Pure Cycle Corp (PCYO) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Pure Cycle Corporation fiscal year-end August 2011 financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference -- Mark Harding, President and CEO.

Thanks very much, [Jovan]. I'd like to welcome you all to our year-end results call. As in all our other calls, we have some slides for this call that you can follow along with. I will be working off the slides and try and note the transition of the slides as we progress through the presentation. The slides should come up with the presentation as you're listening to it.

If you're calling without computer access and you wanted to see the slides, the slides are also available on our website. They will be under the latest financial news sections. They will be the 2011 fiscal year-end results financial slides.

So, with that, I would like to get started. We will go through a brief overview of the Company, give you a little bit of background on not only what the Company does, but what some of the significant highlights have been for 2011.

And then, we will transition into some of the financial highlights for the year, and then after that we will turn it over to a Q&A session, so that if you guys want to drill down on anything specific, please don't hesitate to give us a question at the question-and-answer phase.

So, with that, we will turn to the slides. And I will start with our Safe Harbor statement, by noting that statements that are not historical facts contained in this presentation are forward-looking statements that involve risk and uncertainties that could cause actual results to differ from projected results.

I think most of you are familiar with the Safe Harbor. We'll move on to Slide 3, which will really kind of give you an overview of the Company. We are a wholesale water and wastewater service provider. We provide wholesale services to local governments, industrial, or commercial customers that provide water and wastewater services.

Through agreements that we have with these agencies, we serve governmental entities who ultimately serve the end customers throughout the Front Range. And we have specific target areas where we provide service not only to exclusive franchise areas, but also properties that we own and control.

We currently provide a modest amount of services to wholesale service on two governmental agencies, which have about 260 water connections and about 160 wastewater connections. And then, we also do some contract operations where we operate and maintain systems of other water providers.

Moving on to Slide 4, some of the income that is generated from the use of our water assets -- we really have three principal areas where our water assets are used. One is going to be the M&I sector, where we provide municipal and industrial water services to our wholesale providers, and that ultimately goes to the residential customers.

And we have sort of cradle-to-grave services where we develop the supply, we own the supply first and foremost, as the resource itself. And we differentiate the business by the fact that we own water in a water-limited area. We develop those supplies. We treat those supplies for potable consumption.

We store them for distribution, not only for ongoing day-to-day operations, but for peaking operations through irrigation seasons. And then we collect that water back once it's been turned into wastewater, and we treat that wastewater and ultimately reuse that wastewater supply for irrigation uses.

Also, we own substantial assets through an acquisition that we had in 2006, where we currently lease about 17,000 acres that we own in Southern Colorado. We lease that out to as many as 80 different tenant farmers, where the Company manages those properties and generates revenue for our management partner, High Plains A&M, who is the leasing manager on that. And that's the group that we acquired that property from.

Those proceeds currently go to High Plains A&M, and we generate about a $1 million a year from our farming operation. And that income was about what we generated this year. We are looking at opportunities with those farm income proceeds, and we will highlight some of the differences in 2012 from 2011 from those later in the presentation.

More recently, some of the activities and some of the acquisitions that the Company has been involved with is to diversify from some of the housing-related municipal and industrial demands, to also the industrial market for hydraulic fracturing water, and through the growing Niobrara formation, not only in the Wattenberg field, but also extending down into Arapahoe, Douglas, and Elbert Counties.

The Company is looking at expanding our footprint and our also production capacities to meet the growing demands of those. And I'll talk a little bit more about that in a little more detail in the presentation. Moving on to the next slide, what this will kind of give you is a target area where we provide our services.

We generally focus our energies along the I-70 corridor, which will be along Interstate 70, really adjacent to where our one acquisition for 2011 was -- that's Sky Ranch property, which we'll describe a little bit later. But also, look to provide services to this area. This is probably one of the more attractive areas for urban growth in the Denver metropolitan area, due to many factors, some of those being that the land assemblages, the transportation access corridors, the proximity to the employment centers, and the topography of the ground itself.

The Lowry Range, where the Company has the exclusive wholesale water and wastewater service, continues to be part of our service area and a target market. And then, extending services to the Arapahoe County Fairgrounds, and then other industrial accounts that we have in and around this area.

Transitioning a little bit to the next slide, to really drill down a little bit on this 2011 acquisition that we had with Sky Ranch. The property is about 930 acres, and with it came about 820 acre feet of water. We acquired the project through a bankruptcy proceeding for about $7 million. And the attractiveness of the property is that it is a ready to go, fully zoned, master planned community.

We have a very attractive zoning on the property, up to five units to the acre, which gives us a total of 4,850 single-family equivalents; and single-family equivalents is the Company's unit of measure that we measure how a water demand profile is allocated to our water resource portfolio. It includes a high amount of residential, in all platforms of residential development. You have single-family detached, single-family attached, multifamily attached products out there.

It has tremendous commercial potential, right along the interstate, right where you would think you would have a lot of that commercial, industrial, and retail activity. We believe this project is ideally located, with excellent transportation access, in an area that allows us to deliver entry-level housing, which is where we think that sweet spot of the market is going to be. And entry-level housing in the Denver market is really housing that its entry price point is less than $300,000.

It's also ideally located in an active area for the Niobrara exploration. And as many of you know, earlier this year, in March of this year, we entered into a mineral lease and surface use agreement with Anadarko, and I will talk a little bit more about the Anadarko transaction a little bit later in the presentation.

How the -- we will transition to the next slide, Slide 7 -- how the acquisition was financed. The Company financed this through two instruments. One was that we took 5.5 million of common stock off our effective shelf registration and placed that directly, and then also had a $5.2 million convertible note, which did convert into common stock in January of this year.

And of the proceeds of about $10.7 million, nearly $11 million in proceeds, $6.3 million was used to complete the acquisition. We had about $700,000 as a hard option payment on the property at the end of 2010. And then, the remaining proceeds will be used for the -- paying the costs of the acquisition, some of the legal, attorney fees, transaction costs through the bankruptcy court, and then also be used for working capital for the Company.

So, what I want to do, really, is talk a little bit about some of the things that are very exciting for us this year. And one of those is the oil and gas lease details. We entered into an oil and gas lease and a surface use agreement with Anadarko in March of 2011, and we received approximately $1.3 million in the upfront bonus payment and some surface damage payments that will be defined as the drilling on the property commences.

The upfront payment is being recognized as income over the three-year term of the lease, so Anadarko has a three-year initial term from March of 2011 to enter into production of the oil and gas on the property. This was a competitively leased bid property, and we had competing leases not only with Anadarko, but also from ConocoPhillips and Chesapeake.

And they were all very good lease opportunities. And some of the reasons why we selected Anadarko were that they had had a large majority of the mineral interest in the property surrounding Sky Ranch. And, in fact, they had held half of the property, half of a section of ground, about 300- plus acres, from an acquisition that they had from the Union Pacific Railroad, where they purchased a mineral estate from the railroad grant, the checkerboard, every other section railroad grant.

So, not only did they have a preexisting lease with us that we picked up when we acquired the property, but they also had a lease interest on surrounding properties. They were very sensitive to our zoning and the master planned status of the community, and really worked with us on the surface use agreement to define how oil and gas exploration can work in conjunction with master planned communities.

It's our expectation that much of the oil and gas development activities will be developed before substantial residential development of the property occurs. So, we'll have that out of the way and developed and reclaimed by the time we have master planned communities. But we look to siting these oil and gas wells so that they would have a minimal impact on any of the developable property on the master planned community. And overall, they were the best lease proposals, so we're very excited about working with them.

If you move to the next slide, what I want to do is talk a little bit about the Niobrara formation and why that has an impact to a water company. Normally, what we see in a water company is that it is an industrial use for water. And because of the mineral estate that we own in conjunction with the Sky Ranch property, it also presents us an opportunity to generate revenue from the oil and gas royalty revenues that we receive.

There are two significant properties located in and around where we define our service area, along the I-70 corridor, that have yet to enter into oil and gas leases, and these are substantial property holding interests. One of them is the Denver International Airport area, which is owned by the City of Denver, and it's about 15,000 acres.

They are currently evaluating their opportunities for leasing that property to various oil companies. And if they work within the schedule that they've laid out, they may end up entering into a transaction on that by the end of the year.

The second one, which we do have an interest in, in providing water and wastewater service to, is the Lowry Range. The state Land Board has entered into a process where they are evaluating, through a competitive bid process, select oil and gas companies that they are inviting to bid on that property. They have laid out their process, and are looking to complete that process sometime in the first quarter of next year.

The area that you see highlighted here, you can see where the Wattenberg field is generally located. And that generally is bounded by Weld County on the north side. Typically, the definition of the Wattenberg area may not extend down into Arapahoe and Adams and Elbert Counties, but the Niobrara formation does.

And so, what they are looking at is, in addition to the focus that they've really had a lot of their exploratory efforts on the Wattenberg field, they are seeing a lot of activity in the Niobrara formation extending south into Adams County, where the DIA parcel is, down into Arapahoe County, where our Sky Ranch parcel is and where the Lowry parcel is.

It continues farther south, extending into Elbert County, all the way down into El Paso County, which is where the City of Colorado Springs is. And there's a major oil company, Ultra Petroleum, who made a large investment in the Colorado Springs area, the Banning Lewis Ranch, that they are just starting their activities on exploring what that opportunity might mean to them.

And continuing even farther south, the Niobrara play has shown signs all the way through the State of Colorado down into New Mexico. But most of the activity has been focused up in this northern part in the Wattenberg field, and then now starting to extend south into Adams and Arapahoe Counties. If you move on to the next slide, what this tries to give you is an indication of some of the major leaseholders in this area -- as I mentioned, Anadarko, who we entered into our agreement with, with Sky Ranch; ConocoPhillips has a substantial position in this area, as does Chesapeake.

If you take a look at just this particular area, and we'll define that as sort of the east Aurora, Arapahoe, Elbert County area, it may total as much as 300,000 acres that is being the focus of the -- still continuing to focus in on the Niobrara and the Codell formations, but extending from the Wattenberg field up -- what we have seen in the northern and northeast part of the state.

If you move to the next slide, talking a little bit about what this means to the Company, this certainly is --development of this play has made itself available through the development of horizontal well development and horizontal fracturing. The fracturing is a very large water customer, which requires capacity for additional water supplies in a really water-short area.

And we are -- one of the focuses of our target service area has been that this is a water-short area. We've been accumulating a large portfolio of water in this region, and have developed capacities in this region, not only for water and wastewater service, but are looking to expand those capacities to meet the growing demand for this, for this frac water play.

So, what we're looking at in 2012 is expanding and doubling our capacity. We anticipate drilling two new wells to increase our capacity to over 1 million gallons per day, and construct some additional storage facilities that allow us to customize the water quality for the oil and gas operators, and then, also, taking a look at, expanding, and adding another 50% capacity in 2013 with an additional two wells. So, we are seeing tremendous opportunity in this area, we are seeing tremendous demand for our resources in this area, and are looking to respond to that through these additional investments.

If you move on to page 12, that will give you kind of a footprint of where we are located and where some of our capacities and system expansions are likely to occur. Certainly, one of those is going to be at the Sky Ranch system, bringing on capacity at that system. That system is a highly advantaged site, because it is right along the Interstate. It has an interchange right at the highway, so it allows you to serve both north and south of the interstate without actually having to get on the interstate. So, we have capacity expansion that we anticipate sometime by mid-summer next year.

Extending farther down, we have various expansion points, which all are going to be along the transportation corridors, making sure that we have easy access to be able to service filling these trucks that will deliver water to each individual drill site. And then, also, to the extent that we can serve that through developing the system on the Lowry property and delivering that directly on the ground and minimizing some of the haul costs and minimizing some of the impacts that these trucks will have on unimproved roads, we look to do that within the Lowry footprint, as well.

So, we have a couple of areas that we are looking at placement of additional capacities, and then extending all the way down to the Arapahoe County, Weld -- or Elbert County line on the south side. These well fracs can use between 2 million and 5 million gallons of water, depending on the size of the frac and the number of stages that they are looking for.

And what we are looking at is really expanding our supply capacities to over a 30-mile reach, extending from I-70 on the north side to the south and southern/eastern side, along the Arapahoe-Elbert County line. That will give you an overview of what we are looking at on expansion, and also what this opportunity represents for us on the water fracking, and how we look to expand our system to help monetize those assets for 2012 and continuing.

I also want to talk a little bit, if you move to the next slide, 13, talk a little bit about some of the changes in our Arkansas River water assets. August 31 was the fifth-year anniversary of our acquisition, and there were certain events that occurred on that fifth-year anniversary. One of them was that High Plains A&M would have the election and the opportunity to move their participation percentage in our tap fees from a 10% participation to a 20% participation, continuing [thereforward].

And they did make that election, so we will have them participate at a 20% of aggregate taps as we add them to the system. And then, correspondingly, we reduced the number of taps that there are available to participate by half, so they have the opportunity to participate in about 19,500 remaining taps.

Additionally, what we see in that anniversary is that from fiscal year 2012 rolling forward, the Company will be able to credit a portion of the farm income, about 26.5% of the net farm revenues, against the Tap Participation Fee liability. So, we will credit about -- if the revenue remains consistent, about $950,000 to $1 million a year.

We will credit about $250,000 against the Tap Participation Fee liability for the fiscal years '12, '13, and '14; and then, after 2014, after September of 2014, 100% of those farm incomes will transition to the Company. So, we will be receiving those -- that revenue, if that maintains its stability, about $1 million a year, we will receive that income to the Company after that time.

The next slide really highlights some of the location of our farm interests, and it's in the southern part of the State of Colorado. We have our interest in the Fort Lyon Canal system, which is a canal that extends over 100 miles in Southeast Colorado, from La Junta through Lamar. It's in three different counties -- in Otero, Bent, and Prowers Counties. And so, you see a snapshot of some of the locations of those farms in that area.

With that, I guess I'd like to transition to some of the financial highlights for the year-end 2011. If you move to Slide 16, the financial results, if you take a look at water deliveries -- water usage revenues were up slightly from 2010, about 12% over 2010. And that's primarily due to modest increases in the rate per thousand gallons that we have delivered to our customers.

The total gallons of water delivered, slightly up from 2010, and that was really attributable to more of an inline season -- irrigation season this year. There was a lot of moisture in the early part of the season, but then it became more typical toward the latter part of the season. We expect the water deliveries for 2012 to be up significantly, not because of the weather issues or the irrigation customers that we have, but predominantly because of the expectation that we have in delivering additional water service to the growing demand for frac water services.

Transitioning to slide 17 -- the G&A expenses were up also in 2011, and that's attributable to two primary areas. One was some bonuses that we paid to Management, our employees, for the completion of the Sky Ranch acquisition; and then, also, increased professional service fees associated with that acquisition.

There were some acquisition costs, some increased legal professional fees and some bankruptcy costs associated with that, that were one-time costs. We don't expect those to be carrying forward. The normalized G&A expenses are probably going to be, on a cash-burn basis, normalizing about $1.5 million a year.

Moving to Slide 18, summary of the net loss financial results -- again, these are a bit skewed, just because of the accounting for the Tap Participation Fee. And what that is, is just to remind those and really introduce that to new accounts to the Company.

We are accounting for the ultimate liability, the Tap Participation Fee, on an imputed interest method, where we value what the payment of that 20% of the tap fees, over those 20,000 taps over time would be, discount those back, and then report that as the gross liability on our balance sheet. And then, we impute the interest associated with that.

So, when you see these high net loss numbers, a significant portion of that, almost 65% of that, is associated with that imputed interest. It's not a direct interest cost, but it is an imputed interest cost to our financial statements. It skews our net loss a little bit, but with a little bit of discussion, I think it helps clarify the net loss of the Company.

Transitioning to the financial results, current assets are up, that's principally due to the capital raise that we had in 2010 associated with the acquisition of the Sky Ranch. And then, also, the oil and gas lease that we had with Anadarko.

Total assets also, next slide up, associated with the acquisition, about another $10 million associated with the Sky Ranch acquisition and some of the other capital components of the oil and gas lease. Similarly, equity up about $5 million, again attributable to the placement in 2010, the equity placement in 2010.

Slide 22, kind of a depressing stock activity chart, and one that we really recognize. We have had a volatile year of trading activity. And while I can say it's probably not unusual, given how equities have traded this year, I can say this is certainly not where Management or the Board believe it should be.

We are -- I'm sure you are accustomed to CEOs saying in that all your portfolios that stocks are not where they'd like them to be. But we are very optimistic that we can take a look at the diversification that we have invested in with this Sky Ranch acquisition, and the opportunities presenting themselves from the Niobrara formation, not only on opportunities for oil royalties on Sky Ranch, but also for the opportunity to provide water for water fracking in this area, that we will have some material results that will change this trend in 2012.

We do want to update you on some of the housing activity, because ultimately the Company is in the business of providing water and wastewater service for residential development. And housing has had its share of struggles, and I think it continues to be in that range of struggling. The year-end starts for 2011, ending September 30, are in line, if not slightly down, from 2010.

We still had starts of about 3,600, 3,700 units in 2010-2011 time frame. Some of the highlights are that the entry home market continues to make up the largest share of this market. And so, we are increasing what the demographics are that's increasing its penetration by about 8%. And the start of home markets is that market, about $300,000 and less.

Inventories are continuing to decline, so we look at that as an opportunity and good maturation into the market. Housing looks to continue to struggle in 2012, but we find our Sky Ranch property in the right target demographic.

It's in the right price point market, where we are looking to deliver these entry-level houses. It's in the right location, from the standpoint of access to transportation. It is completely zoned and ready to go, and if we continue to see economic growth activity as a result of some of the statewide oil and gas activity, we are hopeful that Sky Ranch is going to play an important part of that.

And so, we continue to be very mindful of that -- we are going to be investing in water-related facilities that will get water available to the sites, so that is going to give us another leg up in how the development of the Sky Ranch project will look. We continue to meet with area developers and home builders, and the property continues to show well. And I think it is very well-received, not only in terms of the Company's acquisition and what we're looking to do with that, but also how we can created opportunities with the low land basis that we have in that.

Let me transition to some summary information on our balance sheet. What this shows is a solid cash position. We have a little over $5 million in current assets, and really want to emphasize that the Company has no maturity debt. As you see, the Tap Participation Fee liability is something I explained a little bit earlier.

We have a net present value of the future payments that we have and owe to High Plains, associated with the acquisition (inaudible) asset. And those are payable as we receive taps. So, that's that present value, and that's where we get that imputed interest figure from.

And then, other long-term liabilities are also the comprehensive amendment agreement, the CAA agreement that the Company still has outstanding. And again, those are derivative function as we sell taps. We have obligations that we have associated with that. So, these are all just more analogous to royalty production payments, but they are recorded as our liabilities on the balance sheet.

If you move to Slide 25, statement of operations, as we talked about a little bit, G&A was up in '11, but that should normalize in '12 to about that $1.5 million cash burn rate. So, with that, what we bring to you today is really a very healthy, a very solid balance sheet, with a Company that has had some diversification through some acquisitions this year that have worked out very well for us.

It's worked out well not only in positioning the Company for opportunities to meet challenges coming into 2012 and continuing forward, but also for the opportunity to grow and expand our systems. With that, [Jovan], I would like to turn it over to you and see if we have any questions, and see if we can drill down on any of the specifics.

Thank you. (Operator Instructions) Mason Matschke, Raymond James.

Hi, Mark, how are you?

I'm good, Mason. How are you?

I'm good. Hey, I saw a lot of good press on Anadarko and their drilling in the Wattenberg fields. It would help a little bit if I could understand how far that is from water that you have available for sale. And then, I wanted to understand a little bit about competitors and how you -- what is your plan to provide water to these drill sites?

It's a good question. The Wattenberg field, if you look at the historical circle around the Wattenberg field, that's probably going to be maybe 20 miles north of Sky Ranch. And a lot of those definitions of the Wattenberg field start to extend down into Adams County. It depends on, really, the definition. There's not really a hard line that says -- this is where the Wattenberg field is. But generally, most of the characteristics define that field in the Weld County area, which will be a little bit from our property. The nice part about our water and where we are located is, that we have such a broad reach of supply, that really extend from the Arapahoe-Adams County line, right there at I-70. And with the interchange, it gives us access that we can get right to north of that property.

So, we're going to probably be the closest water source as they extend down into the DIA, Adams County, clearly down into the Sky Ranch play within the Arapahoe County area. And really, that's our target service area. If you look at the availability of water -- one, there's two real limitations for water for this particular use. One is, when they're up in sort of the Weld County, up in the Northeast Colorado area, you have a lot of agriculture water that's up in that area. The dilemma with the agricultural water is that that's not decreed for industrial applications. You can use it for agricultural operations, but you can't use it for industrial applications.

So, what you find is, there's a very -- even though you may have a lot of physical water that's available, you have a real supply limitation, because it's not adjudicated for that specific use. And so, what they have been seeing is, extensive hauls on this water to bring where water is legally and physically available to these particular drill sites. And so, I think we have a very broad reach in extending into Adams County, all into Arapahoe County, and then into Elbert County with this opportunity. As you saw on one of our slides, where we would be looking at those system expansions, we are looking at making capacities available throughout that range -- from Sky Ranch, really hitting that Adams County area, to our Lowry supplies, then extending down to the Arapahoe, Elbert County supply, to allow that to pursue those Elbert County interests, as well.

How many different firms or counties or companies like yourself do you see providing water?

That's yet to be defined. A lot of the cities have very strict ordinances, that they don't allow water to go outside the city boundaries. And they do that for very specific reasons. The ratepayers and the taxpayers of those given cities have paid to develop those supplies for the benefit and for the use of the citizens of those communities. And so, it's very difficult for an oil company to get supplies from community-based systems, because if they're using the water within the boundaries of the community, then they can do that.

But if they are taking that outside the boundaries of the community, which a lot of this is, this is in mostly the rural areas and the unincorporated areas, then it becomes problematic for them to be able to extend those municipal supplies. The way oil and gas companies typically handle this is through vendors. They have various relationships with service vendors that will provide these supplies to them on a turnkey basis, where they will contract for the source, they have the haul trucks, they have the frac tanks, and they handle the logistics of being able to get water to the particular site.

One of the things that we're looking at is working with a number of these different service companies, and have had a number of conversations with two or three different service companies to be able to extend those supplies, make those supplies available to them, and then really try and work out the logistics, whether that's to haul this water directly, to be able to set up various transfer stations where we have a facility and we can fill a 100,000 gallon, maybe a one- or two-day storage of water, and then they can transfer that, maybe even running a line on the ground to the various rig sites. So, we want to try and optimize that to the extent possible, to help not only be competitive, but also work on the logistics of delivery.

Can I hit one more question about the Lowry Range? What's happening there with potential drilling? And could you talk about how your rights to provide water there, how that would work?

So, what we -- the state Land Board is evaluating what they want to do with that particular project. They will have a presentation in December, the early part of December, that they have engaged a consultant to help them through this oil and gas process. They typically, the state Land Board typically -- they have about 3 million acres of surface land throughout the State of Colorado, and they're very sophisticated at oil and gas leases.

They typically just do auctions on their lease, on their mineral lease interests, and this year has been probably the largest receivership of bonuses that the state Land Board has ever had, and the largest number of nominees for their lands throughout the state. But with Lowry, they wanted to take a different approach. They didn't want to necessarily just put that up for auction. They wanted to really look at the operator, look at some of the unique characteristics of Lowry, some of the conservation objectives that Lowry holds, and some of the water-related issues.

We have reservoir storage sites out there, so they were trying to blend in multifacets to the lease-out at Lowry. So, they've been -- they've had a request for qualification out to the market. We'll look at those qualifications and try and come with the recommendations to the Board of a select group of candidates that they would like to invite to bid on that process. They've laid out a schedule for that, which I think will conclude sometime in the first part of next year. Pursuant to our relationship with the Land Board, we have the exclusive rights to provide water and wastewater service to 24,000 of the 27,000 acres.

As you all might remember, in 2008, they were looking at developing a portion of that property, and they were looking at six square miles. Two square miles of that fell within our exclusive rights, and four square miles were outside our exclusive rights. So, they do have lands at Lowry that are outside our lease interest with them. And we would look to extend our opportunity to provide water service to those sections, as well. But for the bulk of the Lowry property, we do have the relationship where we provide exclusive water service to that. And so, we would work with whatever, whomever the oil and gas operator is and extend services to them, so that they have adequate water supplies, and be able to do that principally by locating facilities on the Lowry property itself.

Okay, thanks for that explanation.

Dorsey Gardner, Kelso Management.

How are you?

Good, Dorsey. How are you?

Good, thanks. I'm curious -- are you actually in negotiations with these oil companies or somebody who might supply the oil companies? Or is this something that is sort of coming down the road, or you've had discussions with them, or where are you on these?

Yes, we have. We've had direct conversations with oil companies, as the principals, and also as in operators of that, the service bureaus associated with that. So, it's yet to be defined as to whether our relationship will be directly with one of the oil companies, or whether they will just defer to the service providers and provide service directly through a turnkey logistical basis there. So, we've actually covered both sides of that, Dorsey.

Okay. And I know it's difficult to estimate what the size of the business could be, but I have no idea what 1 million gallons of water would -- what the revenue would be or what the gross margins would be. But can you give me some idea what you're thinking of, in terms of the volume of business that might be involved?

Sure. Just to give you some metrics that we use on that, as we mentioned earlier, there's between 2 million and 5 million gallons of water for every frac. So, if you look at the low end of that, that could be as much as $25,000 in water revenue, the high end of that might be $40,000 of water revenue. And that translates into the equivalent of between 15 and 40 homes worth of water for a year. So, it is a large customer.

When you look at the aggregate logistics of the customer, though, given the size of our portfolio, it's really not a substantial amount of water. And this is one where we don't collect any tap fees associated with this, because this is sort of a use of water, one-time use of water. We're not extending infrastructure to provide service to that on an ongoing basis. And what you will see is that this becomes a material component for -- if you are looking at the well, the cost of the well, they're looking at these wells costing some where between $4 million and $5 million.

So, $25,000 to $40,000 for the water feature of that, and that's just sort of the water cost. Then the water haul can cost significantly more. It can cost maybe three times as much to deliver the water to the site as it does to purchase the water. So, the logistical sensitivities are very high there. When we can extend that service by delivery directly to the well site, that's an enormous opportunity for us to be a very cost-advantaged way of getting water.

Are you set up to deliver? You're talking about trucking the water.

The majority of these will get trucked water; but in the case of Lowry, where we have facilities that are going to be there, and you don't have existing roads that you have the opportunity, you can extend as much as two miles of line on the ground and deliver to the tank, directly to the rig site. And so, that infrastructure may be a lot more attractive, where they don't have to put these very heavy haul trucks over the ground, where they don't even have improved roads out there. They can deliver it via truck, but it certainly does do a lot of environmental wear and tear on native ground.

So, we look to make those infrastructures in areas that logistically can provide service to the greatest extent possible by delivery, via running some line on the ground directly to rig sites. And we can access probably half the site of Lowry that way. Depending on the number of well sites -- and that's one of the things that the state is looking at, is how many well sites they're looking at on the property, when they take into account some of their conservation objectives.

And then, optimistically, if you were looking out two or three years and things worked out quite well in the fracking area, could you do a couple million dollars worth of business? And what does that mean in terms of bottom line?

You know, we're going to know a little bit more of that probably through the first half of next year, as to what this play will look like and the number of wells that this will look like, given the amount of leased land that's in this particular area, we'll see. Anadarko, Chesapeake, ConocoPhillips all look to probably attack this in a similar fashion with these horizontal wells and the fracking of the wells. This is a very good opportunity for the Company to monetize its assets. Net margins on that -- we'll see how those play out, depending on the infrastructure that we look to do on delivery and making sure that we can minimize some of that haul cost.

So, some of that stuff is still in flux, but it will be pretty attractive for the Company, Dorsey. I don't want to get into setting some expectations on results just yet, until we get a little bit more specific. But we are looking at how that would work on the issues of each of the sites that we identified in our slide. If you look at the five or six different sites that we have there, where we're looking at expanding our facilities, the net cost of our wells are known. We know what those are going to be.

If we put a small tank at each of those locations, so that we can customize the water and really don't do much to the water, I mean, it comes out of the ground as a potable water supply -- but to the extent that they want to tweak the water one way or another for a particular frac, that we have the flexibility of doing that. So, we want to be careful about some of those investments and pricing some of those investments into our rate, as we deliver these supplies to the operators, whether that's directly to the oil companies or to the service vendors.

I don't want to take too much time, but -- and is there a possibility for reclaiming this water? That's obviously an issue.

Yes, there is. And typically, there's two things that you do. You have produced water, some of that is going to be flowback water from the frac itself, that gets somewhere between 30% and 40% of the water back in its initial production. And then, you ultimately always are going to have some produced water. Now, this is a fairly liquid-rich play. You're going to see more oil than you have gases here, or the expectation is you will see more oil than gas, but you still see water associated with that. We are probably not in that business.

We are probably not in that business. We are not in the business of treating produced water. We don't have the technology for doing that. We wouldn't want to mix the produced water with our wastewater treatment process. That's not a good combination of technologies. And then, there are operators that are looking at specifically going after this produced water and being able to do some treatment of that, some recycling of that, and some disposal of that. Colorado is a fairly friendly state for disposal, and how the disposal work is, you drill a well below the formation, and then you dispose of that water into a poorer quality formation than what they're taking it out of.

Thank you very much, Mark.

[Ed Sweeney, Starboard].

Hi, Mark. The lawsuit got wrapped up a little while ago with, what was it, with Aurora?

Right.

The municipality there. And I thought one of the ramifications of that was going to be that these guys are going to have to come and do a deal with you one way or the other, whether buying the reservoir. What's the status on that? Because that was like a possible $20 million deal.

Yes, the opportunity there is that the City of Aurora has a large project that they've put online and are delivering water to their system, and it's directly to their water treatment plant. And we have a reservoir that they had made a filing on, that overlapped our reservoir. Ultimately, that was resolved in the Company's favor by saying -- Aurora cannot keep their footprint of a potential reservoir over the top of our reservoir. I think Aurora still has a strong interest in that reservoir site. We have had a number of conversations with them, together with the state Land Board, associated with that reservoir site.

And what you see is really some overlapping issues here with the oil and gas lease, the storage site -- that storage site is one of the storage sites that the state Land Board is taking a look at and making sure that the oil and gas operations don't conflict with the water operations, as well as some of the other storage sites. We have three other storage sites on that, in addition to that one. And so, what we are -- we have had a number of conversations with the state, with the City of Aurora, about those opportunities and doing some trading of various interests that we have, that the state has, that Aurora has, to pursue a transaction in that area.

I don't want to get too specific about those. Those are continuing discussions, and we're very optimistic that all those can be -- there's a pony in there for each of us, so that we all get the core objectives of what it is that we are looking for without impacting anybody else's objectives. The state can move forward with the oil and gas. That still allows them to develop the resource, the oil and gas resource, beneath the reservoirs, through the horizontal technologies. They're able to generate revenue, not only from the mineral interest, but from our royalty revenue that we have as we sell water on the Lowry Range, they generate a royalty revenue associated with that.

We can reconfigure some of the storage opportunities that we have to one of the other sites, that allow us to maintain the aggregate footprint of storage that we are looking for, and still find an opportunity to participate the one site that Aurora has interest in for the City's use. So, we are working together with all those interested. I am eternally optimistic that those will conclude, but don't really have a good time frame that I can give you a sense as to how that will come down. But the oil and gas opportunity certainly has renewed the focus and the emphasis there.

And now, what about the other sources of revenues for these municipalities? Like the water fracking and the Sky Ranch, these are new developments, or new things that have come along. But even a long time ago, we were looking at this, saying this Company has a lot of potential, and -- at least to cover -- to get to break even on the $1.5 million a year burn, that was our hope, let's just put this back four or five years ago and by now we would be getting there, on just the outright water revenue and the tap fees or deals that you do with municipalities. Is there anything getting close with doing a deal with municipalities, outside of the oil and gas revenue and Sky Ranch?

You know, I think the best opportunity for us, and really one of the diversifications that we were looking at as a Company and as our Board took a look at this, was the opportunity to control that process a little tighter, where we acquired the Sky Ranch land interest. And there's nearly $200 million worth of water and wastewater tap revenues associated with providing water and wastewater service on that property; and so, we have a cost basis in that land at about $900 a lot. And so, when we are generating something in the range of $27,000, $28,000 combined water and sewer taps on those properties, the land is a very insignificant component to that.

And that's where we are getting a lot of traction with developers and home builders, is to the extent that we can provide low-cost lots on the land side and maintain a competitive position on our taps, then that property is positioned very nicely for this entry-level product. And that's where the inventory really is. That's where you find declining inventories in the whole metropolitan area, where these entry-level lots are the ones that people want. That's where the market is at. They want projects that are ready to go. Sky Ranch is clearly there. It's ready to go. We have our zoning. By 2012, we will have the entry point of our water system up and operating, so that when a developer comes in, he has not only low land, but existing water on the site. We can quickly build the wastewater operations and provide those lots.

So, that's really the opportunity we are looking to pursue in the short term, and then really branch the system from there to areas along the corridor. The corridor -- I-70 corridor itself, remains what we believe to be the primary attractive area for new growth in the region. Now, that said, new growth in the region is really a -- it's a function of where housing is nationally, although I think Colorado positions itself a little bit better than other areas, but yet we are still growing. This area in the I-70 corridor is at least one of the more active areas in the region, so those things are all very nice metrics. We just don't have the clarity that we may have thought we had in 2006-2007 time frame, before all this happened.

You seem -- it was my perception that the closer things were actually, these other municipalities, that now if they had any more incremental growth, they were going to need to do -- possibly do a deal with you or need the potential to get water. Whereas, I understand your point where you bought Sky Ranch dirt cheap, and any further new developments in big ones, you would basically be in the best position. But I would have thought by now, we would have had some of these other municipalities, that are -- if they have any incremental growth, they would need -- my understanding, at least this was my perceptions, were that they were the closer things to doing a deal a while ago. Like four or five years ago, Sky Ranch -- you weren't thinking about taking that over and starting -- getting a developer and the whole bit, because it was such a mess back then. I thought the closer revenue model was going to be from these municipalities.

And that's still there, Ed. A lot of the municipalities, if you take a look at how water systems are financed, they're typically financed through revenue-based instruments, where you are pledging tap fee revenue and usage revenue that are to be added to your system. And those are very unpredictable. Even in the good days, it was hard to forecast those out. Now, even -- if you think it's difficult, it's near impossible to forecast those out.

So, what the Company provides is an opportunity that we provide an alternative to that, where we are not in a position of having to issue these revenue debt instruments and be clear on this crystal ball of how taps are going to get added to the system. We have the inventory of our supply, and we can take capital, put our assets for service to these additional municipalities, as well as capital development and tie into those systems. And we're working on doing that with a number of municipalities participating in regional-based projects. So, as those things mature, we will continue to come back to you and give you a little bit more guidance as to how that's going to affect the Company.

Now, what about -- there are no concerns about the fracking and the water and contamination. You hear all these things. That's kind of what things would get caught up in the east in New York and Pennsylvania. So, that you have no concerns about?

We don't. And, in fact, what we look to do with Anadarko on the Sky Ranch property is, we look to develop our water wells on the same pad site as their oil and gas wells. And the reason for doing that, the reason we have some confidence that the frac and the frac chemicals and the hydrocarbons associated with oil and gas development do not weigh into the water-bearing formations is really a function of the geology that we have here in Colorado.

If you take a look at how the geology differentiates itself, we'll say the first 2,000 feet in various intervals, there are the water-bearing formations. And then, from about 2,000 feet to 7,000 feet, you have about a mile of this Pierre Shale that really is absolutely impenetrable. We have seen the impenetrability of that by virtue of some of the technology that we have developed in fracking, through our horizontal well development technologies. And really, what you will see is that all the fracking for the oil and gas operations occur below the Pierre Shale. And so, we have no issues associated with fracking associated down at those depths. The only issue that we want to keep track of, and we want to monitor, is any surface issues. As safe and as controlled as they are on developing transferring water from the well to the tank, there are opportunities and issues for things to happen at the surface.

What we want to do is make sure that we contain those surface directly away from any alluvial water sources that we're going to be developing, and that we have the ability to monitor anything that's going to occur at those sites, so that we know immediately. We don't know months down the road if there's an issue, we will know immediately if there are issues. But, no, we don't have any concerns over these deep formations and fracking and the oil and gas development impacting any of our water or our water quality.

Okay, thank you.

[Shane Calhoun, Nokara Capital].

Mark, how many wells has Anadarko -- I know they have, I think they are slated for three -- how many are functioning right now?

I'd probably defer to you some of the Anadarko releases. They have a number of wells in what we would define as the Wattenberg field. In this particular area, in the Adams, Arapahoe, Elbert County area, I know they drilled one well on the state Land Board Lowry Range. And they drilled that from -- they were -- interesting, they purchased a preexisting lease that had a section or two of ground from the 22,000 acres that the state Land Board had, and so they went out, they did some seismic on that, and they drilled a horizontal well. I'm learning some of the technology in the oil and gas industry. They call that a tight hole, which by what I understand the definition is, they're not going to tell anybody what the results of that are.

So, I know that they have that one well, and we will eventually learn results of that. But I think that's going to be learned after the state Land Board's bid process on the Lowry property is known, whether they're a candidate for that or one of the other companies are a candidate for that. I know ConocoPhillips has a number of well permits that are pulled in this play. I know Chesapeake has a number of well permits that are pulled in this play. And my understanding is that Anadarko has a few that they are pulling as well, and they are going to ramp up their exploration in this field in 2012.

I guess specifically, what they signed the lease for with you guys --

Okay, on Sky Ranch itself.

Sky Ranch. There's three wells. Have they started drilling on any of those three yet?

Not yet, not yet.

Have they given any indication on what the revenue potential is off those wells, since you get a 20% share of that?

Yes, we do get a 20% share of that. It's fairly easy to do sort of a back-of-the-envelope analysis of that and some of the metrics, depending on the price per barrel that they get. But if you use 100 barrels of -- per 100 barrel of production of oil per day, at $100 a barrel, our 20% interest, if they maintain that over the year, generates $700,000 in royalty. And so, not assuming that any of those are the right numbers, but you can do your sensitivity analysis on that and say -- okay, what are these wells producing in this area? Are they producing 100 barrels? Are they producing 500 barrels? 700 barrels? And then, factor in the price of oil, and it's somewhere in that $90 to $100 a barrel -- and we're on a gross basis, so we will be right near where the price of oil is. And then the production, the daily production on that. So, that will give you a metric of what we look to generate per well on Sky Ranch.

And who is supplying the oil or the water to them right now for the drilling?

Most of that stuff is up in Weld County. They haven't drilled much. The one that they drilled at Lowry, we provided them water for their fracking on the Lowry well. The Weld County area, as I said, they're pulling water from all available sources that they can. The challenge there is that a lot of this water is not decreed for this particular use, so they have to find both the physical availability and the legal availability of that water.

And I know someone asked it earlier, but I don't think I understood it, so I apologize for asking the same question twice. But just to understand the revenue model for the well in 2012, increase it over a million gallons per day -- how does that work, assuming you sell the full million each day, what does the revenue model on that look like?

We typically sell that at our published fire hydrant rates, which are about $9 per 1,000 gallons. So, 1 million gallons at $9, that's about $9,000.

Per day or year?

Per day.

Per day, okay, great.

Selling all million gallons at that price.

Okay. And I'm just curious, on the farm leases that came up for extension, why didn't you guys take that in-house, since it generates over $900,000 in revenue? Why renew with HP?

They had the right to do that. They had the right to extend that for another three years. If certain conditions weren't met on the aggregate economic interest or the consideration that we paid on them, then they could extend that for another three years. So, it was their election to extend that for the additional three years.

And do you see other lease deals in the pipeline right now, are there any of those types of discussions going on? Or is Anadarko the one-time shot?

Well, certainly, from our mineral estate, we only own the mineral estate on the Sky Ranch. So, we're not going to find -- really, in this play, we don't have other mineral estates. But we do have 17,500 acres in the southeast part of the State of Colorado. And depending on how far the Niobrara formation extends, we could conceivably see activity in that area. The Banning Lewis Ranch outside of Colorado Springs is probably maybe 40 miles from where some of our farm interests start. So, it's -- the oil and gas interests are continuing to extend south. We are actively watching what happens in that play in the Colorado Springs area and see what that activity is, because that will continue to generate additional activity in the southern part of the state. We don't own full mineral interest on our 17,000 acres, but we have a mineral estate in those farms that we acquired in Southeast Colorado.

And I'm just curious -- with this drilling, how realistic would it be to expect a developer to come in and develop some of these properties or lots that you have?

So, what happens is, these sites ultimately reclaim down to about a three-acre site. And one of the surface use agreements that we had with Anadarko was trying to be able to position those in commercial corridor areas, where they're not in a residential area, they're not going to affect a residential -- they're not going to be in somebody's back yard, they're not going to be right next to somebody's back yard. We can put them on major transportation corridors, where you are going to have retail commercial activity anyway, so that it does not really disrupt the footprint of it. They are going to be in sites where we would otherwise have our water facilities. So, from a tank standpoint, our tank is going to be 10 times as big as some of their oil and gas tanks. So, the footprint of these things are very modest when you get them drilled and reclaimed. And the real attraction here is to do this in advance of some of that residential activity.

And did I hear you correctly? Would you, if a developer came in, would you sell them the land for $900 a lot?

No, I told you, that's what our basis of it was. We are certainly incentified with a low cost basis, and our interest really is generating tap fee revenue associated with that. So, my interest in working with the developer, I do want to incentify that, and I have some room to work with them on.

And what do you think the estimated tap fee revenue would look like today, in the current environment?

Our water tap fee revenues today are $22,500, and our sewer tap is right around $5,000.

And one last question on the Western Slope Paradise Water Supply.

Yes.

What's going on there?

Say that again? I lost you.

With Paradise Water Supply on the Western Slope, what's going on with kind of -- I think all the back and forth you guys have had with the water board and whatnot?

Yes, that's a conditionally decreed asset on the Colorado River. And what we are looking at is really a similar-type play, where we can find an energy company, and there's a number of energy companies working in that area, that's right in the middle of the [Peyonce] and the [Rhone] plateau. And it's not a real strategic asset for us; it's kind of disjuncted from the core assets that we have, and developing those core assets for municipal use. So, we are looking at exploring the opportunities of that with one of the oil and gas companies. How we do that -- we have a wide range of flexibility in being able to either work together with them on that or diversify that asset and allow them to take it forward.

Are there plans to do another equity raise, as you kind of build out these other two wells and probably some other CapEx investment?

We don't have that at the time. I think we have a solid cash position right now, that certainly would extend into the proposed expansion of our water systems through 2013. So, we don't have that, but if there are opportunities that present themselves, we will certainly highlight that with you all and see how we might want to pursue those.

Great. Thank you for your time.

Elliott Knight, Knight Advisors.

Mark, you've covered most of the questions. The figure $1.5 million was mentioned as a burn rate. Is that pretty close to what it is now?

You know, but for last year, which we had some extraordinary one-times, yes.

What do you think it is now, without the extraordinary items?

It's about that $1.5 million. It's probably about $1.8 million, and then we have about normalized revenue at $300,000. So, a net burn of about $1.5 million.

Okay. Looking ahead to this fiscal year, August of 2012 and then August of 2013 as best you can, do you think you are going to get to being cash flow positive?

So, just go ahead and put the tough question out there for us.

Why not?

You know, honestly, Elliott, I would love to be able to give you guidance that said that we would, given everything we know, we don't have any real contracts in place that give us the ability to give that kind of guidance, right now. It's certainly -- there are opportunities that we have that could get us there, and I'm very excited about that. And if I can give you guidance at mid-year basis, I will certainly try and do that.

Tap fees have stayed level, at around $22,500 the last two, three years. I'm assuming that's about what -- there will be no change in them this July. Is that --

They typically adjust in January. Our rate base districts adjust in January, and then we have a six-month lag on that. So, next July. And they have held them relatively flat for a period of years, really for two reasons -- one, they didn't want to disincentify whatever growth they did have occurring in their areas, and that there wasn't substantial growth for them to really benefit from a change in those rates. So, they will probably maintain that level, and then you may see some movement in that as housing starts to recover.

Thank you.

At this time, I would like to turn it over to our speakers for any closing remarks.

Again, I would like to thank you all for your continued support for the Corporation. As you probably gleaned from my comments in the questions, 2011 has been a very important year for the Company. We have had the opportunity to diversify away from what is a sluggish housing market. Housing will still continue to be a very strong component of the Corporation and monetizing the corporate assets.

Our water portfolio continues to grow in value. We are very excited about these acquisitions that we have made, not only on the water portfolio, but also in the property acquisition and in our ability to help incentify growth to the Company's service areas. We are excited about some of the monetization of these assets in non-housing-related area, being the oil and gas area. And so, we look forward to delivering very outstanding results in 2012 and carrying forward.

If you all have other follow-up questions, don't hesitate to give me a call. As I may not have mentioned, I will be in New York the end of the month, presenting at the New York Society Security Analyst 15th Annual Water Conference on December 1. So, I will be in New York on November 30 and December 1, and then I will also be in Boston on December 2 for some investor meetings. But if any of you are in the area and would like to catch up on some of our operations, some of the results, please feel free to give me a call. We have some group meetings that I would love to invite you to. Or, if that doesn't work out, maybe we can schedule some one-on-ones. So, with that, I will sign off and look forward to talking with you again in the future.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.