Good morning and welcome to Pure Cycle Corporation’s first quarter 2023 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require Operator assistance during this conference, please press star, zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Mark Harding, President and CEO of Pure Cycle. You may begin.

Thank you Jenny. Good morning everyone. I’d like to welcome you to our first quarter earnings call for our fiscal year 2023, and happy new year to you all. We have a slide deck for this. If you can surf over to our website at purecyclewater.com on the landing page, you’ll find a button on there where you can click on that and then we will actually forward through the slides, but it will give you the ability to see some of the text in the slides within the presentation. With that, I’m also joined today this morning by Kevin McNeill, our CFO, and Dirk Lashnits, our Vice President and Director of Land Development, who will also give you updates into some of the business segments and the financial reportings, and then at the end we’ll have a brief Q&A for those of you who want to drill down on some of the specifics. With that, let me first start with our Safe Harbor statement, which I’m sure most of you are familiar with. Statements that are not historical facts that are contained or incorporated by reference in this presentation are forward-looking statements. With that, we’ll get the lawyers out of the room and we’ll start. I’ll just be very brief on some of the overview of the company, but for those of you that are first-timers to the call or new to the company, we really operate on three primary business segments, really that are fundamentally interconnected to each other at the DNA level of the company. We’re a water-wastewater utility company, where we own water in a water-short region here in the State of Colorado and the west. We develop those water rights and we are cradle-to-grave on the water rights, where we develop the wells, the distribution…

Thanks Mark, good morning. Land development - so here’s our flagship project, called the Sky Ranch. Every time I see it, it’s overall view, it always reminds me of the dreaded Tetris piece from that game. This is 930 acres, like Mark said, on the developing edge of development out on the east side of Denver. It has 3,200 residential lot capacity and 2 million square feet of commercial capacity, and we’re about 15 miles east of downtown Denver. Sky Ranch has probably got about a 10 to 15-year build-out that will be heavily dependent on our market conditions. We’re going to build this out in multiple phases. Over the last probably four or five years, you’ve heard us talk a lot about our first phase - that’s the first 500 lots, that’s pretty much in the books, and we’re now moving onto our second phase. That first phase is the block on the left side of the picture, and then our second phase is kind of the middle portion of the parcel, and then future phases will grow out to the east, and our commercial piece is the northern block adjacent to I-70. We plan to build about on average, probably about 250 lots per year out here, and we’ll layer in our schools and commercial pieces and rec centers, all those things that go along with a master planned community. Phasing--as I mentioned, Phase 1 in the books, that was 500 lots. We also had our pilot program for our build-to-rent lots, so we had four occupied units in that phase, 100% complete. Then moving into our second phase, this is 850 lots. We’re sub-dividing this into four sub-phases - that’s 2A through 2D. We are well underway in our Phase 2A - that’s about 80% complete, and…

We’ve got the top one.

Yes, the top one, top two even. Good for stability and in it for the long haul. They’ve certainly seen some of the market swings and are good partners in helping mitigate that. Low unemployment, this is obviously a really important one, we hope that stays positive. House prices still appreciating by now, still a good investment. Lower average days on the market - houses are still selling pretty quickly and those are some typical numbers there. Last year, we were down--in Denver at least, we were under 10 days on average, and houses were selling above asking price sight unseen, day of asking. A year ago, we had that peak and even today with some of the slowdown, we’re still seeing, based on market, in the 20s, so that’s all still good outlook. Onto the bad, or opportunities that we have here, again the abrupt uptick in interest rates kind of shocked the system, and I think we’re slowly adjusting to that. Again, we’re still in kind of historical norms. A lot of the important metrics still trending downward - builder confidence is down, applications for mortgages are down, buyer traffic in the model homes is down, home sales are all down, and then combine that with higher material and labor costs and then our cancellations on contracts are still up. You know, I do think at the end of the day for us, houses are too costly. We need to figure out ways to recalibrate that. The land development side that we do is a link in that chain and how do we adjust for those changing markets, and the way we do that is mostly on a timing--from a timing standpoint, and that’s really our challenge, is trying to time our deliveries. We have a long lead time in the development business. We’re probably anywhere from at the earliest six months, but more likely a year out from when that demand comes online, so we have that challenge on trying to find the right time to build our lots. Here is just a slide, it’s a couple of the--it touches on the job growth chart, interest rates and some sales information. Back to Mark.

I’m going to push this over to Kevin and he’ll give you an update on some of the rental segment, and also just some brief stats on the quarterly performance.

Thanks Mark, thanks Dirk. Yes, so our single family rental, our newest division that we launched in 2021, we continued growing it. We’re up to--we’ve got four houses completed now as of December 15. We’ve got 10 more under construction, and those will be delivered throughout the year, throughout our fiscal 2023. The four that are rented are all rented from $2,800 a month to $3,000 a month, pretty stable renters, we think, so still very optimistic about this market. With this new segment, especially with interest rates continuing to climb, with home values continuing to stay high and the slowing of that market, the rental rate market in Colorado especially is going to be very strong. This is some projections that we put together using our fiscal year from last year, our 2022 results, just because the first quarter is a smaller piece to look at. We’ve projected out with 14 home and 50 homes. Fifty would be the entire Phase 2, 46 homes there and four homes in Phase 1. What you see is our current projections, obviously depending on cost and interest rates and everything else, is about a million dollars a year, just short of a million dollars a year in free cash flows from operations of just the rental units. It doesn’t include obviously overhead or anything like that, but--. The financial results for the quarter, it wasn’t the strongest quarter we’ve obviously had. There was, from a water-wastewater standpoint, as Mark touched on earlier, we continue to invest in the water infrastructure, a little over $67 million now in water rights, which we can pass that water rights themselves and supply infrastructure to bring the water to our customers. We delivered about 67 million gallons this quarter, which is down a little bit from…

Thank you. Okay, so what are our takeaways here? I guess takeaways for management would be the stewardship of how we handle our business model. We’ve got very valuable, very low cost basis legacy assets here, both in terms of the water and the land side of the equation, and what we’ve done successfully is really make sure that we carefully position you all with your invested capital to market exposures, and so one of the ways that we do that is through how we handle our builder contracts, and those of you that are familiar with the company kind of had this appreciation, but we have a lot delivery agreement structure where our builders are working in partnership with us on delivery of this very expensive infrastructure, when you’re in a high cost business where we’re delivering horizontal infrastructure for master planned communities and then the housing side of it, the vertical side is handled by the homebuilders. But that infrastructure is very expensive, and we want to make sure that neither we nor the builders, our builder partners have too much exposures in softer markets, and we’re in a softer market right now. Really, the validation of that business model is the fact that we don’t have any exposure in there, right? As you saw in the presentation and Dirk highlighted, we’ve got about 15% of the Phase 2B, which really would be the grading and the over-excavation components of that, that we’ve invested in, and that’s been covered by our homebuilder customers, so that’s not a significant investment in there. Then as their lot deliveries, and this is about pace, right - this is about how many lots they want to have in inventory because they want to match their sales cycle, and maybe in Phase 1,…

Thank you very much - I am indeed waiting for my lunch as it’s five past two. [Operator instructions] Your first question is coming from Robert Howard from Boiling Point Resources. Robert, your line is live.

Good morning.

Good morning Robert.

I just had a--hi, I just had a quick question on the--for the new customers that are getting added on. You talked about $1,500 of annual revenue from the water customers when they come on. I was just wondering, at least maybe at Sky Ranch, as you’re adding customers, how much additional costs might there be? Are the--you know, is the infrastructure and kind of everything in place so that $1,500 is really kind of almost all incremental, or is there additional costs that kind of get layered on as you’re still kind of building up stuff, or have you kind of reached a critical mass when maybe the costs are decreasing a lot slower than they were earlier in the project?

That’s a good question, and really we segment some of that brick and mortar cost for adding those connections into the tap fee charges. Typically, the way we see it is that the connection charges, that $33,000 for a tap fee charge, we build the wells, the treatment facilities, all of the brick and mortar stuff that delivers that water to the customer through that capital allocation base, and a lot of that is sub--is early on investment that we’ve had, and then also what we see is the oil and gas revenues tend to allow us to expand that system apart from the tap. The way we usually look at is that’s a 50% margin business, but it becomes a little bit better margins because some of the oil and gas revenue, we can allocate to expanding that supply side in advance of those tap connections. When we get the actual connections, the $1,500 connection per year which is really your point, there are additional costs in that because we have an operating entity where we’ve got chemical costs to make sure that we disinfect the water, we have lab costs because we have to continuously sample our water and make sure that our water meets all of the primary and secondary clean water standards, so that business we typically also look at as a 50% business, 50% margin business, and it’s not so much on the capital side as it is on the operating side. We have operators that are making sure that they’re going out, making sure the system is operating correctly, taking a look at whatever’s occurring daily, nightly, weekly on those sorts of things, in addition to really the lab costs. That’s how that divides out. There’s not a significant uptick in that - as a matter of fact, it’s usually a little bit better on the front end because everything is brand new and it operates the way it’s supposed to. But we really--we look at those margins as about those 50% in each segment of that, if that answers your question.

Yes, sure. Then just that $1,500 number, I think you guys have kind of been talking about that for a number of years. Is there pressure on that, or I don’t know, is the market rate elsewhere in Denver, are other people charging that amount, or is there possible pressure for that going up, just inflation in general? How are you able to kind of keep the customer rates flat?

Yes, and I would say there’s two rates there. There’d be the tap fee rate and then the usage rate. The tap fee rate probably has a little bit more upward mobility just because of the scarcity value, and as you continue to hear about the competitiveness of water rights and the incremental costs, because we have to go farther and farther out to reach for those water supplies, I’d say our tap fees have a little higher upside than, say, necessarily usage rates. The usage rates will continue to grow. We continue to grow those for making sure that we keep up with our inflation costs as well as anticipatory costs for whatever the evolving regulatory climate is going to look like, but that’s a little bit more inflation-oriented as opposed to the value of water in water short areas and the cost of water, acquiring those water rights from farther and farther areas. When you take a look at those two revenue streams, there’s probably a little more strength in the tap fee side, which is going to be our big number. You apply that to our portfolio - we have 60,000 connection worth of that, so that’s over $2 billion worth of revenue potential over time as opposed to that $1,500. That’s been a stagnant number. We’re probably a little bit above that - that’s just been a metric number that we continue to look at. I would say that that continues to go at about 3%, 3.5% per year.

Okay, great. That’s all I’ve got. Thanks a lot.

Thanks.

Thank you very much. Your next question is coming from Bill Cunningham, who is a private investor. Bill, your line is live.

Hi Mark, how are you doing?

Just living the dream, Bill!

Good. You know, on the last conference call, I had made the comment about the unusually good results, which were a result of lot sales and tap fees, and we talked about how earnings are lumpy so we might not see the same results quarter to quarter, and this quarter proved exactly what you were talking about. I kind of did some penciling out of things ahead of time to kind of figure out what your numbers might be and thought it was 50/50 as to whether you’d be reporting a loss or a profit this quarter, so it was kind of a pleasant surprise that you actually squeaked through with a bit of a profit. Hopefully nobody else was surprised with the results being not as good as the prior quarter.

No, that’s true, Bill. You know, it’s cyclical in a couple of ways. One, because of the way our year-end reports, that puts us into--and where we report, right? I mean, Denver, as most of you all found out, Denver’s a great place to live except maybe December-January-February, so cyclically we have--and we’re in the outdoor business, right, so a lot of our water supplies, outdoor irrigation, outdoor land development activities, outdoor sales for single family homes are all cyclical in the winter months. It is pretty predictable. We are grateful that we were still able to be profitable, and we will continue to strive to do that quarter over quarter.

I do have a couple of particular questions for you. One is I was looking at the tap fees sold in the totals - your 10-K at August 31 said that 618 taps had been sold in Sky Ranch. Your press release said four more were sold this quarter, but then you reported a total of 766 taps that have been sold so far in Sky Ranch, so I’m confused on the difference between the 766 and the 622.

Yes, and really what we--and this was a real strong push to normalize the number of tap connections. There’s a difference between the residential connections, and then we have the CAB, the governmental entity that’s responsible for the parks and the open space and the outdoor irrigation, and they pay a tap fee but they’re only connection, and so that’s the difference. What you’ll see is when we report the number of irrigation connections, that’s a higher number, and so--and we’ve been really trying to normalize that for everybody so that people like you, who really drill down into the numbers, can get a feel for that $1,500 per connection per year amount, what is that applying to. That’s--now we’re really trying to give you all a little more clarity, is this applying that to 1,246 number of connections. When we send out a bill, that’s not 1,246 bills because there may be one customer that might have 50 of those connections, but that equates out to the same number of connections, so that’s what we’ve tried to--I was figuring, would I do that statistic this quarter? I’m like, Cunningham is going to call me out on this thing! So I’m glad you did, I appreciate that, but we did that with you in mind specifically, for the detail orientation as well as Robert, who came back and said, okay, I’m really tracking this $1,500 per connection. We really want to give the market a better, clearer understanding of how to compute that number.

Okay, great. Thank you. Then also, I have some questions on the different builders in Phase 2A. There seems to be a big difference from builder to builder as to what they’re doing there. I mean, KB looks like they’re going gangbusters, where they’ve sold 27 homes already, which I think is about two-thirds of their total, and Challenger with their homes seems to be doing okay also. Lennar has just started selling their single family homes, but their townhomes are still listed as coming soon--

Pending - right, right.

--and then D.R. Horton, we had talked about last quarter, where I guess they were having to do some revisions to their building plans with the County and hadn’t started yet, so I’m just wondering what might be going on with a couple of the laggards here with Lennar townhomes and the D.R. Horton homes.

You know, those are the two largest builders that Dirk was referring to, and I’d say they all kind of look at their own scheduling and this is new for both of those builders. This is kind of a new project that they’re in, and I think Lennar has got--they’ve probably got--of their townhomes, they’ve probably got 18 spec townhomes under construction, so what they’re really--more Lennar than D.R. Horton, are really pushing for the seasonal downtime where they can build and then hit the market in kind of the March cycle with a ton of product. They like the product that they have because it’s very price-sensitive product. Those townhome products are going to do extremely well, and I think what Lennar’s forecasting is we want to have a good inventory of those. I think we showed some aerials of that, and if we didn’t do it in the earnings presentation, jump on the website because we throw up a lot of our drone shots on that. You can see the bulk of the starts and the numbers out there, and I think we’ve got more than maybe 60, close to 70 vertical construction out there, of homes out there, and you’re right - KB’s done very well out there because they’ve got a paired product. Again, that’s higher density, better price points out there. Challenger is very competitive on the price, and then Horton--you know, they’re pulling lots of taps, so we know that they’ve got lots of building permits that they’ve got teed up, and then they’re just going to line build. They’re just going to throw everything they’ve got at it, do it all at once, and they’re pretty stylistic for the builders, each of [indiscernible].

Well, it’s great to know that Lennar is actually building the townhouses right now, because just looking at the website--

Yes, they’re very aggressively building.

Wow, okay. That’s great, because when you look at the website and see Coming Soon, you just figure that nothing has happened yet, so--

No, I think they’ve got four six-packs under--

--that’s very positive news.

Yes, yes.

Okay, great. Thank you very much, Mark.

You bet.

Thank you. Your next question is coming from Bill Miller, who is a private investor. Bill, your line is live.

Hi there, Mark.

Morning Bill.

Happy new year. I wonder where we are with two things: one, you at one time indicated you might buy back some of the lots for the build-to-rent part of your business; and secondly, where do we think we are with the I-70 development, which can either be sometime near term, and I wondered whether you could give us any indication of how soon that might take place.

In terms of the buyback and some of the other phases of the lots, we’re moving forward with Phase 2B, we’re recording our plat this month, and then we’ll get a sense from the builders. I think the builders were really hoping to wait to see how their traffic activity was going to look for the first part of the year, and so we’ve reached out to each of them and let them know, you know, as you look to your close, if you have--if your absorptions extend yourselves out a little bit farther than you would otherwise want to inventory, we will pull whatever number of lots back from that. All four of our builders have that offer, we’ve made that offer to them. They’re all under contract, so I’ve got to work with them on their cooperation, but I’m pretty confident we’re going to claw back--not claw back, we’re going to be invited back in a couple of those from some of the builders, because it’s a win-win for them. They can not close on that lot and then we’re talking with them specifically to say, but you can still build the house on that. That’s an opportunity for them not to have to--it really is a win-win, right? They can manage their cash flows so that they actually can still show positive sales on Sky Ranch to a customer that they know and they understand, which would be us, as opposed to waiting for traffic and contracts and cancellations. This is a great opportunity for both us and them to really continue to build the portfolio, and we’re seeing extremely strong demand. Every time we finish one of these houses and we put it up, it is gobbled up. We put it out on Zillo and it’s…

Well, what about buying back stock under various informed decisions?

That’s a great opportunity for us, and if the market continues to frustrate that stock price, we’re there now. We’re ready to do that. Do I have an answer for you at what price do we buy stock? I don’t.

Okay, well sounds good. Keep going.

Thank you.

Okay, we have now reached the end of the question and answer session. I will now hand back over to Mark for any closing comments.

So in closing, I guess I want to continue to thank you all for your continued support and confidence in our business, our business model and our team here. I want to recognize and give a shout-out to our board of directors - they’re an outstanding group of folks that continue to give our management team very sound and reasoned and expert advice into all business segments that we have. We’ve built a great board that has disciplines in each of these to help us continue to evaluate those decisions and make good decisions for our investors and our invested capital. As Kevin mentioned, we have our annual shareholder meeting. There’s not anything exciting on the shareholder plans, but if you haven’t voted your shares, please vote them. We look forward to an update sometime in the April timeframe to give you a little bit more detail on the markets. If you weren’t able to ask a question or if you’re listening to this on a replay, don’t hesitate to give me a holler and we’d be happy to give you any color or any information that would help you guide decisions in ownership of the stock. With that, I will close, and thank you all. Look forward to speaking to you again soon.

Thank you Mark. This concludes today’s conference. You may now disconnect your lines at this time. Thank you for your participation.

Thank you Jenny.