Pure Cycle Corp (PCYO) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter Pure Cycle financial results conference call. At this time all participants are in a listen-only mode. We will facilitate a question-and-answer session at the end of the conference. (OPERATOR INSTRUCTIONS). I would now like to turn your presentation over to your host, Mr. Mark Harding, President. Please proceed.

Thank you. I would like to welcome you all to our third-quarter earnings call for the period ended May 31st, 2008. As always, we have a brief presentation for you that you can access through our website, and I will try and note transition of the slide so that you can click through the slide presentation as I go through and highlight some key areas.

What we'd like to do is overview the financial results, and we'll start out with a brief synopsis of some of the progress that the Company has made the day and then really give you a picture of what the financial performances were for the nine months ended May 31st, 2008.

The first slide is our Safe Harbor statement. As you are all aware, certain statements made in this presentation are, other than purely historical information, include projections, forecasts and estimates and forward-looking statements.

If you want to move to the first slide, the summary of the significant events in this quarter's results are -- we will highlight this a little bit more, but in early March of 2008, we filed an 8-K statement that reflected a water court filing that was made by Lend Lease. Subsequent to that filing, in April of this year, the Colorado Water Court upheld their November ruling, which effectively required the applicant of a water right, our neighboring City of Aurora, to remove certain reservoir sites that they had applied for which were overlapping sites that the State Land Board had identified in our lease agreement between Rangeview and Pure Cycle. So that was a judicial confirmation of a ruling that was also held in November of last year.

We also had, this quarter, another test and data set point for our Well Enhancement and Recovery System, which is a tool that the Company has developed, together with a proprietary process for enhancing production of groundwater wells here. I'll highlight that a little bit more on the presentation as well.

We also saw the market increase in our cap fees, increasing about another 8% to $21,500. If you transition to the next slide, some of the significant events for the nine-month period, as we reported earlier in our first-quarter results, we had repurchased some additional CAA interest. We acquired about another $5 million of CAA interest in October of 2007 for approximately 200,000 shares of restricted common stock. Just due to the accounting rules of that, that resulted in a net loss of approximately $273,000. As of the end of -- actually, this should be May 31st, 2008, we have CAA interest held by third parties of about $3.5 million.

If you move to the next slide, another thing that the Company does is, we continue to evaluate the tap participation fee payable, which is the royalty interest to the High Plains A&M who we've purchased the Arkansas asset from. And as a result of that evaluation, the tap participation fee, what we do is do a market assessment of how the taps in the region are performing and the Company's best estimate for forecast of tap takedown agreements with some comparative analysis of master planned communities around the area to give us an idea of what that estimated future payments would look like.

So that resulted in an increase from $104 million to about $108 million. Due to the increase in the effective interest method and imputed interest expense from a -- it actually decreased a bit from $183,000 to $1.1 million for the three months ended November 30th, and then it decreased as of the fiscal year end.

The events of the next slide -- let's talk a little bit about the 8-K filing and the Water Court rulings. In March we issued an 8-K which really highlighted an application, an amicus brief application that was filed by Lend Lease in the City of Aurora's Water Court case. Lend Lease sought to support the City of Aurora's filing for reconsideration to have the Water Court allow the City of Aurora to include certain reservoir sites. We have three reservoir sites on the Lowry Range property that are part of our water portfolio and water development plan for water resources to the Lowry Range and the city had filed overlapping Water Court case over those three reservoir sites.

That filing was done in 2003, and what the city was looking to do was try and find potential storage sites for that. We have been working with the city over the last five years to discuss potential access to those sites, together with the State Land Board, and had not reached a conclusive agreement for those. The trial was set to come up before the Water Court in December of last year, so the Water Court ruled that without permission to include those sites, that the city would have to remove those sites. Lend Lease filed a brief that was seeking to support Aurora's being able to keep those sites in their Water Court application.

While not an issue in the Water Court case, Lend Lease made some additional statements regarding that they may not have to obtain water and wastewater service from us on the two sections that are governed under the lease. If you remember how this development parcel is structured, two sections are covered under our lease, four sections are not.

In April of this year the Water Court denied Lend Lease's motion in that amicus brief, and they also upheld their 2007 order that granted -- or that required Aurora to remove those sites.

So in May of this year, the Water Court issued a final decree which was drafted for the City of Aurora which finalized the fact that those reservoirs were not a part of the City of Aurora's case.

Aurora has filed an appellant decision in that, and all of the appellant cases go directly to the Supreme Court. So that will continue to work its way through the process, ultimately through the Supreme Court, probably sometime later this year/next year time frame.

On the broader issue, Pure Cycle continues to meet with Lend Lease, the State Land Board and the City of Aurora to discuss water and wastewater issues and services out at the Lowry Range. It's a complex discussion where you have a number of interests and a number of issues, including reservoir and service to all six sections out there. We will keep you apprised as to those discussions and how those are maturing, as those continue to avail themselves.

If you advance to the next slide, we'll talk a little bit about area tap fees. They continue to increase, although a little bit more moderately than in previous years. If you take a look at our three rate-based districts, East Cherry Creek Valley, Parker and the town of Castle Rock, each of those averages result in about $21,700 to the Company, increased our water tap fees effective July 1st to $21,500.

If you advance to the next slide, this will give you a market comparison of some of the other area water providers and what their tap fees are. Traditionally, these water providers take a look and assess their tap fees at the end of the year, modify those in the January time frame, and then the Company has about a six-month lag time before we take a look at what their rates and charges are. We notify our customers, and then our rates are effective on July 1st.

Advancing to the next slide, from a historical perspective of the rates over the last six years, as you can see, we have had a very significant increase in tap fees over that period of time. The Company expects that there will be more moderate growth in the tap fees. They had a significant increase, double-digit increases for three consecutive years. So I think we are expecting a lot, slightly more moderate growth, probably in line with historic averages, in the 7% to 9% range.

If you advance to the next slide, it will give you a little bit of an overview of the market activities. As you are aware of, we have a service agreement with Sky Ranch. Sky Ranch is still working its way through bankruptcy petition of Neumann Homes. The property is likely to have repositioned to a new owner later this year. We haven't had any update as to those bankruptcy provisions other than the fact that it continues to work its way through. This is sort of an identification of those two sections. As we made you aware of, the section that the Company has with its agreement with the state of Colorado and the State Land Board are two sections of the 3900 acres that includes the development parcel. This also highlights the conservation area and the water resource area and the three reservoirs that are in the water resource area -- I'm sorry. There's the two reservoirs that are in the water resource area and the one reservoir that's in the conservation area. We're the reservoirs that were at issue in the overlapping filing with the City of Aurora.

As I mentioned earlier, the Company continues its discussions with the multiple parties on those -- on water and wastewater service to the Lowry Range.

Let me talk a little bit about the market conditions. The market housing conditions here in Colorado remain weak. Colorado housing is soft, similar to the national trend, as evidenced by housing starts. If you take a look at housing starts at March 31st, 2008, for the rolling 12-month average on the 11-county front range, housing starts are off about 28%, a decrease of about 28% over 2007 starts.

And then, if you compare the 11-county to the eight-county Denver Metro area, again, those are soft by about another 28%, about 9300 starts compared to the previous year of 13,000.

Then we drill down a little bit further into our submarket of Arapahoe County, and again that shows about a third softer than the previous year, about 36% softer. The trend in housing starts are indicative of builders only starting new homes to meet demand. So they don't really start houses until they get a transaction for those, which means most of the inventory is gone. These are just-in-time housing starts where you actually have a customer, a purchase contract for those particular houses.

If you move to the next slide, foreclosures are still a significant impact in the market. However, we are showing signs of improvement. The Fannin County Denver Metro area foreclosures decreased -- or increased about 15% for the first six months of 2008 compared to 2007. This is a drop of about 25% increase from the first six months of '07 over '06, so we are showing a bit more stability coming into the market. Overall, composite of Denver, or Colorado vacancy rates for rental properties, actually increased to 6.1% in March 31st, 2008, up from about 5.7% of September in 2007. This is principally due to more product hitting the market. Because the housing starts are really tight in its market, what you see is a very high percentage of people into the rental market, and there have been a lot of new apartment complexes come in and hit the market to absorb some of that demand capacity.

Advancing to the next slide, talking a little bit more about the job growth, the Colorado job market is still very attractive. From May '07 to May '08, wage and salary employment increased by 34,000 jobs, which is about a 1.5% increase, is still a positive growth. Seasonally adjusted unemployment rate in Colorado rose slightly to 4.9%, which still is lower than the 5.5% national average.

Before we move onto the financial results, I'd like to talk a little bit more about our well enhancement technology and the development of additional wells and how this technology has the potential for helping Denver area water providers in their groundwater development.

Over the past two years, the Company has been developing a tool, which is a packer tool, it's a specially designed packer tool together with the technology to be able to improve the productivity and operation of groundwater wells. These groundwater wells are very deep wells, very extensive wells costing in the range of $500,000 to $700,000 per well.

What they do is they are able to drill down 1800 to 2000 feet and develop these aquifers which are producing water for growth in the Denver area. The Company has a significant amount of its portfolio in the Denver Basin, which has some of these aquifers as part of its portfolio. What we sought to do was to be able to find ways to improve the productivity of these wells, so that not only do you enhance the availability of water from this particular source, but you also provide a cost enhancement to development of these wells.

The initial use of the tool and the technology was in February of this year, and it had very positive results to the well that we had done that with. We had worked with a neighboring water provider in the Denver area. They were very satisfied, delighted with the results of that well and agreed to use the tool for a second time. That second use of the tool was in late June, so we're just seeing some of the results of the well. We're still in the process of completing that well for the municipality on that, but the results and the data show very, very promising results.

So, as we get more information about that, we will continue to update you with that. But it's a tremendous opportunity for the Company and, I think, for the market as a whole to be able to increase the productivity of water in a water-short region.

So with that, what we'd like to do is move to some financial results, specific financial results for the nine months ended. The first metric we'll show is the water deliveries for the period ending. We had about 20.5 million gallons of water delivered, so that's in line with the comparable period in 2007. Revenues are slightly up, due to an increase in water usage fees and also just due to timing of customer usage. We have an increasing block scale, so it's very sensitive to the timing of how much water is used in any given month. You've got a particular dry month where you have high water usage. Then, you have slightly different and increasing fees with that increasing block scale.

Moving to the results of total revenue for the nine months ended, again, that shows a slight increase and [same attributation] because of water usage fees and timing of customer usage.

Moving forward to the NOL, the NOLs this year are in line with last year's NOLs. Increase in G&A expenses are a little note in the next slide, but the net loss includes a significant number of non-cash items, approximately $3.3 million and $3.5 million in comparable years for imputed interest on the tap participation fee, the CAA loss of about $275,000 and then non-cash depreciation of approximately $286 million and $274 million for comparable periods.

Moving onto G&A expenses, slightly higher G&A expense of $1.8 million versus $1.6 million in 2007. Those are mainly attributable to some increased fees due to negotiations on the Lowry Range project, and then the FAS 123-R G&A figures for stock-based compensation expense, which is also a non-cash compensation expense.

Moving forward into current assets, current assets of around $5.9 million compared to 2007, where we had about $7.3 million. The Company continues to maintain a negative cash burn rate of about $1.1 million a year, so we have a very secure cash position relative to the annual overhead operations of the Company. So you look at our investments in water and wastewater systems, maintained the net asset of $103 million period ending 2008 is comparable to 2007. Total assets of around $110 million. That, again, is in line with prior year, and then total equity of around $54 million compared to $57 million. The decrease in equity in 2008 was mainly due to net losses and an increase in fiscal 2007 mainly due to an equity offering from the stock options and exercised offset by net loss.

So those are kind of the summary of the general characteristics of the quarter, general characteristics of the Company's position over the nine months ended, and then just some of the financial matrices that we track for you. Again, the key dynamics are that we continue to work with the bankruptcy provision in the Sky Ranch scenario to identify potential candidates for the development of the Sky Ranch property. We have been contacted by several different entities that are looking at that particular project, so we expect to see that replay sometime later this year.

Then ultimately, the discussions that we have ongoing with the state, with the City of Aurora, with Lend Lease on the Lowry Range, and we will keep you apprised of that.

So with that, what I'd like to do is turn it over for any questions. If you all have any questions, please feel free to chime in and I will do my best to give you solid answers.

(OPERATOR INSTRUCTIONS). Peter Trapp, Bifrost Partners.

I have kind of an oddball question or comment for you. As you are aware, the Democratic Convention is coming to Denver. Well, you may or may not be aware, but it is, and it's fairly soon.

Very difficult not to be aware that.

Okay, and there are a lot of environmental/green focuses that the Democratic Convention that are going to highlight. There was even a person that was written up in the Wall Street Journal, there was a person who is in charge of this whole project of coming up with green projects or green focuses to highlight at the conference. And I'm just wondering if, A, you are aware of it; B, if you have been contacted. If you have, are you doing anything about it? And if so, what are you intending to talk about or do?

You know, we are aware of it. It's a very, very unique opportunity for us to showcase Denver and highlight some of the alternate energy and renewable features that Denver is really pushing and the state of Colorado is pushing. Certainly, Pure Cycle and our activities in water and water development really complement a lot of those renewable, sustainable water features. We live in a water-short region, and as you all are aware, we are very sensitive about water development and how we develop those water supplies.

Some of our key areas of focus have been and continue to be that we have sustainable, renewable and reusable water supplies. By that, what we do is we utilize multiple different sources of water. We use Denver Basin groundwater sources and use those as a drought supply. We use those as a high-quality supplies. We use that as an available supply for incremental development of resources. Then, we implement some of our renewable water features, whether those renewable features include some of the South Platte River rights or some of the Arkansas River rights that we've recently obtained to be able to efficiently develop those supplies.

We've been working with agricultural interests. Your question really spurs another area of focus, is that we've been really actively working with some of those interests in the Arkansas Valley to be able to pursue rotational crop fallowing and being able to bring a new dynamic to how agricultural water transfers to local municipal interests. And ourselves, together with a number of interests in the Arkansas Valley and the Lower Arkansas Valley Water Conservancy District have made great strides on being able to provide new [matrices] for agricultural water use and improving efficiencies for agricultural supplies.

We have 18,000 acres of ground that we irrigate. The Company has a very limited number of actual farms that we're actually operating ourselves with some tenant farmers. What we look to do is try and find better ways of managing those crops. And then ultimately, Peter, I think one of the key elements of our green footprint is our ability to use and reuse water supplies. We look to be able to completely reuse our water supplies to extinction. We treat our water and wastewater locally. We're able to bring those supplies back. We have dual distribution systems where we are able to bring those water supplies in and reuse those supplies.

Now, what are we doing about all of that for the Democratic National Convention? We're not doing any. Those conversations and highlights are really at the state level. The state level is really pursuing some of those policy issues. I am not aware of what the state is pursuing in terms of policy directives at the DNC, but I know that what we seek to do in terms of use and reuse of water supplies are very strategic in terms of what the state policies are as well.

There's probably not a forum for the Company to be able to present on that, but it's certainly something that we continue to emphasize not only from a responsible water provider standpoint, but also because it is a limited resource and it's a resource that we need to continue to protect and use wisely and efficiently.

Well, some of the companies that I know are actually doing demonstrations or having site visits. That's why I asked, because it would be a good opportunity for you. But anyway, moving on, I guess as a neophyte on the legal side I'm kind of puzzled as to why you are not getting the freedom to continue with your project and your ownership of the water. Can you explain to me what their grounds for appeal are and what your general thoughts are in the appellate and in the Supreme Court?

You bet, you bet, and that's an important distinction, Peter. What this entails is a new Water Court application by the City of Aurora. It has nothing to do with our portfolio whatsoever. And so, as cities, municipalities and anybody seeking to appropriate and develop new water supplies, what they do is they file an application for a water right. In this case, the City of Aurora filed for an application for a water right, which would have been a 2003 water right on the Platte system about 40 miles north of Denver.

In addition to filing on that application for water rights, they sought to find a place to store that water. They had identified eight different reservoir sites. So when you're filing on that, a lot of times what's not known is ultimately where you're going to build storage, how you're going to configure your infrastructure, because it takes a tremendous amount of analysis to determine that. So they can put any number of sites, any number of pipeline alignments, any number of diversion points in any Water Court application.

Until they get closer to water, their actual trial date, they want to evaluate and leave as much flexibility in their system as possible. So it's not unusual for overlapping storage sites or overlapping alignments while the application process is being pursued. And then, once you've filed that and you publish that, then everybody that has an objection to those particular processes file their statement of opposition.

Now, in this particular case, we were one of 37 entities that filed statements of opposition in this case. So we weren't the only ones that had a perceived conflict with what they were trying to pursue. And that's not at all atypical, either, in a Water Court application. So over that five-year period, what happens is the applicant typically hones down what is that they are looking to do, how they are looking to do it. And in our particular case, the whole issue centered around these sites are already allocated.

And the city didn't say that they weren't allocated. They did recognize that they were allocated, but what they were saying was, we'd still like to leave them in the application because at some point in the future maybe we're able to find a workable relationship where we can get access to those sites. So our position was, we had five years to do that. We haven't been able to come to that determination, and without that determination then you don't have our permission for those sites. And, the Water Court agreed with that. And that's pretty typical, Peter.

The appeal to the Supreme Court -- there is no appellate court process in Water Court, so it goes directly to the Supreme Court. That's a placeholder, necessarily. If we're able to negotiate an agreement while we are still pending in the appellate process, then they can still maintain their 2003 application and still maintain those sites in that 2003 application. But there's not -- you never know with litigation. It always has the opportunity. But our full downside here is that they keep the sites in and they don't get use of the sites, they just get to keep them in the application. That's our only downside here. They're not going to be able to take the sites, they're not going to be able to use those sites without the Land Board and our permission, it just leaves them in their application. That's the only downside here.

Okay, because I think the market is maybe misunderstanding, then, the situation that in fact you basically have a chance to lose it all.

Yes. That's not really at risk here in terms of the Water Court application. And that's an important distinction and something that we should continue to emphasize.

(OPERATOR INSTRUCTIONS) [Elliott Knight], Knight Advisors.

I have a question about Sky Ranch. I'm not all that familiar with what happens when a property comes out of bankruptcy. In the case of Sky Ranch, is there any reason to think that the next developer will have a cost advantage over competitors in the area; i.e., will the next developer be able to acquire land at below-market prices and therefore be able to offer home sites and build homes at lower prices than somewhere else in the Denver area?

Well, that's a good question. I will give you my general impression, having probably less understanding of that process than you have.

Impossible for that to be less, because I know nothing about it.

What my understanding is here, is that the developer, Neumann had had debt related to the project. So let's just say, my recollection is, they have something like $18 million against the 1000 acres that they have, so it would be $18,000 an acre ground. If somebody were to come in and pay the bank note off, then they would be able to get the property for what the debt was on the land.

Now, this is sort of a subset of the entire Neumann bankruptcy. So it's much cleaner in resolving the issue of the Sky Ranch issue than it necessarily is on the corporate side. But to my understanding, if somebody came in and bid the $18 million, then that would be their basis in the land. If somebody wanted to come in and bid something less than that, where it wasn't the full amount, then it takes the consent of the creditor in that case, and is the creditor willing to take less than what is owed on the land? And I think that's really where this sits is, do they want to sell it for less than the $18 million? Do they have any perception that there's any equity in it, and that there's multiple bidders on it, then they can sell it for more than the $18 million?

So that would be where this Sky Ranch parcel is positioned in it. I honestly don't know what the bank is looking at, if they are looking at any equity in the project or if there's something -- if the property isn't worth what the note is. I honestly don't know either side of that.

Okay, because if the property isn't worth what the note is worth, then the answer to my question is, no, the buyer or the next owner probably wouldn't have an advantage.

Well, that depends, because you may have surrounding properties that people bought and they bought with cash, and they may have bought it for a higher basis than what this property will be selling for, particularly if they bought those properties in the last five years. If they bought those properties in the last five years, then they're going to have a higher basis in the land than this particular one is because, in the true essence of a market sale of that property, if we have a weak real estate market, then that's going to be reflected in raw land prices, and they'd be selling that property for less than what properties had sold for previously. So there may be an opportunity for the next guy in the line, and it's sort of indicative of real estate transactions, is the third guy in the deal usually has the best price in it. So we're looking at the third owner of Sky Ranch coming into the play.

So there could be an advantage; we just --

Yes, there could be. It just depends on what the other surrounding property owners had.

Second question -- the Colorado River water rights, it seems to me last year we were in the process of jumping through hoops on that. Has at all been taken care of for another six years?

Yes, it has.

[Ed Sweeney], [Starboard Funds].

Last year I thought you had pretty good lines on possibly doing some deals with municipalities that were going to get you potential significant revenue, outside of this Lowry Ranch and Sky Ranch, that probably were going to be more imminent revenue. Where do you stand on any of those? Are those still possibilities, and are they close possibilities?

They are. We are working with several, and there's probably one or two that are at a pretty advanced stage that we're working with. They're at various levels of due diligence. What we have done is recommend certain things in terms of rate structures and how we deliver water, and they're working through some of those issues with their consultants and they've gotten some feedback from their consultants that are consistent and in line with some of the expectation that the companies have proposed. So a lot of that has come around. These transactions do have very long sales cycles, even longer than the sales cycles that we estimate the long sales cycle to be. So I am optimistic that there are those transactions out there and that the company would be in a position of being much more specific about those later this year.

And now, are these significant revenues that you're looking at potentially? If you do a few of them, you're going to cut into that $1.1 million burn for the regular operating cost?

Yes. From a standpoint of a significant transaction, they're relatively small transactions but they do have a very big impact from the Company's standpoint because right now we're generating around $300,000 a year, and a very, very small transaction would have a significant impact in our revenues. But yes, it does; they do have the potential of repositioning the company from cash flow negative to cash flow positive.

And right now, from the standpoint of, the reality is, with Lowry Ranch, the likelihood that Lend Lease is actually going to be building within the next year or two years -- do you have any sense of that possibility or the probability on that?

I don't. They've not given us much guidance in terms of when they'd like to develop that. But, given the market and where it's at now, I think that there is probably not a strong likelihood of them starting anything this year. If they do start anything in '09, it would be very late in '09. I would probably look for them to be more active in 2010 versus '09.

And, as far as cash on the books, you should still be in pretty good shape? You're not going to have to do any more cash raises, are you?

That's correct, Ed. We've got about $1.1 million negative burn with nearly $6 million on the balance sheet. So we've got about 5.5 years of operating capital. So I think we are well-positioned, well-positioned cash standpoint, and also well-positioned to make investments in facilities and infrastructure for a Lend Lease or one of the other communities that we are working with.

(OPERATOR INSTRUCTIONS). It appears we have no more audio questions at this time.

Okay. Well, I would like to thank you all for your attention on the call. If something comes up or if somebody is listening on a rebroadcast, please do not hesitate to give us a call, and we will continue to keep you apprised. Thank you very much.

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Have a good day.