PURE CYCLE CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW The discussion and analysis below includes certain forward-looking statements that are subject to risks, uncertainties and other factors, as described in “Risk Factors” in the 2020 Annual Report, that could cause our actual growth, results of operations, performance, financial position and business prospects and opportunities for this fiscal year and periods that follow to differ materially from those expressed in or implied by those forward-looking statements. Readers are cautioned that forward-looking statements contained in this Quarterly Report on Form 10-Q should be read in conjunction with our disclosure under the heading “Disclosure Regarding Forward-Looking Statements” below. The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand our results of operations and financial condition and should be read in conjunction with the accompanying condensed consolidated financial statements and the notes thereto and the financial statements and the notes thereto contained in the 2020 Annual Report. This section focuses on the key indicators reviewed by management in evaluating our financial condition and operating performance, including the following: ● Revenue generated from providing water and wastewater services; ● Revenue from lot sales at Sky Ranch; ● Expenses associated with developing our water and land assets; and ● Cash available to continue development of our land, water rights and service agreements. Our Business We are a diversified land and water resource development company. At our core, we are an innovative and vertically integrated wholesale water and wastewater service provider that, in addition to owning and developing water and wastewater resources, is developing a master planned community on land we own and to which we provide water and wastewater services. We have accumulated valuable water and land interests over the past 30 years and have developed an extensive network of wholesale water production, storage, treatment and distribution systems, and wastewater collection and treatment systems that we use to serve domestic, commercial and industrial customers in the Denver metropolitan region. Our primary land asset, Sky Ranch, is located in one of the most active development areas in the Denver metropolitan region along the quickly developing I-70 corridor, and we are developing lots at Sky Ranch for residential, commercial, retail, and light industrial uses. Although we report our results of operations in two segments, our water and wastewater resource development segment and our land development segment, we operate these segments as a cohesive business designed to provide a cost effective, sustainable and value-added business enterprise. Water and Wastewater Water resources throughout the western United States and more prominently in Colorado are a scarce and valuable resource. We own or control a portfolio of 29,500 acre-feet of groundwater and surface water supplies, 26,000 acre-feet of adjudicated reservoir sites, wastewater reclamation facilities, water treatment facilities, potable and raw water storage facilities, wells and water production facilities, and roughly 50 miles of water distribution and wastewater collection lines. Our water supplies and wholesale facilities are located in southeast Denver, in Arapahoe County, an area which is limited in both water availability and infrastructure to produce, treat, store, and distribute water and wastewater, which we believe provides us with a unique competitive advantage in offering these services. We provide wholesale water and wastewater service to local governments, including the Rangeview District, Arapahoe County, the Sky Ranch CAB, and Elbert 86 District. Our mission is to provide sustainable, reliable, high quality water to our customers and collect and treat wastewater using advance water treatment systems, which produce high quality reclaimed water we can reuse for outdoor irrigation and industrial demands. By using and reusing our water supplies, we seek to demonstrate good stewardship over our valuable water rights in the water-scarce Denver, Colorado region. We design, permit, construct, operate and maintain wholesale water and wastewater systems that we own or operate on behalf of governmental entities. We also design, permit, construct, operate and maintain retail distribution and collection systems that we own or operate on behalf of our governmental customers. Additionally, we handle administrative functions, including meter reading, billing and collection of monthly water and wastewater revenues, regulatory water quality monitoring, sampling, testing, and reporting requirements to the Colorado Department of Public Health and Environment. 16 Index Land Development Our Land Development segment is primarily focused on actively developing the Sky Ranch Master Planned Community located along the I-70 corridor to provide residential, commercial, retail, and light industrial lots. Sky Ranch is zoned to include up to 3,200 single-family and multifamily homes, parks, open spaces, trails, recreational centers, schools, and over two million square feet of retail, commercial and light industrial space just four miles south of Denver International Airport. Our land development activities include the design, permitting, and construction of all the horizontal infrastructure, including, storm water, drainage, roads, curbs, sidewalks, parks, open space, trails and other infrastructure to deliver “ready to build” finished lots to home builders and commercial customers. Our land development activities generate revenue from the sale of finished lots as well as construction revenues from activities where we construct infrastructure on behalf of others. Land development revenues come from our home builder customers under specific agreements for the delivery of finished lots as well as reimbursements for the construction of public improvements, such as roads, curbs, storm water, drainage, sidewalks, parks, open space, trails etc., which come from the local governmental entity, the Sky Ranch CAB, subject to the approval and issuance of municipal bonds to fund such reimbursements. Our land development activities provide a strategic complement to our water and wastewater services because a significant component of any master planned community is providing high quality domestic water, irrigation water, and wastewater to the community. Having control over land and the water and wastewater services enables us to build infrastructure for potable water and irrigation distribution, wastewater and storm water collection, roads, parks, open spaces and other investments efficiently, and to manage delivery of these investments to match take-down commitments from our home builder customers without significant excess capacity in any of these investments. In June 2017, we entered into separate contracts with Richmond American Homes, Taylor Morrison, and KB Home, pursuant to which we agreed to sell 506 total single-family, detached residential lots at the Sky Ranch property. We are obligated, pursuant to these contracts, to construct infrastructure and other public improvements as well as wholesale infrastructure improvements (i.e., a wastewater reclamation facility and wholesale water facilities). As of November 30, 2020, we have incurred $34.5 million related to the development of the first filing of Sky Ranch out of the total estimated $35.8 million. We anticipate the remaining $1.3 million will be incurred during our fiscal 2021. These amounts include estimated reimbursable costs of $31.6 million, for which we received a partial reimbursement of $10.5 million in November 2019. We believe the outstanding $21.1 million of remaining reimbursables from the Sky Ranch CAB will be paid from future municipal bonds as the project continues to grow its assessed value and tax base. As of November 30, 2020, we have recognized $35.4 million of the sales price contracted for with the home builders and the remaining $1.4 million is expected to be recognized as revenue in our fiscal 2021. In addition, from the start of development at Sky Ranch through November 30, 2020, the Sky Ranch development produced $9.9 million of water and wastewater tap fees, and we expect that an additional $5.0 million of tap fees will be received during our remaining fiscal 2021. In November 2020, we entered into separate contracts with KB Home, Meritage Homes, Melody (a DR Horton Company) and Challenger Homes to sell 789 single-family attached and detached residential lots at the Sky Ranch property. This next development phase of Sky Ranch will incorporate approximately 250 acres and is planned to be completed in four sub-phases. Due to our strong performance in the first filing of the Sky Ranch project, we were able to realize a 30% increase in our lot price from $75,000 for a 50’ lot in phase one to $97,000 for the same 50’ lot in the first subphase of filing two. The timing of cash flows will include certain milestone deliveries, including, but not limited to, completion of governmental approvals for final plats, installation of wet utility public improvements, and final completion of lot deliveries. In January 2021, we expect to begin construction on the second filing at Sky Ranch, which is expected to include 895 residential lots. The 106 lots not currently under contract to home builders are being retained for future use. Recent Developments As the novel strain of the coronavirus (“COVID-19”) continues to escalate, we have taken measures to protect the health and well-being of our employees, customers, business partners, and their families. We have staggered the in-office work hours of various staff to ensure we can maintain proper social distancing, we require face coverings in all indoor settings as well as when employees are unable to maintain proper distance while working outside, and we have enhanced our cleaning and disinfecting activities. We have been able to maintain our level of efficiency with the use of video conferencing and electronic data sharing platforms. We were informed that our builder customers also took precautionary measures to ensure the safety of their employees, customers, business partners, and their families. These measures varied by builder. As a result, some of our builder customers reported material net housing order declines during the period (compared to the same period a year prior). However, they are also reporting material increases in orders since the stay-at-home orders have been reduced. We had been expecting to accelerate deliveries of the remaining finished lots at Sky Ranch into fiscal 2020; however, as a result of the COVID-19 precautionary measures and stay-at-home orders, we delivered the remaining lots during the three months ended November 30, 2020. These deliveries were still ahead of the original delivery dates set forth in our contracts with the home builders by nearly two years. The most dramatic impact on our operations has been the delay in inspections, the permit process and other activities requiring governmental agencies due to expansive work restrictions imposed on their operations. We expect COVID-19 to continue to play a role in potential delays related to the second filing at Sky Ranch due to rapidly changing governmental orders, city and country shutdowns, and public health concerns. Mainly, we have experienced delays in the permitting process through the county. 17 Index Results of Operations Executive Summary The results of our operations for the three months ended November 30, 2020 and 2019 are as follows: Table 1 - Summary of Results of Operations Three Months Ended November 30, 2020 2019 $ Change % Change (In thousands except for water deliveries) Millions of gallons of water delivered 104 16 88 549 % Municipal water usage revenues $ 167 $ 103 $ 64 62 % Oil and gas operations water usage revenues 1,199 37 1,162 3,141 % Total metered water usage revenues $ 1,366 $ 140 $ 1,226 876 % Operating costs to deliver water (excluding depreciation and depletion) 545 254 291 115 % Water delivery gross margin $ 821 $ (114 ) $ 935 820 % Water delivery gross margin % 60 % (81 )% Wastewater treatment revenues $ 42 $ 20 $ 22 110 % Operating costs to treat wastewater 92 26 66 254 % Wastewater treatment gross margin $ (50 ) $ (6 ) $ (44 ) 733 % Wastewater treatment gross margin % (119 )% (30 )% Lot sales revenue $ 2,356 $ 8,542 $ (6,186 ) (72 )% Land development construction costs incurred 1,719 8,063 (6,344 ) (79 )% Land development gross margin $ 637 $ 479 $ 158 33 % Land development gross margin % 27 % 6 % Water and wastewater tap fees $ 1,083 $ 1,672 $ (589 ) (35 )% Other income $ 152 $ 6,662 $ (6,510 ) (98 )% Other income costs incurred $ 24 $ 24 $ — — General and administrative expenses $ 1,086 $ 801 $ 285 36 % Net income $ 845 $ 5,763 $ (4,918 ) (85 )% Discussion of Changes in Summary Results Metered water usage revenues – Our water service charges include a fixed monthly fee and a fee based on actual amounts of metered water delivered, which is based on a tiered pricing structure that provides for higher prices as customers use greater amounts of water. We typically negotiate the terms of our rates and charges with our wholesale customers as a component of our service agreements prior to commencement of service. Our rates and charges for service on the Lowry Range are based on the average rates and charges of three surrounding water providers. Water deliveries and water revenues increased during the three months ended November 30, 2020, as compared to the three months ended November 30, 2019, primarily as a result of water sales to oil and gas operations. Water delivery gross margin increased from fiscal year 2020 as a result of the difference in metered rates for fracking water compared to rates for tap customers, as revenues received for fracking water have a higher margin. Increases and decreases in water deliveries charged at different rates will result in disproportionate increases and decreases in revenues and margins. The following tables detail the sources of our sales, the number of kgal (1,000 gallons) sold, and the average price per kgal for the three months ended November 30, 2020 and 2019. 18 Index Table 2 - Water Revenue Summary Three Months Ended November 30, 2020 2019 Customer Type Sales (In thousands) kgal Average price per kgal Sales (In thousands) kgal Average price per kgal On Site $ 32 2,642 $ 11.92 $ 41 5,460 $ 7.47 Export – Commercial 21 2,353 9.12 14 1,644 8.64 Sky Ranch 99 12,298 8.06 9 373 23.89 Wild Pointe 15 6,496 2.32 39 7,776 5.07 Fracking 1,199 80,104 14.97 37 748 49.97 $ 1,366 103,893 $ 13.15 $ 140 16,001 $ 8.79 Wastewater treatment revenues – Our wastewater customers are charged based on the estimated amount of wastewater treated. Wastewater treatment revenues increased during the three months ended November 30, 2020, as compared to the three months ended November 30, 2019. The increase was primarily due to increased wastewater treatment revenues from the development at Sky Ranch. The wastewater gross margin decreased compared to the three months ended November 30, 2019, due to an increase in staff required to maintain the water reclamation facility at Sky Ranch development and additional startup costs related to the new facility, which went into service in the second quarter of fiscal 2020. As we add customers to the wastewater system, the margins are expected to increase as the system was designed to provide services to more than 2,000 connections, which has the effect of overburdening the initial revenues with higher per unit costs upfront. Lot sales revenues – Lot sales revenues decreased during the three months ended November 30, 2020 compared to the three months ended November 30, 2019, primarily as a result of timing of our progress of the first filing at Sky Ranch. To date, we have recognized $35.4 million of the estimated total revenue $36.8 million related to the first filing at Sky Ranch. Revenue for KB Homes, for which we recognize revenue when finished lots have been delivered, has been fully recognized. The remaining revenues relate to Richmond Home and Taylor Morrison and will be recognized in our fiscal 2021. Water and wastewater tap fees – Tap fees and other revenues decreased during the three months ended November 30, 2020 compared to the three months ended November 30, 2019, primarily as a result of timing of tap sales by our homebuilder customers. During the three months ended November 30, 2020, we sold 35 water and wastewater taps at Sky Ranch and 1 water tap at Wild Pointe, compared to 58 water and wastewater taps during the three months ended November 30, 2019. Tap sales are driven by home closings and are not contractually established with the builders. General and Administrative Expenses Significant general and administrative (“G&A”) expenses for the three months ended November 30, 2020 and 2019, respectively, were: Table 3 - Significant G&A Expenses Three Months Ended November 30, 2020 2019 $ Change % Change (In thousands) Salary and salary-related expenses: Including share-based compensation $ 685 $ 412 $ 273 66 % Excluding share-based compensation $ 588 $ 306 $ 282 92 % Professional fees $ 186 $ 145 $ 41 28 % Fees paid to directors and D&O insurance $ 50 $ 49 $ 1 2 % Public entity related expenses $ 29 $ 28 $ 1 4 % Salary and salary-related expenses – Salary and salary-related expenses increased for the three months ended November 30, 2020, as compared to the three months ended November 30, 2019, primarily as a result of increased headcount of 5, fiscal 2021 bonus accrual and the addition of our 401K match policy. Professional fees – Professional fees increased for the three months ended November 30, 2020, as compared to the three months ended November 30, 2019, primarily as a result of increased consulting services and increased audit and tax fees. Other Income and Expense Items 19 Index Table 4 - Other Items Three Months Ended November 30, 2020 2019 $ Change % Change (In thousands) Other income items: Oil and gas royalty income, net $ 75 $ 270 $ (195 ) (72 )% Oil and gas lease income, net $ 52 $ 62 $ (10 ) (16 )% Interest income $ 15 $ 54 $ (39 ) (72 )% Other income $ 10 — $ 10 — Income from reimbursement of construction costs (related party) $ — $ 6,276 $ (6,276 ) (100 )% Oil and gas royalty income – Oil and gas royalty income decreased during the three months ended November 30, 2020 compared to the three months ended November 30, 2019, primarily as a result of decreased oil and gas production. As a result of COVID-19 and the resulting economic effects caused by stay-at-home orders and less travel and commuting, oil and gas prices decreased significantly and have not rebounded, making new production less attractive to oil and gas companies. Oil and gas lease income – Oil and gas lease income decreased during the three months ended November 30, 2020 compared to the three months ended November 30, 2019, primarily as a result of the expiration of our lease with Bison Oil and Gas, LLP. Interest income – Interest income represents interest earned on the temporary investment of capital in cash and cash equivalents, investments, finance charges, and interest accrued on the notes receivable from the Rangeview District and the Sky Ranch Districts. The decrease in the three months ended November 30, 2020 compared to 2019 was primarily attributable to short term investments held in the first quarter of fiscal 2020. Due to the current low interest rates, we are no longer holding any short-term investments. Income from reimbursement of construction costs - related party – In November 2019, the Sky Ranch CAB issued $13.2 million of bonds related to the public improvements at Sky Ranch. This is only a portion of the total $31.6 million which is eligible for reimbursement. We anticipate the Sky Ranch CAB will reimburse us for the remaining $21.1 million either by the issuance of bonds for that amount in the future as development continues at Sky Ranch or from property tax assessments received by the Sky Ranch CAB. Of the $13.2 million of bonds issued, we received $10.5 million, which represents the partial reimbursement of the advances we made to the Sky Ranch CAB for construction of the public improvements pursuant to a funding agreement between us and the Sky Ranch CAB. Of the $10.5 million we received, $4.2 million was recorded as a reduction to the Land Development Inventories account and $6.3 million was recognized as Income from reimbursement of construction costs - related party in other income. Liquidity, Capital Resources and Financial Position At November 30, 2020, our working capital, defined as current assets less current liabilities, was $19.9 million, which included $21.3 million in cash and cash equivalents. We believe that as of November 30, 2020, and as of the date of the filing of this Quarterly Report on Form 10-Q, we have sufficient working capital to fund our operations for the next 12 months. Sky Ranch Development The first filing at Sky Ranch is nearing completion, with approximately $1.3 million remaining obligations. Filing 2 is preparing to break ground January 2021. We anticipate future revenues from water and wastewater tap fees as well as progress payments from our homebuilder customers and our existing cash balances will fund our obligations for the next 12 months. ECCV Capacity Operating System The Rangeview District may purchase water produced from East Cherry Creek Valley Water and Sanitation District’s (“ECCV”) Land Board system. ECCV’s Land Board system is comprised of eight wells and more than 10 miles of buried water pipeline located on the Lowry Range. In May 2012, we entered into an agreement to operate and maintain the ECCV facilities, allowing us to utilize the system to provide water to commercial and industrial customers, including customers providing water for drilling and hydraulic fracturing of oil and gas wells. Our costs associated with the use of the ECCV system are a flat fee of eight thousand dollars per month from January 1, 2013 through December 31, 2020, and will decrease to three thousand dollars per month from January 1, 2021 through April 2032. Additionally, we pay a fee per 1,000 gallons of water produced from the ECCV’s system, which is included in the water usage fees charged to customers. The ECCV system is anticipated to continue to cost us approximately ten thousand dollars per month to maintain going forward. 20 Index South Metropolitan Water Supply Authority (“SMWSA”) and the Water Infrastructure Supply Efficiency Partnership (“WISE”) We have entered into a financing agreement that obligates us to fund the Rangeview District’s cost of participating in WISE. We anticipate that we will be investing $1.1 million in 2021 and $7.5 million in total for the fiscal years 2022 through 2025 to fund the Rangeview District’s obligation to purchase water and infrastructure for WISE, its obligations related to SMWSA, and the construction of a connection to the WISE system. In exchange for funding the Rangeview District’s obligations in WISE, we will have the sole right to use and reuse the Rangeview District’s 9% share of the WISE water and infrastructure to provide water service to the Rangeview District’s customers and to receive the revenue from such service. Our current WISE subscription entitles us to approximately three million gallons per day of transmission pipeline capacity and 500 acre feet per year of water. Summary Cash Flows Table Table 5 - Summary Cash Flows Table Three Months Ended November 30, 2020 2019 $ Change % Change (In thousands) Cash provided by (used in): Operating activities $ 6 $ 14,721 $ (14,715 ) (100 )% Investing activities $ (499 ) $ 2,875 $ (3,374 ) (117 )% Financing activities $ (1 ) $ (2 ) $ 1 50 % Changes in Operating Activities – Operating activities include revenues produced by our segments less costs incurred in the delivery of those services and G&A expenses. Cash provided by operations decreased in the three months ended November 30, 2020 compared to 2019, primarily as a result of the bond payment we received as partial reimbursement of public improvement expenditures from the Sky Ranch CAB and increased lot sales revenues in the three months ended November 30, 2019. Changes in Investing Activities – During the three months ended November 30, 2020, investing activities used $0.5 million primarily due to investments in our water, water systems, and land development activities. Conversely, during the three months ended November 30, 2019, investing activities produced $2.9 million, primarily as a result of the sale of short-term investments, partially offset by investments in our water, water systems, and land development activities. Off-Balance Sheet Arrangements Our off-balance sheet arrangements consist entirely of the contingent portion of the CAA as described in Note 5 – Long-Term Obligations and Operating Lease – Participating Interests in Export Water Supply to the accompanying condensed consolidated financial statements. The contingent liability is not reflected on our balance sheet because the obligation to pay the CAA is contingent on sales of Export Water, the amounts and timing of which are not reasonably determinable. Critical Accounting Policies and Use of Estimates Our critical accounting policies and estimates are described in “Critical Accounting Policies and Estimates” within Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended August 31, 2020 and Note 2 of the Notes to Consolidated Financial Statements in “Financial Statements and Supplementary Data” included as Item 8 in our Annual Report on Form 10-K for the year ended August 31, 2020. With the exception of updates to significant accounting policies discussed in Note 1 of this Quarterly Report on Form 10-Q, the accounting policies and estimates used in preparing our interim condensed consolidated financial statements for the three months ended November 30, 2020 are the same as those described in our Annual Report on Form 10-K for the year ended August 31, 2020. There have been no changes to our critical accounting policies during the quarter ended November 30, 2020. Certain information and note disclosures normally included in our annual financial statements prepared in accordance with GAAP have been condensed or omitted from the interim financial statements included in this Quarterly Report on Form 10-Q pursuant to the rules and regulations of the SEC, although we believe that the disclosures made are adequate to make the information not misleading. The unaudited condensed consolidated financial statements and other information included in this Quarterly Report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the year ended August 31, 2020. Recently Adopted and Issued Accounting Pronouncements See Note 1 – Presentation of Interim Information to the accompanying condensed consolidated financial statements for recently adopted and issued accounting pronouncements. 21 Index Disclosure Regarding Forward-Looking Statements Statements that are not historical facts contained in or incorporated by reference into this Quarterly Report on Form 10-Q are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements involve risks and uncertainties that could cause actual results to differ from projected results. The words “anticipate,” “goal,” “seek,” “project,” “strategy,” “future,” “likely,” “may,” “should,” “will,” “believe,” “estimate,” “expect,” “plan,” “intend” and similar expressions and references to future periods, as they relate to us, are intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions . These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including without limitation the risks described in “Risk Factors” in Part II Item 1A of our most recent Annual Report on Form 10- K, and in the reports we file with the Securities and Exchange Commission. These risks are not exhaustive. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Forward-looking statements should not be relied upon as predictions of future events. We can provide no assurance that the events and circumstances reflected in the forward-looking statements will be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. We assume no obligation to update or supplement forward-looking statements, except as may be required under applicable law. 22 Index Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.