Pure Cycle Corporation (PCYO) Q4 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Pure Cycle earnings conference call. [Operator Instructions] As a reminder this conference call is being recorded. I would now like to turn the conference over to Mark Harding, President and CEO. Please begin.

Thank you. Good afternoon. I'd like to welcome you all to our 2013 year-end call. As with the prior calls, we have a slide deck for this call that you'll have to access through our website. So you can go over to purecyclewater.com and on the front page of our website, you'll see a section down there called Latest Report and you can click on that presentation. The slides are right there. As you're on your computers, I will note the transition of slides through my presentation so that you can match the slides to the dialogue in the presentation. So with that, let's begin. Our first slide is of course, our Safe Harbor statement that's referencing the 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 the projected results. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. We cannot assure you that any of the expectations will be realized. For additional disclosures of our Safe Harbor statement, please refer to this slide. Okay. On our first slide, or move to the Slide 3. I want to lead off with a really good slide that really set the tone for our year end. We had a terrific year end. I want to note a very important fiscal note, which is revenues this year. The company generated more than $1.8 million in revenues for 2013. We have a typo in there, its fiscal year 2013. We generated a little over $1.8 million, the difference there between $1.79 million is we had some consulting revenues that really weren't part of our 4 operating business revenue sources. So to highlight our 4 areas of activities, as most of you know, we have our municipal water and wastewater service business, which had revenues in par with last year about $220,000 in revenue. We have our agricultural segment, agricultural leasing revenues were about $1.25 million for fiscal 2013. We have our industrial water sales, selling water to the oil and gas industry for drilling and hydraulic fracturing, which generated about $326,000 and then we have some oil royalty leases from some properties that we own here in the Denver area. If you move to the next slide, focusing on our core business, enterprise being our wholesale water and wastewater service business. There were not any new changes to this business segment. We do have a little bit modest increase in revenues just due to some rate increases. This segment is mostly tied to the recovery of the housing markets. Our revenues were really in line with last year's revenues about $220,000. Moving on to the next slide. What this really illustrates is our primary area of emphasis, which continues to be our service area with the State Land Board's Lowry Range and the eastern I-70 corridor, including our Sky Ranch property and adjoining areas in this area, such as the Arapahoe County Fairgrounds. Our real focus here is to provide water and wastewater service in a cost-effective way in and around areas where our Denver portfolio originates, really to allow us a very cost-effective incremental increase in our service capacities. If you move to the next slide, one of the key areas of progress that we've made is -- in the wholesale water and wastewater service area is our participation, together with the Rangeview Metropolitan District who is a district that we operate through intergovernmental agreements, with a regional project known as the Water Infrastructure Supply Efficiency project, which is acronym-ed as WISE. The WISE project seeks to interconnect the water systems from 12-area water providers to deliver new water supply, increase reliability of the existing supplies and to be able to interconnect the infrastructure, water delivery infrastructure for all of the water providers in the south and southeast metropolitan area. This year saw some significant milestones to advance this project with only a few pieces needed to be put together to complete this project before it becomes operational. The objectives of this project really are to deliver new water to each participant, which will -- we will be a participant too and, more importantly, to be able to move water supplies among each of the water participants as the infrastructure will be interconnected. We look forward to our continuing participation in this landmark regional project. And this is really one of the first cooperative water projects in the Denver metropolitan area and we're delighted and privileged to be a participant in this project. Moving onto the next slide. I'd like to give you guys a brief update on the local housing market, which continues to perform well. Housing starts continue to increase year-over-year and lot availability continued to decline, 2 things that we the kind of track on an ongoing basis. Both of those bode well for the development in our service area and areas surrounding our service area, as well as our Sky Ranch project. You can see the metrics of those statistics that we get from Metrostudy, which is a real estate tracking firm here. It's actually a national tracking firm that has tracking services here in Colorado. But the specifics are, we increased housing starts by another 34% year-over-year from 2012 to 2013 and the inventory of finished homes continues to decrease and the supply of lots continues to decrease. So with that as kind of an overview of our municipal water and wastewater service business, I'd like to move to the next slide and really talk a little bit about our agricultural segment, which performed very well during 2013, generating a little more than $1.2 million in revenue. This was slightly more than our expected annual results due to the timing of our taking over this operations last year. We expect this segment to generate a little more, right around $1 million a year and look to continue to improve the return of this operating asset by building and adding farm improvements, such as center pivot systems, sprinkler systems in 2014. As a component of this on the next slide, I want to talk a little bit about, as we're talking about our agricultural farms, the High Plains A&M default. A brief update to that default, we purchased additional farms -- or additional notes, not additional farms. We purchased additional notes, which were High Plains notes, throughout the year and are finalizing the purchase of the remaining notes not already bought by the company. There's probably 3 or 4 remaining notes that we're working on with the sellers of those notes to be able to purchase those to completely remedy the default by High Plains. We are processing these notes through a foreclosure process to clear title to the property, and then ultimately we'll seek our remedies under the Asset Purchase Agreement with the High Plains A&M. We are in various litigations with High Plains surrounding this default. While I understand there's a great interest in the outcome here, I'm limited in what I can -- in my remarks about this as we are in active litigation. But that said, what I do want to emphasize that it is the company's preference in any litigation, whether it's High Plains litigations or other litigations that the company is involved with, to really resolve our issues with the party by settlement rather than through the court process. So it is still management as well as our board's intent to try and resolve this through settlement rather than through litigation, but the company is prepared to continue to proceed through the foreclosure process and through our remedies through the litigation process. Some of the results of that have been indicated in our year-end results, which you will see in our income statement and our financial statements later in the presentation. Transitioning to the next slide to give you kind of an overview of our farming operations. We own about 16,800 -- I think I have a fast-finger typo in that. I think that says 17,800, but it's actually 16,800 acres of irrigated farmland in southeast Colorado. We have approximately 80 tenant farmers and most of these tenant farmers are cash-lease tenant farmers that farm using flood irrigation, and this kind of gives you an illustration. The canal that we have our rights to is the Fort Lyon Canal and it extends -- it's one of the older canal systems. I think it's the largest canal system in the state of Colorado that extends over 100 miles in irrigation, almost 100,000 acres of irrigated farmland. Transitioning to the next slide. The principal crops are mostly feed crops. We expect to see more higher-value crops as we add some of the farm improvements such as sprinklers, and move our farms from a cash lease to a crop share lease. We believe there is significant room to improve the returns on this asset by making these improvements, making these investments and being able to generate significant crop share returns with our tenant farmers on more higher-value crops than maybe necessarily the alfalfa or sorghum crops. With that as a summary of our agricultural operations, I want to move a little bit to kind of the area of real excitement for the company, which is our industrial water sales. We've had a robust growth in selling water to the oil and gas industry during 2013, mostly for drilling and frac-ing of oil wells in and around our service area. Colorado has seen an explosion of new oil and gas activity in recent years to develop the Niobrara oil shale formation. Revenues for 2013 for industrial sales generated about $325,000 in revenue and are expected to increase significantly as our operators move from an assessment phase to understand the orientation of the formations, their drilling programs and how they'd like to drill out each of the various potential formations into what they define as a development phase over the next several months or a year or so. Moving to the next slide. This slide really gives you an illustration of where some of the excitement is coming from on this Niobrara formation. Being that many of the operators believe there is as many as 5 productive oil-bearing formations in this Niobrara formation, kind of shows you an orientation of where some of the core Wattenberg field is, a little bit farther north of us, maybe 50 miles north of where we are. We're in what they define as the southern Wattenberg field and in our area of interest, we're looking at maybe as much as 200 square miles where oil and gas operators have leased out those areas, those leasehold interests. The next slide really kind of drills down on some of those leasehold interests. If you look at that, kind of defines where our service area is with the bright yellow lines being the Lowry Range, some of the water distribution systems that we have there and then really, our primary operator in this area is ConocoPhillips. They've leased up about 130,000 acres. They have -- to date, they have drilled approximately 17 wells, each of them using about 7 million gallons of water to drill, to frac and to complete those wells. So as they move from the assessment phase, they've given us some guidance that 2014 will continue through their assessment phase and then they'll make a determination on which areas that they want to focus on for actual production development of the formations. But what that does do for us is it does have a large water demand component to this. As they move to the development phase, those areas that they seek to develop, they could develop as many as 8 to 10 wells per formation that they seek to develop. So if they find that there is multiple formations that they want to develop, they could develop a number of wells, horizontal wells using water to frac each of those wells. So we look forward to increasing our supply capacities to meet that continuing demand. Transitioning to the next slide. Continuing with our oil and gas opportunities, we have 2 mineral leases with ConocoPhillips: 1 small lease on approximately 42 acres on the eastern side of the Lowry Range and then the larger lease totaling approximately 640 acres at Sky Ranch. The small lease was renewed by Conoco last June and then our larger Sky Ranch lease is a 5-year lease. It was a 3-year lease with a 2-year renewal. The start date on that was March 2011, which will extend until March of 2014 and Conoco can extend that for an additional bonus payment of about $1.25 million and get an additional 2 years on that. If you take a look at the next slide, that's an illustration of some of the activity that we've had with our operator, Conoco, on the Sky Ranch lease who are looking to identify new well sites from the original well sites. They've reoriented their alignment of the wells from a north-south orientation to an east-west orientation. So we've looked at where potential sites would be, new sites for them on that, and we look to really minimize our sites to the impact with the potential development of the properties. So we look for orientation of well sites along roadways that are less desirable for residential development activity. Conoco has applied for 2 well permits on the site to be able to drill multiple wells, horizontal wells on that site. They're looking at 10,000-foot lateral wells. So they're looking at drilling not only through our 640 acres but into the adjoining sections, so pooling 1,260-acre well pad sites with that. And that seems to be one of the trends in this area is to have 2-square-mile pooling of interest and have 10,000-foot laterals. They just frac-ed their first 10,000-foot lateral last week that we delivered them water for and I've not got the results of how the frac went or how much water was used for that frac. It's in excess of the 7 million gallons that we've been seeing for the 5,000-foot laterals, but we haven't got those final numbers yet. The next slide, really the slide details some of the specifics of our Sky Ranch lease, the oil and gas lease specifically, terms and conditions of that and the opportunity for them to extend that for additional 2 years in March of next year. So with that as an overview of our business and kind of the general trends, what I'd like to do is move to a summary of the financial performance for 2013. 2013, as I mentioned, was a good year. I mean, it's kind of a transition year for us. Last year, I think our total revenues were about $300,000 and generating revenues of about $1.8 million is really a breakout year for the company. Our water deliveries increased and we had nearly 2x the amount of water deliveries this year over last year and then more than doubled our revenues associated with those, moving from about $180,000 to over $0.5 million in water deliveries, both in terms of our domestic unit -- domestic water sales, as well as our industrial water sales. Moving to the next slide. General and administrative expenses were in line with prior year. The company continues to be good stewards of its invested capital. In our overhead, generally, are a little higher than what we would see in normal years of operating due to legal costs relating to the High Plains default and pursuing remedies in the foreclosures of those notes, those defaulted notes by High Plains. Moving on to the next slide. The income statement looks significantly improved with revenues up over 500%, maintaining our costs and our G&A in line. We have a decrease in the imputed noncash interest expense from the royalty liability that we have to High Plains A&M, that Tap Participation Fee liability as a result of the some of the foreclosures from the HP A&M default. So you'll see that continuing to improve, but that shows up significantly well. We did have some significant impairments and write-off issues last year. If you want to move to the next slide, that's really highlighted in that slide on what each of those components were last year. If you've been following the company, you certainly know that the company had written off part of our West slope assets. We still own the asset, but we impaired the asset last year, full impairment of that asset last year pending reconsideration of what we want to do with that asset, as well as some write-downs of some farms that we identified for sale. We have approximately 5 farms that we have under contract to sell that will close later in the year as a result of some of the High Plains foreclosures. Again, most of the NOL, a good, maybe 2/3 of the NOL that we have is going to come from that imputed interest expense from the royalty obligation to High Plains A&M. So it's a noncash interest expense. Keeping track of really the company's general and administrative expenses, really, we are still in line with really where our expenses have been for the last several years. Moving to the next slide, liquidity. Liquidity decreased as we used some of those monies to purchase the defaulted High Plains notes. We have contracted to sell 5 farms, as I mentioned previously, which would generate about $5 million for the company and those are set to close sometime in 2014. So we believe we have an excellent liquidity position to continue to operate, continue to invest in additional capacities of our water delivery system should that need arise as our demand for our industrial water continues to grow or any other opportunities for the company. Moving onto the next slide, total assets. Total assets decreased slightly again because of the cash used to purchase some of those High Plains A&M notes. Many of these notes that High Plains had defaulted on, the company had issued company notes in exchange, our notes, for the defaulted High Plains notes. So most of those notes are 5-year notes that you'll see that we did pick up some debt associated with this default that's referenced in our balance sheet, but very modest debt -- 5-year debt that has terms over a 5-year period at 5%. The next slide, finally, our equity increase and that increases as a result of our remedies against High Plains default. As we're able to process farms through the foreclosure system, we are able to reduce the liability and then the debit to that will go to additional paid-in capital. So you'll see a little pickup on that as a result of a few farms that have taken through the foreclosure process. The last slide is really kind of an overview of our balance sheet and kind of gives you the financial performance. We have a very solid current asset position, relatively modest level of debt with about $5.4 million of debt associated with that, and most of those are going to be those 5-year notes from High Plains A&M. The current liability portion of that is going to be the remaining notes that we are purchasing from High Plains A&M that we're working with the sellers of those to be able to restructure those, either by purchasing those or purchasing those with notes from the company. So with that, I think I'd like to turn it back over to Latoya and we can open it up to questions and answers to see if you all have any questions.

[Operator Instructions] And the first question is from Brent Rystrom of Feltl.

Just a couple of quick questions. Mark, can you kind of give us some thoughts on the crop share leases? I would assume that you're doing, as we've talked in the past, maybe a 30%, 35% share. Have you further thoughts on how you're going to do those crop share leases with the center pivot irrigation?

We have. Most of these are going to be 1/3, 2/3. So we will participate in the actual crop benefits of that, at the 1/3, 2/3 level. The farmer itself will be responsible for all the input cost. So the company doesn't incur anything other than the investment in the sprinkler system and then the farmer -- the tenant farmer will manage the crops if they grow. They'll manage the seed, the water, operating cost to operate the sprinklers and all of the input costs to that crop, whether that's going to be any chemicals, any harvesting, bringing that to market. So we will participate in auditing that trail as they bring that crop to market and then divide those proceeds 1/3, 2/3.

And so it will be proceeds? You don't have a choice to take the grain, for example, if you want it?

That's the one thing that we're still having outstanding is whether or not we want to take delivery of the commodity rather than deliver to market.

All right. And then just from a simplistic perspective, the center pivot is going to cover roughly 111 acres on each 160. Will you be doing anything on the corners or will that land lay fallow?

No. We will typically use the same sort of the old system of flood irrigation on the corners to the extent that some of those corners are -- some corners may roll out of production to leverage the use of the water, but it kind of depends on the farm. We're doing, I think, 3 of these this year -- 2 or 3 of these this year and it depends on -- I think, 2 of them, the corners can be irrigated in the normal flood system to allow us to continue to get yield on that productive ground, and then 1 of them has a difficulty with getting the delivery of the water to the corners of it.

All right. So from a simplistic perspective, you will have 40-some acres on the old system at 100 or 125 an acre, and then 110 acres or so on the new system at the crop share rate?

Correct.

All right. As far as the Tap Participation Fee, did I read it right in the 10-K that subsequent to the quarter, there's been another $11.9 million resolved?

Yes. We had a few that were all together, so they kind of straddled the August 31 year. So we had some that were in the end of August, some that were in the beginning of September. And then a lot of these have a very long lead time in processing those. So we keep chipping away at these or will continue to chip away at these. We did have the High Plains sort of challenge the foreclosure process. We did do a court proceeding on that. The court ruled in our favor. We're sort of waiting to see how that settles out, but we will continue to process these through throughout the year.

And then final question on that. How should we think about the Tap Participation Fee in the forward quarter? Should we base it proportionally on the remaining liability, the proportional amount of parcels that are still out there that haven't been resolved? I would assume it's an amount that diminishes considerably, quarterly as the quarter goes forward. Is that a fair way of looking at it?

Yes, I think so. We're still working with High Plains on this and as I sort of mentioned at the outset, we'd really like to find a settlement route with them but are prepared to fully proceed and really have the ability to proceed through each of these foreclosures. So we'll kind of chip away at that. I think our preference would be to be able to resolve it with one fell swoop, but barring that as an option for us, I think we have a path and a remedy where we can address these a few each quarter. It will likely take us through most of the fiscal year to be able to take a look at most of these foreclosures just because of the lead time on them.

[Operator Instructions] And I'm not showing any further questions at this time. I'll turn the call back over for closing remarks.

Super. Thank you. So really, just to close out the year, the company really is excited about being able to really demonstrate the value of these assets. They have continued to grow in value year-over-year. The company's ideology continues -- has been and continues to be that water continues to grow in its value and, really, this has been one of the first years we've been able to demonstrate that to the market. Some of the things that we're working on -- I know a lot of you are interested in sort of the real estate market here in the Denver area and it is been a very exciting market. It's probably one of the best-performing real estate markets, major metropolitan areas in the country. We continue to work on our Sky Ranch project. That's the bulk of the company's energies right now. Most of my time is spent really understanding what the development of that property would look like. So the company is going to spend and dedicate a considerable amount of time in 2014 really to identify how -- perhaps who we are going to work with in developing that property. We think we understand a great deal about the utility side of it, but we also understand that we're not a developer and probably don't look to be the developer, but have a certain interest in partnering with a developer on that and being able to bring that expertise to Sky Ranch and being able to kick that project off with a very exciting start. Don't have any real guidance to give you on that yet. We want to be cautious about that because we have the ability to do a lot of different structures for that Sky Ranch property. We have a tremendous amount of flexibility being able to structure how we do that, how we participate with that, how we participate the land side and how we can deliver incremental water service to the property, which is an enormous advantage to developing properties. So we're very excited about that. We've met with a lot of homebuilders in the area. We've met with a lot of developers in the area. The dialogue continues to be very robust and we'll see how that continues to progress over the coming months of the following quarters. As many of you know, I will be in New York, I'm catching a flight later tonight but presenting at 2 water conferences, the water conference at the New York Society of Security Analysts tomorrow and the Janney water Industrials Conference on Thursday. And so I have a schedule where I'll be meeting with a few institutional accounts while I'm in New York. If any of you are in the New York area that have an interest, please shout out or e-mail and see if we can't get together and give you a more personalized update on the company's progress and really our excitement for not only what we're seeing in the coming months, but also how our runway looks over the next several years. I'm delighted, had a great year, look forward to another high productivity year, year-over-year water deliveries and year-over-year revenues. And if any of you have any questions that you were looking to ask, but didn't quite get the technology on joining in on the call, don't hesitate to give me a call and follow up with that. And we look forward to additional presentations in the future. So with that, I will thank you, all, again for your continued support and look forward to speaking with you soon.

Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.