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| PCYO > SEC Filings for PCYO > Form 10-Q on 13-Jul-2012 | All Recent SEC Filings |
13-Jul-2012
Quarterly Report
Overview
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 financial statements and the notes thereto and the financial statements and the notes thereto contained in our 2011 Annual Report on Form 10-K (the "2011 Annual Report").
The following section focuses on the key indicators reviewed by management in evaluating our financial condition and operating performance, including the following:
• Revenue generated from providing wholesale water and wastewater services;
• Expenses associated with developing our water assets; and
• Cash available to continue development of our water rights and service agreements.
Our MD&A section includes the following items:
Our Business - a general description of our business, our services and our business strategy.
Results of Operations - an analysis of our results of operations for the periods presented in our financial statements.
Liquidity, Capital Resources and Financial Position - an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements.
Critical Accounting Policies and Use of Estimates - a discussion of our critical accounting policies that require critical judgments, assumptions and estimates.
Forward-looking statements - an identification of forward-looking statements and a description of risks that could cause actual results to differ materially from those discussed in forward-looking statements.
Our Business
We are a Colorado corporation that provides wholesale water and wastewater services to our customers which are local governmental entities that provide water and wastewater services to their end-use customers, and industrial and commercial customers, located in the greater Denver, Colorado metropolitan area. Services we provide include designing, constructing, operating and maintaining wholesale water and wastewater systems using our balanced water portfolio consisting of surface water and groundwater supplies, surface water storage, aquifer storage, and reclaimed water supplies.
We generate revenues predominately from three sources: (i) one time water and wastewater tap fees, (ii) construction fees, and (iii) monthly service fees. Our revenue sources and how we account for them are described in greater detail in the 2011 Annual Report. We typically negotiate the payment terms for tap fees, construction fees, and other water and wastewater service fees with our wholesale customers as a component of our service agreements prior to construction of the project.
We currently provide wholesale water service predominately to two local governmental entity customers. Our largest customer is the Rangeview Metropolitan District (the "District"), a quasi-municipal political subdivision of the State of Colorado which is described further in the 2011 Annual Report. We provide service to the District and its end-use customers pursuant to "The Rangeview Water Agreements" (defined in Note 4 to the 2011 Annual Report). Through our governmental entity wholesale customers, we serve 258 Single Family Equivalent ("SFE") water connections and 157 SFE wastewater connections located in southeastern metropolitan Denver.
Results of operations
Executive Summary
The results of our operations for the three and nine months ended May 31, 2012 and 2011 are as follows:
Summary Table 1
Three months ended:
May 31, 2012 May 31, 2011 $ Change % Change
Millions of gallons of water delivered 6.3 6.4 (0.1 ) -2 %
Water revenues generated $ 32,300 $ 32,000 $ 300 1 %
Operating costs to deliver water $ 16,800 $ 11,400 $ 5,400 47 %
(excluding depreciation and depletion)
Water delivery gross margin % 48 % 64 %
Wastewater treatment revenues $ 11,300 $ 17,700 $ (6,400 ) -36 %
Operating costs to treat wastewater $ 5,400 $ 4,900 $ 500 10 %
Wastewater treatment gross margin % 52 % 72 %
General and administrative expenses $ 621,200 $ 481,200 $ 140,000 29 %
Net losses $ 1,420,000 $ 1,362,900 $ 57,100 4 %
Nine months ended:
May 31, 2012 May 31, 2011 $ Change % Change
Millions of gallons of water delivered 16.9 17.5 (0.6 ) -3 %
Water revenues generated $ 98,300 $ 93,600 $ 4,700 5 %
Operating costs to deliver water $ 48,500 $ 33,100 $ 15,400 47 %
(excluding depreciation and depletion)
Water delivery gross margin % 51 % 65 %
Wastewater treatment revenues $ 34,900 $ 53,200 $ (18,300 ) -34 %
Operating costs to treat wastewater $ 15,900 $ 14,300 $ 1,600 11 %
Wastewater treatment gross margin % 54 % 73 %
General and administrative expenses $ 1,804,500 $ 1,670,000 $ 134,500 8 %
Net losses $ 4,145,300 $ 4,604,600 $ (459,300 ) -10 %
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Water Usage Revenues
Our water service charges include a fixed monthly fee and a fee based on actual amounts of water used, which is based on a tiered pricing structure that provides for higher prices as customers use greater amounts of water. Our rates and charges are established based on the average of three surrounding water providers.
Water deliveries decreased 2% and 3% during the three and nine months ended May 31, 2012, compared to the three and nine months ended May 31, 2011. The declines in the water usage were due to our largest customer closing dormitories as a result of budget cutbacks resulting in less water required for students living at the facility. Water revenues increased 1% and 5% during the three and nine months ended May 31, 2012, compared to the three and nine months ended May 31, 2011, respectively. The increase in the three and nine months ended May 31, 2012 is due to increased water usage fees effective July 1, 2011 and large industrial customers buying bulk water deliveries in fiscal 2012 resulting in charges at the higher end of our tiered pricing structure. The gross margins on delivering water decreased during the three and nine months ended May 31, 2012, compared to the three and nine months ended May 31, 2011, due mainly to increased energy costs related to higher pumping demands to produce water for oil and gas well drilling and fracking activities and the increased costs to produce additional water to meet the higher short term demands of such drilling and fracking activities.
Wastewater Treatment Revenues
Our wastewater customer used to be charged a flat monthly fee based on the number of tap connections; however, beginning July 1, 2011, we agreed to charge our wastewater customer based on the amount of wastewater treated due to a reduction in their water consumption.
Wastewater fees decreased 36% and 34% during the three and nine months ended May 31, 2012, compared to the three and nine months ended May 31, 2011, which was primarily a result of the change in how our wastewater customer is charged as described above.
Tap Fees
In August 2005, we entered into the Water Service Agreement (the "County Agreement") with Arapahoe County (the "County"). In fiscal 2006, we began recognizing water tap fees as revenue ratably over the estimated service period upon completion of the "Wholesale Facilities" (defined in the 2011 Annual Report) constructed to provide service to the County. We recognized $3,600 and $10,700 of water tap fee revenues during each of the three and nine months ended May 31, 2012 and 2011, respectively. The water tap fees to be recognized over this period are net of the royalty payments to the State of Colorado Board of Land Commissioners (the "Land Board") and amounts paid to third parties pursuant to the "CAA" which is described in Note 4 to the accompanying financial statements.
We recognized $10,400 and $31,100 of "Special Facilities" (defined in the 2011 Annual Report) funding as revenue during each of the three and nine months ended May 31, 2012 and 2011, respectively. This is the ratable portion of the Special Facilities funding proceeds received from the County pursuant to the County Agreement as more fully described in Note 4 to the 2011 Annual Report.
At May 31, 2012, we have deferred recognition of $1.3 million of water tap and construction fee revenue from the County, which will be recognized as revenue ratably over the estimated useful accounting life of the assets constructed with the construction proceeds as described above.
We did not sell any water or wastewater taps during the three and nine months ended May 31, 2012 or 2011. We did reduce the Tap Participation Fee (as defined in Note 1 to the accompanying financial statements) by the equivalent of 12 and 36 taps during the three and nine months ended May 31, 2012, as described in Note 4 to the accompanying financial statements.
General and Administrative and Other Expenses
Significant balances classified as general and administrative ("G&A") expenses
for the three and nine months ended May 31, 2012 and May 31, 2011, were:
Table 2 - Signficant Balances in G&A
Three months ended:
May 31, 2012 May 31, 2011 $ Change % Change
Salary and salary related expenses:
Including share-based compensation $ 138,300 $ 153,900 $ (15,600 ) -10 %
Excluding share-based compensation $ 136,100 $ 128,900 $ 7,200 6 %
Professional fees $ 196,200 $ 81,300 $ 114,900 141 %
Water assessment fees $ 92,500 $ 84,400 $ 8,100 10 %
Directors fees (including insurance) $ 11,800 $ 11,400 $ 400 4 %
Public entity related expenses $ 32,500 $ 32,700 $ (200 ) -1 %
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Table 2a - Signficant Balances in G&A
Nine months ended:
May 31, 2012 May 31, 2011 $ Change % Change
Salary and salary related expenses:
Including share-based compensation $ 499,700 $ 652,100 $ (152,400 ) -23 %
Excluding share-based compensation $ 457,400 $ 582,800 $ (125,400 ) -22 %
Professional fees $ 515,900 $ 264,300 $ 251,600 95 %
Water assessment fees $ 269,000 $ 255,300 $ 13,700 5 %
Directors fees (including insurance) $ 105,900 $ 120,100 $ (14,200 ) -12 %
Public entity related expenses $ 80,600 $ 80,600 $ - 0 %
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Salary and salary related expenses including share-based compensation decreased 10% and 23% for the three and nine months ended May 31, 2012, as compared to the three and nine months ended May 31, 2011, respectively. The decrease in the nine months ended May 31, 2012 is mainly a result of lower bonuses paid to employees. In the first quarter of fiscal 2011, we paid bonuses totaling $180,000 to employees, and in the first quarter of fiscal 2012, we paid bonuses totaling $47,000 to employees. The salary and salary related expenses noted above include $2,100 and $25,000 of share-based compensation expenses for the three months ended May 31, 2012 and 2011, respectively. The salary and salary related expenses noted above include $42,300 and $69,300 of share-based compensation expenses for the nine months ended May 31, 2012 and 2011, respectively.
Professional fees (legal and accounting) increased 141% and 95% during the three and nine months ended May 31, 2012, as compared to the three and nine months ended May 31, 2011, respectively. This is mainly due to additional legal fees related to the lawsuit we filed against the State of Colorado by and through the Land Board in December 2011, and the lawsuit filed against us by High Plains A&M, LLC (HP A&M). Both lawsuits are explained in greater detail in Part II, Item 1 below.
Water assessment fees, which are mainly paid to the Fort Lyon Canal Company ("FLCC"), are the fees we pay for our share of the maintenance of the canals in the Arkansas River Valley. The fees are approved by the shareholders of the canal companies. As of May 31, 2012, we hold approximately 26% of the voting shares of the FLCC, and in December 2011, the FLCC shareholders approved an increase in the fees from $15.50 per share to $17.00 per share. This increase went into effect January 1, 2012.
Directors fees, including D&O insurance, increased 4% for the three months ended May 31, 2012 as compared to May 31, 2011 and decreased 12% for the nine months ended May 31, 2012, as compared to May 31, 2011. The decrease for the nine months ended May 31, 2012 was due to a board member resigning from the board in September 2011, which reduced the total annual fees paid to directors.
Costs associated with corporate governance and costs associated with being a publicly traded entity decreased 1% and remain unchanged during the three and nine months ended May 31, 2012, as compared to May 31, 2011, respectively.
Other income and Expense Items
Table 3 - Other Items
Three months ended:
May 31, 2012 May 31, 2011 $ Change % Change
Expense items:
Depreciation and depletion expense $ 77,700 $ 75,100 $ 2,600 3 %
Imputed interest expense $ 873,000 $ 969,000 $ (96,000 ) -10 %
Income items:
Oil and gas lease income $ 104,600 $ 95,600 $ 9,000 9 %
Interest income $ 12,800 $ 14,500 $ (1,700 ) -12 %
Table 3a - Other Items
Nine months ended:
May 31, 2012 May 31, 2011 $ Change % Change
Other expense items:
Depreciation and depletion expense $ 230,300 $ 225,500 $ 4,800 2 %
Imputed interest expense $ 2,586,800 $ 3,014,700 $ (427,900 ) -14 %
Interest expense on Convertible
Note - Related Party $ - $ 151,700 $ (151,700 ) -100 %
Other income items:
Oil and gas lease income $ 319,400 $ 95,600 $ 223,800 234 %
Interest income $ 42,400 $ 41,600 $ 800 2 %
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Imputed interest expense is related to the Tap Participation Fee payable to HP A&M. This represents the expensed portion of the difference between the estimated fair value of the payments to be made to HP A&M and the discounted present value of those payments imputed using the effective interest method. The decrease in the imputed interest expense is a result of the updated valuation performed during the first quarter of fiscal 2012, which is explained in greater detail in Note 4 to the accompanying financial statements.
Interest was expensed on the Convertible Note - Related Party (as defined in Note 4 to the 2011 Annual Report) during the three and nine months ended May 31, 2011, which bore simple interest at 10% per annum. This was not an expense item for fiscal 2012, as we issued 1.9 million unregistered shares of common stock upon conversion of the Convertible Note - Related Party on January 11, 2011.
The oil and gas lease income amounts are due to the March 10, 2011, signing of the Paid-Up Oil and Gas Lease (the "O&G Lease") and Surface Use and Damage Agreement (the "Surface Use Agreement") with Anadarko E&P Company, L.P. ("Anadarko"), a wholly-owned subsidiary of Anadarko Petroleum Company. During fiscal 2011, we received payments of $1,243,400 from Anadarko for the purpose of exploring for, developing, producing and marketing oil and gas on 634 acres of mineral estate we owned at our Sky Ranch property. The oil and gas rights under the remaining approximately 304 acres at Sky Ranch are already owned by Anadarko. The income received from Anadarko is being recognizing to income over the initial three year term of the O&G Lease, which began on March 10, 2011.
Interest income represents interest earned on the temporary investment of capital in available-for-sale securities, interest accrued on the note payable by the District and interest accrued on the Special Facilities construction proceeds receivable from the County. The increases are due to increases in interest rates.
Liquidity, Financial Resources and Financial Condition
At May 31, 2012, our working capital, defined as current assets less current liabilities, was approximately $2.7 million. As of May 31, 2012, we had approximately $3.0 million of cash and cash equivalents and marketable securities. As of the date of the filing of this quarterly report on Form 10-Q, we have an effective shelf registration statement pursuant to which we may elect to sell up to another $4.45 million of stock at any time and from time to time. We believe that as of the date of the filing of this quarterly report on Form 10-Q and as of May 31, 2012, we have sufficient working capital to fund our operations for the next fiscal year.
The Tap Participation Fee
Pursuant to the Arkansas River Agreement, effective as of September 1, 2011, HP A&M elected to increase the Tap Participation Fee percentage from 10% to 20% and take a corresponding 50% reduction in the number of taps subject to the Tap Participation Fee. In addition, the initial term of the farm management agreement with HP A&M expired on August 31, 2011. During the extended term of the management agreement, we are permitted to allocate 26.9% of the Net Revenues (defined as all lease and related income received from the farms less employee expenses, direct expenses for managing the leases and a reasonable overhead allocation) paid to HP A&M against the Tap Participation Fee.
As a result of the events described above, we revalued the Tap Participation Fee liability during the fiscal quarter ended November 30, 2011. The updated valuation and the events described above resulted in the following:
• Our obligation to pay HP A&M 10% of the gross proceeds, or the equivalent thereof, from the sale of the next 38,937 water taps at the beginning of fiscal 2012 is now an obligation to pay 20% of the gross proceeds, or the equivalent thereof, from the sale of the next 19,433 water taps.
• The total estimated payments to HP A&M for the Tap Participation Fee increased $7.5 million from the previous valuation completed in fiscal 2009. The total estimated payments were then discounted to the current valuation date and the difference between the amount reflected on the Company's balance sheet and the total estimated payments is imputed as interest expense over the estimated development life using the effective interest method. The imputed effective interest rate decreased from 6.3% to 5.3% and the amount of interest imputed during the three and nine months ended May 31, 2012 was $873,000 and $2.6 million, respectively.
• The $67.4 million Tap Participation Fee payable at May 31, 2012, includes $22.9 million of interest which has been imputed since the acquisition date, recorded using the effective interest method.
• During the three and nine months ended May 31, 2012, we allocated $47,400 and $142,300, respectively, to the Tap Participation Fee liability and to additional paid in capital (due to HP A&M being deemed a related party). This is the equivalent of 12 and 36 water taps, respectively.
Additional information on the elections made by HP A&M, the terms of the Arkansas River Agreement, the estimation of the fair value of the Tap Participation Fee liability, the calculation of the percentage of Net Revenues and the reduction of water taps subject to the Tap Participation Fee is included in Note 1 and Note 4 to the accompanying financial statements.
Payment of the Tap Participation Fee may be accelerated in the event of a merger, reorganization, sale of substantially all assets, or similar transactions and in the event of bankruptcy and insolvency events.
FLCC Water Assessment Fees
Fort Lyons Canal Company ("FLCC") water assessment fees are payable to the FLCC each calendar year. In December 2011, the board and shareholders of the FLCC voted to increase the calendar 2012 assessment to $17.00 per share from the prior $15.50 per share. The fee increase went into effect on January 1, 2012, and will cost us an additional $33,000 per year.
Summary Cash Flows Table
Table 5 - Summary Cash Flows Table
Nine months ended:
May 31, 2012 May 31, 2011 $ Change % Change
Net cash (used) provided by:
Operating acitivites $ (1,594,400 ) $ (151,200 ) $ (1,443,200 ) 954 %
Investing activities $ 1,714,800 $ (9,972,200 ) $ 11,687,000 -117 %
Financing activities $ 51,300 $ 10,653,100 $ (10,601,800 ) -100 %
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Changes in Operating Activities
Operating activities include revenues we receive from the wholesale sale of water and wastewater services to customers, costs incurred in the delivery of those services, G&A expenses, and other income and expenses.
Net cash used by operations increased 954% during the nine months ended May 31, 2012 compared to May 31, 2011 because we did not have the benefit of the one-time bonus payment of $1,243,400 received pursuant to the O&G lease in fiscal 2011. Additionally, the lawsuits involving the State Land Board and HP A&M resulted in a significant increase in legal fees in 2012.
We will continue to provide domestic water and wastewater service to customers in our service area and we will continue to operate and maintain our water and wastewater systems with our own employees.
Changes in Investing Activities
We continue to incur legal and engineering fees associated with our water rights, and we continue to invest in the right-of-way permit fees to the Department of Interior Bureau of Land Management and legal and engineering costs for our Paradise Water Supply.
Investing activities during the nine months ended May 31, 2012, consisted of us investing $68,900 into our water and wastewater infrastructure and us selling a net $1.8 million of marketable securities. Investing activities during the nine months ended May 31, 2011, consisted of the use of approximately $6.8 million for the acquisition of Sky Ranch, and we invested approximately $3.2 million into certificates of deposit.
Changes in Financing Activities
Financing activities for the nine months ended May 31, 2012 consisted mainly of the receipt of $54,800 from the County related to the Construction Note. Financing activities for the nine months ended May 31, 2011 consisted mainly of the issuance of the $5.2 million Convertible Note and the sale of approximately $5.4 million shares of common stock (net of issuance costs).
Critical Accounting Policies and Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with the timing of revenue recognition, the impairment analysis of our water rights, management's valuation of the Tap Participation Fee, and share-based compensation. Below is a summary of these critical accounting policies.
Revenue Recognition
Our revenues consist mainly of tap fees, monthly service fees and construction revenues. As further described in Note 2 to the accompanying financial statements, proceeds from tap sales are deferred upon receipt and recognized in income based on whether we own or do not own the facilities constructed with the proceeds. When we construct the infrastructure to be owned by the customer, we recognize tap fees pursuant to the percentage-of-completion method. The percentage-of-completion method requires management to estimate the percent of work that is completed on a particular project, which could change materially throughout the duration of the construction period and result in significant fluctuations in revenue recognized during the reporting periods throughout the construction process. We did not recognize any revenues pursuant to the percentage-of-completion method during the three and nine months ended May 31, 2012 or May 31, 2011.
Tap fees derived from agreements for which we own the infrastructure are recognized as revenue ratably over the estimated service life of the assets . . .
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