation expenses. And then, total assets are in line as well, increase mainly due to the Arkansas acquisition and then added additions from the registered offering. Final slide talking about total equity, total equity again is going to be slightly up and it is sort of an offset between the offering and the net loss from the results of financial operations.

So with that, what I would like to do is kind of open up the floor to any questions that you might have and be able to answer any of those. So, if you have any questions, please dial in and I'd love to hear any questions you might have.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Robert Kirkpatrick with Cardinal Capital. Please proceed.

Good afternoon, Mark. I understand that this company has a very important asset that which has been increasing in value, but I would like to know what you are doing to reduce the burn rate of the Company and to increase the revenue and cash flow for the enterprise so that we don't have to worry about a detraction from the value from the ongoing G&A and overhead expenses.

You bet. You know the actual cash burn to the Company is relatively low. We try and operate on a very efficient platform here. Our standard G&A overhead is roughly going to be about $1.5 million a year. And that is up slightly. Some of that cost is going to be up relative to the holding costs of the assets that we own and that is really attributable to the Fort Lyon assessment of about 250 -- somewhere between $250,000 and $280,000 a year. We had a little bit more in that G&A last year, just eating through the acquisition costs. So, you had some transactional costs associated with that that are non-recurring.

We have a pretty efficient team, not only from the management side, but also in terms of the legal representation and accounting representation. So, I do foresee that we will be able to hold into that $1.5 million level. On the earnings side, on the revenue side, you are right. We have a great asset. We have been able to by third-party matrix really define for you what water is doing here in the state and that is sort of attributable in these Tap Fee Rates, and that is as close as we can give the market a comparison to what water situation here is.

And, one of the things we are doing is really working with the local areas. We have a franchise service area that is with the State Land Board, and in part, we were working with the State Land Board on what the opportunities were going to be out there, but it was their asset. The land is controlled by them and they move forward based on what they see is their best vision for the property.

And, we were delighted to have the entrance of Lend Lease into the equation. We are working to get with Lend Lease. They are very early in their stage on development and understanding of the property. And so, we are coordinating our activities with them and really working within their timeline. They are really driving how and when that project is going to move forward and we are responding to any issues that they identify on the utilities side.

On the export water, where those activities don't necessarily relate to the Lowry Range, we are really responsive to the market in trying to make sure that we are an attractive supply solution for developers, property owners and other municipalities in the region.

And, what we try to do is develop our services so that we can provide incremental service so that the developers aren't burdened with the obligation of having inventory high costs on the -- initiating water service so that how they incrementally can develop their property attractive for them. And, particularly when you get into weaker or softer markets, those are going to be very important statistics for them because as they lower down their up front development costs, that is going to be more attractive for them to be able to continue or start their project.

We are also looking at working with area water providers and see if we can't provide solutions for those area water providers that may need supplemental service or additional help with their systems, whether that is to bring additional water supplies to areas that may be not of a critical size to be able to handle those types of investments. There is a high barrier to entry in this business because it is so costly to get these water systems up and operating, whether is it costly to buy the water rights, develop those supplies and bring them to their local areas.

So, there is a fractionated market here where we have 50 plus different water providers, and most of them are small water providers. We are working with a number of those water providers to find solutions for them and being able to bring additional supplies, or replacement supplies, to their community. So we are really multi-faceted, trying to attack a number of different areas, both areas that we have service relationships to, that we have development interests on, areas that are either in close proximity or in logical extension of services areas and then areas where we can extend services to existing providers that need supplemental service.

So, a lot of that is really the focus of our efforts. We have had some successes in those areas and some delays in those areas, particularly with some of the conditions in the market. So, I think that the Company is trying to be fiduciary with its investment capital by keeping its overhead low and making sure that we are doing responsible transactions with the market. But that is a good question.

To follow on to that, are there transactions that have occurred in Colorado, in the water market, year-to-date that you could point to and educate the shareholder base about?

That is one of the frustrations that we have about the state and in the aggregate. There really have not been any substantial water supplies brought online. There are a couple of projects that some other area water providers have really invested into to bring and bolster up their systems, but a lot of those are to either back up their supplies or firm up their supplies. And, there is this concept of firming their supplies.

One of our rate based districts, East Cherry Creek Valley who we peg some of our rates and charges on, did bring on a system in 2006, I think that was a system that was somewhere in the order of magnitude of around $100 million and it was really acquiring additional surface water interests, bringing a pipeline up from maybe 30 miles north of town out into their particular service area, and dealing with about somewhere in the range of 3,500 acre feet of water with the opportunity to expand some of that water supply.

They had some capacity in that line that they can expand that system. The neighboring water provider who is one of the larger water providers in the state, the city of Aurora, has also just started a very large water project which is able to capture some of their reusable water from waste water return flows. So, they are taking and bringing back consumptive use water, water that they have the right to reuse, bringing that back into their city and using that on a basis where they can blend that with their other water supplies to increase the supplies for them.

That is a very big project as well. It is about a $700 million project. They have started construction on that. We are working closely with them to be able to see if there are opportunities for regional assets for water storage or other mechanisms that we might be able to participate some of our assets with them and really look at a more broader context to water development in the region.

So, those are a couple of examples that are water providers that are -- existing, established water providers that are bringing projects online.

Okay. And then finally, as I understand it, the water districts that you price your annual increase and surcharges off of, increased their rates on January 1 of each calendar year. Correct?

That is typically what they do.

So, given that there are now five or six weeks until those rates go into effect, there must be some discussions or some preliminary indications as to what the percentage increase in the three districts is going to be. Can you share with us what those public bodies have talked about with their rate payers?

Yes. They have -- how they seem to look at those is, they price the real value of the new water supplies into their tap fees, and that is what we tend to need to track. I would not be surprised -- some of the leading indicators are that it is going to be in the 8% to 10% range for utilities district. Some of them might be a little bit more, some might be a little bit less.

Great. Thank you so much, Mark. I appreciate your continued work.

You bet. Thank you.

(OPERATOR INSTRUCTIONS)

One of the other things I want to bring up is that I will be in the New York area in December -- December 6, presenting at the NYSSA Water Conference. So, if you have a question that you wanted to raise or as you reflect on and review this call, please feel free to give me a call. I'll be in touch with some of you, and many of you, about an opportunity to visit you that are in New York. And then, otherwise always feel free to give me a call and discuss whatever questions you have about the Company and our assets and the direction that we are taking.

So, with that, if there are no other questions, I would like to thank you again for your participation and look forward to another productive year.

Ladies and gentlemen, this concludes today's presentation. You many now disconnect. Everyone have a great day.