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PCYO > SEC Filings for PCYO > Form 10-Q on 12-Apr-2013All Recent SEC Filings

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Form 10-Q for PURE CYCLE CORP


12-Apr-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

The discussion and analysis below includes forward-looking statements that are subject to risks, uncertainties and other factors, as described in "Rick Factors" in our Annual Report on Form 10-K, 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 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 financial statements and the notes thereto and the financial statements and the notes thereto contained in our 2012 Annual Report on Form 10-K (the "2012 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;

Revenues generated from agricultural operations

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

Pure Cycle Corporation ("we", "us" or "our") is an investor-owned Colorado corporation that (i) provides wholesale water and wastewater services to end-use customers of governmental entities and to commercial and industrial customers and (ii) manages land and water assets for farming.

Wholesale Water and Wastewater

These services include water production, storage, treatment, bulk transmission to retail distribution systems, wastewater collection and treatment, irrigation water treatment and transmission, construction management, billing and collection and emergency response.

We are a vertically integrated wholesale water and wastewater provider, which means we own or control substantially all assets necessary to provide wholesale water and wastewater services to our customers. This includes owning (i) water rights which we use to provide domestic, irrigation, and industrial water to our wholesale customers (we own surface water, groundwater, reclaimed water rights and storage rights), (ii) infrastructure (such as wells, diversion structures, pipelines, reservoirs and treatment facilities) required to withdraw, treat, store and deliver water, (iii) infrastructure required to collect, treat, store and reuse wastewater, and (iv) infrastructure required to treat and deliver reclaimed water for irrigation use.


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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 below. We provide service to the District and its end-use customers pursuant to "The Rangeview Water Agreements" (defined below) between us and the District for the provision of wholesale water service to the District for use in the District's service area. Through our governmental entity wholesale customers, we serve 258 Single Family Equivalent ("SFE") (as defined below) water connections and 157 SFE wastewater connections located in southeastern metropolitan Denver.

We plan to utilize our significant water assets along with our adjudicated reservoir sites to provide wholesale water and wastewater services to local governmental entities which in turn will provide residential/commercial water and wastewater services to communities along the eastern slope of Colorado in the area extending essentially from Fort Collins on the north to Colorado Springs on the south, which is generally referred to as the "Front Range." Principally we target the "I-70 corridor," which is located east of downtown Denver and south of the Denver International Airport. This area is predominately undeveloped and is expected to experience substantial growth over the next 30 years.

Agricultural Operations and Leasing

Beginning August 3, 2012, we assumed management of our farm operations and all associated income and expenses. Beginning September 1, 2012, we began tracking and reporting our farm operations as a separate business segment to reflect management's analysis, investment decision, and operating performance for this business segment. Currently, approximately 90% of our farm operations are managed through cash lease arrangements with local area farmers whereby we charge a fixed fee, billed semi-annually in March and November, to lease our land and the water for agricultural purposes to tenant farmers. We have a small number of crop share leases, pursuant to which we and the tenant farmer jointly share in the gross revenues generate from the crops grown under a 75% farmer, 25% landlord participation. The majority of crops grown on our farms are alfalfa, with a number of acres also planted in corn, sorghum, and wheat. We will continue to review and evaluate ways to enhance the performance of more than 16,000 acres of farm land through relationships with area farmers.

We also own 931 acres of land along the I-70 corridor east of Denver, Colorado that is being held for development. These land interests are described in the Arkansas River Water and Land and Sky Ranch sections of Note 4 - Water Assets to the 2012 Annual Report.

Results of operations

Executive Summary

The results of our operations for the three and six months ended February 28, 2013 and February 29, 2012 are as follows:

                                                          Summary Table 1
                                                           Three months ended:
                                              February 28, 2013            February 29, 2012            $ Change           % Change
Millions of gallons of water delivered                      10.2                          3.1                 7.1                229 %
Water revenues generated                     $           104,300          $            24,400          $   79,900                327 %
Operating costs to deliver water             $            52,100          $            12,600          $   39,500                313 %
(excluding depreciation and depletion)
Water delivery gross margin %                                 50 %                         48 %
Wastewater treatment revenues                $            10,600          $            11,600          $   (1,000 )               -9 %
Operating costs to treat wastewater          $             4,600          $             4,600          $      -                    0 %
Wastewater treatment gross margin %                           57 %                         60 %
Tap and specialty facility revenues          $            14,000          $            14,000          $      -                    0 %
Farm operations revenues                     $           305,200          $               -            $  305,200                100 %
Farm operating costs                         $            26,600          $               -            $   26,600                100 %
Farm operations gross margin %                                91 %
General and administrative expenses          $           559,800          $           583,700          $  (23,900 )               -4 %
Net losses                                   $           914,700          $         1,363,600          $ (448,900 )              -33 %


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                                                            Six months ended:
                                              February 28, 2013            February 29, 2012            $ Change           % Change
Millions of gallons of water delivered                      19.0                         10.6                 8.4                 79 %
Water revenues generated                     $           150,900          $            66,000          $   84,900                129 %
Operating costs to deliver water             $            78,300          $            31,700          $   46,600                147 %
(excluding depreciation and depletion)
Water delivery gross margin %                                 48 %                         52 %
Wastewater treatment revenues                $            21,300          $            23,600          $   (2,300 )              -10 %
Operating costs to treat wastewater          $             7,900          $            10,500          $   (2,600 )              -25 %
Wastewater treatment gross margin %                           63 %                         56 %
Tap and specialty facility revenues          $            27,900          $            27,900          $      -                    0 %
Farm operations revenues                     $           667,900          $               -            $  667,900                100 %
Farm operating costs                         $            46,100          $               -            $   46,100                100 %
Farm operations gross margin %                                93 %
General and administrative expenses          $         1,141,700          $         1,183,200          $  (41,500 )               -4 %
Net losses                                   $         1,992,100          $         2,725,300          $ (733,200 )              -27 %

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 increased 229% and 79% during the three and six months ended February 28, 2013, compared to the three and six months ended February 29, 2012, respectively. The increase in the water usage was due to our selling water to the oil hydrologic fracturing industry. Water revenues increased 327% and 129% during the three and six months ended February 28, 2013, compared to the three and six months ended February 29, 2012, respectively, which is due to the sale of water for fracking water. The gross margins on delivering water increased during the three months ended February 28, 2013, compared to the three months ended February 29, 2012, due to our ability to spread costs over a larger volume of water sales. The gross margins on delivering water decreased during the six months ended February 28, 2013, compared to the six months ended February 29, 2012, due mainly to the increased costs related to the ECCV (defined below) system to meet the higher demands of such drilling and fracking activities.

Wastewater Treatment Revenues

Our wastewater customer is charged based on the amount of wastewater treated.

Wastewater fees decreased 9% and 10% during the three and six months ended February 28, 2013, compared to the three and six months ended February 29, 2012, respectively. This decrease was primarily the result of decreased demand from our only customer.

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 2012 Annual Report) constructed to provide service to the County. We recognized $3,600 and $7,100 of water tap fee revenues during each of the three and six months ended February 28, 2013 and February 29, 2012, 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 - Long-Term Obligations and Operating Lease to the accompanying financial statements.

We recognized $10,400 and $20,800 of "Special Facilities" (defined in the 2012 Annual Report) funding as revenue during each of the three and six months ended February 28, 2013 and February 29, 2012, 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 2 - Summary of Significant Accounting Policies to the 2012 Annual Report.


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At February 28, 2013, 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 or six months ended February 28, 2013 or February 29, 2012, thus there were no reductions in the Tap Participation Fee (as defined in Note 1 - Presentation and Interim Information to the accompanying financial statements) for the three or six months ended February 28, 2013. We did reduce the Tap Participation Fee by the equivalent of 12 and 24 taps during the three and six months ended February 28, 2012, as described in Note 4 - Long-Term Obligations and Operating Lease to the accompanying financial statements.

Farming Operations

Our farming operations include revenues from leases on the farms we own in the Arkansas Valley.

During the three and six months ended February 28, 2013, we received revenues from our farming operations of approximately $305,200 and $669,700, respectively. During the three and six months ended February 29, 2012 we did not have revenues from farming operations because the farming operations were managed by HP A&M pursuant to a property management agreement between us and HP A&M (the "Property Management Agreement"), as described in Note 1 - Presentation of Interim Information to the accompanying financial statements. As a result of HP A&M's default (as described in Note 4 - Long-Term Obligations and Operating Lease to the accompanying financial statements), we terminated the Property Management Agreement and we now manage our farms directly.

General and Administrative and Other Expenses

Significant balances classified as general and administrative ("G&A") expenses
for the three and six months ended February 28, 2013 and February 29, 2012,
respectively were:



                                        Table 2-Signficant Balances in G&A
                                                Three months ended:
                                    February 29, 2013          February 29, 2012         $ Change         % Change
Salary and salary related
expenses:
Including share-based
compensation                       $            128,900       $           159,900       $  (31,000 )            -19 %
Excluding share-based
compensation                       $            116,400       $           138,600       $  (22,200 )            -16 %
Professional fees                  $             52,100       $           127,000       $  (74,900 )            -59 %
Property taxes                     $             53,900       $               -         $   53,900              100 %
Water assessment fees              $             84,200       $            91,000       $   (6,800 )             -7 %
Directors fees (including
insurance)                         $             77,000       $            82,000       $   (5,000 )             -6 %
Public entity related expenses     $             34,300       $            35,700       $   (1,400 )             -4 %

                                        Table 2a-Signficant Balances in G&A
                                                 Six months ended:
                                    February 28, 2013          February 29, 2012         $ Change         % Change
Salary and salary related
expenses:
Including share-based
compensation                       $            263,500       $           361,400       $  (97,900 )            -27 %
Excluding share-based
compensation                       $            240,400       $           321,300       $  (80,900 )            -25 %
Professional fees                  $            141,354       $           319,600       $ (178,246 )            -56 %
Property taxes                     $            208,100       $               -         $  208,100              100 %
Water assessment fees              $            176,200       $           176,400       $     (200 )              0 %
Directors fees (including
insurance)                         $             97,000       $            94,100       $    2,900                3 %
Public entity related expenses     $             52,100       $            49,900       $    2,200                4 %


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Salary and salary related expenses including share-based compensation decreased 19% and 27% for the three and six months ended February 28, 2013, as compared to the three and six months ended February 29, 2012, respectively. In the first quarter of fiscal 2012, we paid bonuses totaling $47,000 to employees which were a non-recurring expense. The salary and salary related expenses noted above include $12,500 and $23,100 of share-based compensation expenses for the three months ended February 28, 2013 and February 29, 2012, respectively. The salary and salary related expenses noted above include $23,100 and $40,100 of share-based compensation expenses for the six months ended February 28, 2013 and February 29, 2012, respectively.

Professional fees (legal and accounting) decreased 59% during the three months ended February 28, 2013, as compared to the three months ended February 29, 2012. The decrease was due to a reduction in general legal fees of approximately $21,000 and litigation legal fees of approximately $57,000. Professional fees (legal and accounting) decreased 56% during the six months ended February 28, 2013, as compared to the six months ended February 29, 2012. The decrease is attributable to a reduction in general legal fees of approximately $80,000 and litigation fees of approximately $107,000.

In conjunction with the HP A&M default we are now responsible for the property taxes associated with the land. We are also now accruing property taxes related to our Sky Ranch property. The expected annual property taxes for calendar year 2012 (due and payable in 2013) for our farming operations and our Sky Ranch property are approximately $142,000 and $90,600, respectively. We anticipate the property taxes will remain consistent through the 2013 calendar year so we are accruing property taxes of approximately $19,400 monthly.

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 canals in the Arkansas River Valley. The fees are approved by the shareholders of the FLCC. As of February 28, 2013, we hold approximately 23% of the voting shares of the FLCC, 4% of which are being held for sale. In December 2011, the FLCC shareholders approved an increase in the fees from $15.50 per share to $17.00 per share. For calendar year 2013 assessment fees decreased from $17.00 per share to $15.00 per share, which decreased our overall assessment fees expense by approximately $28,900 from fiscal year 2012 to fiscal year 2013. Our calendar year assessments for 2013 will be approximately $290,000 and are being expensed ratably during the year.

Directors fees, including D&O insurance, decreased 6% for the three months ended February 28, 2013 as compared to the three months ended February 29, 2012. Directors fees, including D&O insurance, increased 3% for the six months ended February 28, 2013 as compared to the six months ended February 29, 2012. These fees vary due to timing of expenditures, but generally are expected to remain consistent year over year.

Costs associated with corporate governance and costs associated with being a publicly traded entity decreased 4% for the three months ended February 28, 2013 as compared to the three months ended February 29, 2012. Costs associated with corporate governance and costs associated with being a publicly traded entity increased 4% for the six months ended February 28, 2013 as compared to the six months ended February 29, 2012. Our costs fluctuate due to changes in the number of press releases, investor relation initiatives, filing fees and compliance costs for filing with the Securities and Exchange Commission (the "SEC").

Other Income and Expense Items



                                                Table 3-Other Items
                                                Three months ended:
                                    February 28, 2013          February 29, 2012         $ Change         % Change
Income items:
Oil and gas lease income           $            103,600       $           103,600       $      -                  0 %
Interest income                    $              7,500       $            13,800       $   (6,300 )            -46 %
Expense items:
Depreciation and depletion         $             76,500       $            77,100       $     (600 )             -1 %
Imputed interest                   $            650,100       $           862,400       $ (212,300 )            -25 %
Interest expense                   $             73,100       $               -         $   73,100              100 %


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                                               Table 3a-Other Items
                                                 Six months ended:
                                    February 28, 2013         February 29, 2012         $ Change         % Change
Income items:
Oil and gas lease income           $           207,200       $           207,200       $      -                  0 %
Interest income                    $            19,700       $            29,600       $   (9,900 )            -33 %
Expense items:
Depreciation and depletion         $           154,100       $           152,700       $    1,400                1 %
Imputed interest                   $         1,544,800       $         1,713,800       $ (169,000 )            -10 %
Interest expense                   $           103,200       $               -         $  103,200              100 %

The oil and gas lease income amounts represent a portion of the up-front payments we received on March 10, 2011, upon the 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 payments from Andarko for the purpose of exploring for, developing, producing and marketing oil and gas on 634 acres of mineral estate we own at our Sky Ranch property. The income received is being recognized in income over the initial three year term of the O&G Lease, which began on March 10, 2011. In December of 2012 the lease was purchased by a wholly owned subsidiary of ConocoPhillips Company.

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 decrease is due primarily to a decline of interest rates and decrease in marketable securities held by the Company.

Depreciation and depletion decreased 1% during the three months ended February 28, 2013 compared to the three months ended February 29, 2012. Depreciation and depletion increased 1% during the six months ended February 28, 2013 compared to the three months ended February 29, 2012. These expenses are expected to be comparable year over year.

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 2011, which is explained in greater detail in Note 4 - Long-Term Obligations and Operating Lease to the accompanying financial statements.

Interest expense for the three and six months ended February 28, 2013, is related to the interest accrued on the $5.8 million in promissory notes issued to acquire the HP A&M debt. No interest expense was accrued during the three and six months ended February 29, 2012.

Liquidity, Financial Resources and Financial Condition

At February 28, 2013, our working capital, defined as current assets less current liabilities, was approximately $5.3 million. As of February 28, 2013, we had approximately $4.4 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 February 28, 2013, we have sufficient working capital to fund our operations for the next fiscal year.

Arkansas Valley Water Assets

The FLCC water assessments are the charges assessed to the FLCC shareholders for the upkeep and maintenance of the Fort Lyon Canal. The water assessment payments are payable to the FLCC each calendar year. Our calendar year assessments for 2013 will be approximately $290,000 and are being expensed ratably during the year. Our calendar year 2012 property taxes (due and payable in 2013) are approximately $142,000. We anticipate the property taxes for calendar year 2013 to be similar, so we will accrue monthly property taxes of approximately $11,800.


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Sky Ranch Property

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