PURE CYCLE CORP - Quarter Report: 2011 February (Form 10-Q)
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: February 28, 2011
or
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-8814
PURE CYCLE CORPORATION
(Exact name of registrant as specified in its charter)
| Colorado | 84-0705083 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
| 1490 Lafayette Street, Suite 203, Denver, CO | 80218 | |
| (Address of principal executive offices) | (Zip Code) |
(303) 292 — 3456
(Registrant’s telephone number, including area code)
500 E. 8th Ave, Suite 201, Denver CO 80203
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller Reporting Company þ | |||
| (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company filer (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of
April 6, 2011:
| Common stock, 1/3 of $.01 par value | 24,037,596 | ||
| (Class) | (Number of Shares) | ||
PURE CYCLE CORPORATION
INDEX TO February 28, 2011 FORM 10-Q
INDEX TO February 28, 2011 FORM 10-Q
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| PART I — FINANCIAL INFORMATION |
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| PART II — OTHER INFORMATION |
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| Exhibit 31 | ||||||||
| Exhibit 32 | ||||||||
Table of Contents
PURE CYCLE CORPORATION
BALANCE SHEETS
| February 28, 2011 | August 31, 2010 | |||||||
| (unaudited) | ||||||||
ASSETS: |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 217,864 | $ | 12,017 | ||||
Marketable securities |
4,152,515 | 1,435,054 | ||||||
Trade accounts receivable |
54,755 | 71,155 | ||||||
Prepaid expenses |
193,854 | 236,627 | ||||||
Current portion of construction proceeds receivable |
64,783 | 64,783 | ||||||
Total current assets |
4,683,771 | 1,819,636 | ||||||
Investments in water and water systems, net |
106,537,961 | 102,931,347 | ||||||
Land — Sky Ranch |
3,738,955 | — | ||||||
Construction proceeds receivable, less current portion |
329,435 | 351,791 | ||||||
Note receivable — related party: |
||||||||
Rangeview Metropolitan District, including accrued interest |
525,804 | 519,834 | ||||||
Escrow and other items related to the Sky Ranch acquisition |
— | 735,000 | ||||||
Other assets |
98,965 | 20,146 | ||||||
Total assets |
$ | 115,914,891 | $ | 106,377,754 | ||||
LIABILITIES: |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 114,842 | $ | 44,818 | ||||
Accrued liabilities |
120,536 | 70,704 | ||||||
Deferred revenues |
55,800 | 55,800 | ||||||
Total current liabilities |
291,178 | 171,322 | ||||||
Deferred revenues, less current portion |
1,362,402 | 1,390,305 | ||||||
Participating Interests in Export Water Supply |
1,214,022 | 1,214,799 | ||||||
Tap Participation Fee payable to HP A&M,
net of $50.1 million and $52.0 million discount, respectively |
63,035,329 | 61,141,329 | ||||||
Total liabilities |
65,902,931 | 63,917,755 | ||||||
Commitments and Contingencies |
||||||||
SHAREHOLDERS’ EQUITY: |
||||||||
Preferred stock: |
||||||||
Series B — par value $.001 per share, 25 million shares authorized;
432,513 shares issued and outstanding
(liquidation preference of $432,513) |
433 | 433 | ||||||
Common stock: |
||||||||
Par value 1/3 of $.01 per share, 40 million shares authorized;
24,037,596 and 20,206,566 shares outstanding, respectively |
80,130 | 67,360 | ||||||
Additional paid-in capital |
103,126,107 | 92,341,555 | ||||||
Accumulated comprehensive loss |
(5,170 | ) | (1,580 | ) | ||||
Accumulated deficit |
(53,189,540 | ) | (49,947,769 | ) | ||||
Total shareholders’ equity |
50,011,960 | 42,459,999 | ||||||
Total liabilities and shareholders’ equity |
$ | 115,914,891 | $ | 106,377,754 | ||||
See Accompanying Notes to Financial Statements
3
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PURE CYCLE CORPORATION
STATEMENTS OF OPERATIONS
(unaudited)
(unaudited)
| Three months ended: | ||||||||
| February 28, 2011 | February 28, 2010 | |||||||
Revenues: |
||||||||
Metered water usage |
$ | 25,285 | $ | 20,517 | ||||
Wastewater treatment fees |
17,719 | 16,744 | ||||||
Recognition of deferred revenues: |
||||||||
Special facility funding |
10,377 | 10,377 | ||||||
Water tap fees |
3,574 | 3,574 | ||||||
Total revenues |
56,955 | 51,212 | ||||||
Cost of revenues: |
||||||||
Water service operations |
(7,154 | ) | (10,658 | ) | ||||
Wastewater service operations |
(4,606 | ) | (4,810 | ) | ||||
Depletion and depreciation |
(22,069 | ) | (22,050 | ) | ||||
Total cost of revenues |
(33,829 | ) | (37,518 | ) | ||||
Gross margin |
23,126 | 13,694 | ||||||
Expenses: |
||||||||
General and administrative expenses |
(767,095 | ) | (582,766 | ) | ||||
Depreciation |
(53,121 | ) | (74,561 | ) | ||||
Operating loss |
(797,090 | ) | (643,633 | ) | ||||
Other income (expense): |
||||||||
Interest income |
10,344 | 16,522 | ||||||
Gain on sale of land |
— | 9,404 | ||||||
Other |
20,455 | 1,409 | ||||||
Interest expense on Convertible Note — related party |
(60,667 | ) | — | |||||
Interest imputed on the Tap Participation Fee payable to HP A&M |
(954,000 | ) | (898,000 | ) | ||||
Net loss |
$ | (1,780,958 | ) | $ | (1,514,298 | ) | ||
Net loss per common share — basic and diluted |
$ | (0.08 | ) | $ | (0.07 | ) | ||
Weighted average common shares outstanding — basic and diluted |
23,112,616 | 20,206,566 | ||||||
See Accompanying Notes to Financial Statements
4
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PURE CYCLE CORPORATION
STATEMENTS OF OPERATIONS
(unaudited)
(unaudited)
| Six Months Ended: | ||||||||
| February 28, 2011 | February 28, 2010 | |||||||
Revenues: |
||||||||
Metered water usage |
$ | 61,601 | $ | 49,395 | ||||
Wastewater treatment fees |
35,438 | 33,488 | ||||||
Recognition of deferred revenues: |
||||||||
Special facility funding |
20,754 | 20,754 | ||||||
Water tap fees |
7,148 | 7,148 | ||||||
Total revenues |
124,941 | 110,785 | ||||||
Cost of revenues: |
||||||||
Water service operations |
(21,709 | ) | (25,419 | ) | ||||
Wastewater service operations |
(9,416 | ) | (10,439 | ) | ||||
Depletion and depreciation |
(44,200 | ) | (44,154 | ) | ||||
Total cost of revenues |
(75,325 | ) | (80,012 | ) | ||||
Gross margin |
49,616 | 30,773 | ||||||
Expenses: |
||||||||
General and administrative expenses |
(1,188,565 | ) | (940,175 | ) | ||||
Depreciation |
(106,194 | ) | (149,290 | ) | ||||
Operating loss |
(1,245,143 | ) | (1,058,692 | ) | ||||
Other income (expense): |
||||||||
Interest income |
27,094 | 37,173 | ||||||
Gain on sale of land |
— | 9,404 | ||||||
Other |
21,945 | 1,130 | ||||||
Interest expense on Convertible Note — related party |
(151,667 | ) | — | |||||
Interest imputed on the Tap Participation Fee payable to HP A&M |
(1,894,000 | ) | (1,782,000 | ) | ||||
Net loss |
$ | (3,241,771 | ) | $ | (2,792,985 | ) | ||
Net loss per common share — basic and diluted |
$ | (0.15 | ) | $ | (0.14 | ) | ||
Weighted average common shares outstanding — basic and diluted |
22,284,899 | 20,206,566 | ||||||
See Accompanying Notes to Financial Statements
5
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PURE CYCLE CORPORATION
STATEMENTS OF CASH FLOWS
(unaudited)
(unaudited)
| Six months ended: | ||||||||
| February 28, 2011 | February 28, 2010 | |||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (3,241,771 | ) | $ | (2,792,985 | ) | ||
Adjustments to reconcile net loss to net cash
used for operating activities: |
||||||||
Imputed interest on Tap Participation Fee payable to HP A&M |
1,894,000 | 1,782,000 | ||||||
Interest expense on Convertible Note — related party |
151,667 | — | ||||||
Depreciation, depletion and other non-cash items |
144,968 | 195,025 | ||||||
Stock-based compensation expense included with
general and administrative expenses |
44,050 | 42,281 | ||||||
Gain on sale of land |
— | (9,404 | ) | |||||
Interest added to construction proceeds receivable |
(11,893 | ) | (13,589 | ) | ||||
Interest added to notes receivable — related parties: |
||||||||
Rangeview Metropolitan District |
(5,970 | ) | (5,970 | ) | ||||
Changes in operating assets and liabilities: |
||||||||
Trade accounts receivable |
16,400 | 2,648 | ||||||
Prepaid expenses |
42,773 | (41,623 | ) | |||||
Accounts payable and accrued liabilities |
107,360 | 45,371 | ||||||
Deferred revenues |
(27,902 | ) | (27,901 | ) | ||||
Net cash used by operating activities |
(886,318 | ) | (824,147 | ) | ||||
Cash flows from investing activities: |
||||||||
Sales and maturities of marketable securities |
531,157 | 983,721 | ||||||
Purchase of marketable securities |
(3,252,209 | ) | — | |||||
Investments in land, water and water systems |
(6,820,409 | ) | (10,649 | ) | ||||
Net cash (used) provided by investing activities |
(9,541,461 | ) | 973,072 | |||||
Cash flows from financing activities: |
||||||||
Arapahoe County construction proceeds |
34,249 | 41,098 | ||||||
Issuance of Convertible Note Payable — related party |
5,200,000 | — | ||||||
Net proceeds from sale of common stock |
5,401,606 | |||||||
Payments to contingent liability holders |
(2,229 | ) | (1,895 | ) | ||||
Net cash provided by financing activities |
10,633,626 | 39,203 | ||||||
Net change in cash and cash equivalents |
205,847 | 188,128 | ||||||
Cash and cash equivalents — beginning of year |
12,017 | 705,083 | ||||||
Cash and cash equivalents — end of year |
$ | 217,864 | $ | 893,211 | ||||
See Accompanying Notes to Financial Statements
6
Table of Contents
PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
NOTE 1 — PRESENTATION OF INTERIM INFORMATION
The February 28, 2011 balance sheet, the statements of operations for the three and six months
ended February 28, 2011 and 2010, and the statements of cash flows for the six months ended
February 28, 2011 and 2010, respectively, have been prepared by Pure Cycle Corporation (the
“Company”) and have not been audited. In the opinion of management, all adjustments, consisting
only of normal recurring adjustments necessary to present fairly the financial position, results of
operations and cash flows at February 28, 2011, and for all periods presented have been made
appropriately.
Certain information and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of America (“GAAP”)
have been condensed or omitted. It is suggested that these financial statements be read in
conjunction with the financial statements and notes thereto included in the Company’s 2010 Annual
Report on Form 10-K filed with the Securities and Exchange Commission on November 12, 2010. The
results of operations for interim periods presented are not necessarily indicative of the operating
results for the full fiscal year. The August 31, 2010 balance sheet was taken directly from the
Company’s audited financial statements.
Use of Estimates. The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Cash and Cash Equivalents. Cash and cash equivalents include all highly liquid debt instruments
with original maturities of three months or less. The Company’s cash equivalents are comprised
entirely of money market funds maintained at a high quality financial institution.
Financial Instruments — Concentration of Credit Risk and Fair Value. Financial instruments that
potentially subject the Company to concentrations of credit risk consist primarily of cash
equivalents and marketable securities. The Company places its cash equivalents and investments with
a high quality financial institution. At various times throughout the three and six months ended
February 28, 2011, cash deposits have exceeded federally insured limits. The Company invests its
excess cash primarily in certificates of deposit, money market instruments, commercial paper
obligations, corporate bonds and US government treasury obligations. To date, the Company has not
experienced significant losses on any of these investments.
The following methods and assumptions were used to estimate the fair value of each class of
financial instruments for which it is practicable to estimate that value.
Current Assets and Liabilities
The amounts reported on the balance sheet for cash and cash equivalents, trade receivables/payables
and accrued liabilities, approximate their fair values because of the short maturity of these
instruments.
The amounts reported on the balance sheets for marketable securities are the fair values of the
instruments as reported by the financial institution where the funds are held as of February 28,
2011 and August 31, 2010. The Company has recorded net unrealized losses of approximately $5,200
and $1,600 at February 28, 2011 and August 31, 2010, respectively. These securities include only
federally insured certificates of deposit.
Notes Receivable and Construction Proceeds Receivable
The amounts reported on the balance sheet for the Company’s notes receivable and construction
proceeds receivable approximate their fair values as they bear interest at rates which are
comparable to current market rates.
7
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
Long-term Financial Liabilities
The Comprehensive Amendment Agreement No. 1 (the “CAA” as defined in Note 5 below) is comprised of
a recorded balance and an off-balance sheet or “contingent” obligation. The amount payable is a
fixed amount but is repayable only upon the sale of “Export Water” (as defined in Note 4 in the
Company’s 2010 Annual Report on Form 10-K). Because of the uncertainty of the sale of Export
Water, the Company has determined that the contingent portion of the CAA does not have a
determinable fair value.
The fair value of approximately $63.0 million, which is the reported value of the “Tap
Participation Fee” (as described below), is determined by projecting new home development in the
Company’s targeted service area over an estimated development period
Tap Participation Fee. Pursuant to the Asset Purchase Agreement (the “Arkansas River Agreement”)
dated August 31, 2006, the Company granted High Plains A&M, LLC (“HP A&M”) the right to receive
ten percent (10%) of the Company’s gross proceeds, or the equivalent thereof, from the sale of the
next 40,000 water taps sold by the Company from and after the date of the Arkansas River Agreement
(the “Tap Participation Fee”). As a result of land sales in 2006 and 2009 and the sale of
unutilized water rights owned by the Company in the Arkansas River Valley in 2007, at February 28,
2011, there remain 38,937 water taps subject to the Tap Participation Fee.
The Tap Participation Fee is due and payable once the Company has sold a water tap and received
the consideration due for such water tap. The Company did not sell any water taps during the three
and six months ended February 28, 2011 or 2010.
At the acquisition date the Company valued the Tap Participation Fee at approximately $45.6
million using a discounted cash flow analysis of the projected future payments to HP A&M. The
$63.0 million balance at February 28, 2011, includes approximately $18.3 million of imputed
interest, recorded using the effective interest method. The value of the Tap Participation Fee is
estimated by projecting new home development in the Company’s targeted service area over an
estimated development period. Projecting new home development in the Company’s targeted service
area involved the utilization of third party historical and projected housing and population
growth data for the Denver, Colorado metropolitan area, which was applied to an estimated
development pattern, supported by historical development patterns of certain master planned
communities in the Denver, Colorado metropolitan area. This development pattern was then applied
to estimated future water tap fees which were estimated using historical water tap fees. Based on
the weak new home construction market in the Denver metropolitan area, the Company updated its
estimated discounted cash flow analysis as of February 28, 2009. Further details of this update
can be found in Note 7 to the Company’s 2010 Annual Report on Form 10-K. The Company completed an
update to its analysis of the fair value of the Tap Participation Fee as of August 31, 2010, at
which time it determined that changes in the projected estimated discounted cash flows did not
materially impact its February 28, 2009 fair value analysis. Based on a lack of material changes,
no update was deemed necessary at February 28, 2011.
Actual new home development in the Company’s service area and actual future tap fees inevitably
will vary significantly from the Company’s estimates which could have a material impact on the
Company’s financial statements as well as its results of operations. An important component in the
Company’s estimate of the value of the Tap Participation Fee, which is based on historical trends,
is that the Company reasonably expects water tap fees to continue to increase in the coming years.
Tap fees are market based and the continued increase in tap fees reflects, among other things, the
increasing costs to acquire and develop new water supplies. Tap fees thus are partially
indicative of the increasing value of the Company’s water assets. The Company continues to assess
the value of the Tap Participation Fee liability and updates its valuation analysis whenever
events or circumstances indicate the assumptions used to estimate the value of the liability have
changed materially. The difference between the net present value and the estimated realizable
value will be imputed as interest expense using the effective interest method over the estimated
development period utilized in the valuation of the Tap Participation Fee.
The Company imputes interest expense on the unpaid Tap Participation Fee using the effective
interest method over the estimated development period utilized in the valuation of the liability.
The Company imputed interest of approximately $950,000 and $1.9 million during the three and six
months ended February 28, 2011, respectively. The Company imputed interest of approximately
$898,000 and $1.8 million during the three and six months ended February 28, 2010, respectively.
8
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
After August 30, 2011 (five years after the acquisition date), under circumstances defined in the
Arkansas River Agreement, the Tap Participation Fee can increase to 20% of the Company’s water tap
fees and the number of water taps subject to the Tap Participation Fee would be correspondingly
reduced by half. 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.
Revenue Recognition. The Company’s revenue recognition policies have not changed since August 31,
2010, and are more fully described in Note 2 to the financial statements contained in the Company’s
2010 Annual Report on Form 10-K.
The Company recognized approximately $3,600 and $7,100 of water tap fee revenues during each of the
three and six months ended February 28, 2011 and 2010, respectively, related to the Water Service
Agreement (the “County Agreement”) with Arapahoe County (the “County”) entered into in August 2005.
In fiscal 2006, the Company began recognizing the water tap fees as revenue ratably over the
estimated service period upon completion of the “Wholesale Facilities” (defined in the Company’s
2010 Annual Report on Form 10-K). 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 as further described in Note 5 below.
The Company recognized approximately $10,400 and $20,800 of “Special Facilities” (defined in the
Company’s 2010 Annual Report on Form 10-K) funding as revenue during each of the three and six
month periods ended February 28, 2011 and 2010, 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 financial statements contained in the Company’s 2010 Annual
Report on Form 10-K.
As of February 28, 2011, the Company has deferred recognition of approximately $1.4 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.
Royalty and other obligations. Revenues from the sale of Export Water are shown net of royalties
payable to the Land Board. Revenues from the sale of water on the Lowry Range Property are shown
net of the royalties to the Land Board and the fees retained by the Rangeview Metropolitan District
(the “District”).
Water and Wastewater Systems. If costs meet the Company’s capitalization criteria, costs to
construct water and wastewater systems are capitalized as incurred, including interest, and
depreciated over the estimated useful lives of the water and wastewater systems. The Company
capitalizes design and construction costs related to construction activities and it capitalizes
certain legal, engineering and permitting costs relating to the adjudication and improvement of its
water assets.
Depletion and Depreciation of Water Assets. The Company depletes its water assets that are being
utilized on the basis of units produced divided by the total volume of water adjudicated in the
water decrees. Water systems are depreciated on a straight line basis over their estimated useful
lives of up to thirty years.
Share-based Compensation. The Company maintains a stock option plan for the benefit of its
employees and directors. The Company records share-based compensation costs which are measured at
the grant date based on the fair value of the award and are recognized as expense over the
applicable vesting period of the stock award using the straight-line method. The Company has
adopted the alternative transition method for calculating the tax effects of share-based
compensation which allows for a simplified method of calculating the tax effects of employee
share-based compensation. Because the Company has a full valuation allowance on its deferred tax
assets, at this time the granting and exercise of stock options has no impact on the income tax
provisions.
9
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
The Company recognized approximately $22,700 and $44,100 of share-based compensation expenses
during the three and six months ended February 28, 2011, respectively. The Company recognized
approximately $19,600 and $42,300 of share-based compensation expenses during the three and six
months ended February 28, 2010, respectively.
Income taxes. The Company follows a “more-likely-than-not” threshold for the recognition and
de-recognition of tax positions, including any potential interest and penalties relating to tax
positions taken by the Company. The Company does not have any significant unrecognized tax
benefits or liabilities.
The Company files income tax returns with the Internal Revenue Service and the State of Colorado.
The tax years that remain subject to examination are fiscal 2008 through fiscal 2010. The Company
does not believe there will be any material changes in its unrecognized tax positions over the next
twelve months.
The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax
benefits as a component of income tax expense. At February 28, 2011, the Company did not have any
accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest
expense recognized during the three and six months ended February 28, 2011 or 2010.
Loss per Common Share. Loss per common share is computed by dividing net loss by the weighted
average number of shares outstanding during each period. Common stock options and warrants
aggregating approximately 280,100 and 262,600, common share equivalents as of February 28, 2011
and 2010, respectively, and approximately 1.9 million shares underlying the convertible note, prior to conversion have been excluded from the calculation of loss per common share as their
effect is anti-dilutive.
Recently Issued Accounting Pronouncements. The Company continually assesses any new accounting
pronouncements to determine their applicability. Where it is determined that a new accounting
pronouncement affects the Company’s financial reporting, the Company undertakes a study to
determine the consequence of the change to its financial statements and assures that there are
proper controls in place to ascertain that the Company’s financials properly reflect the change.
New pronouncements assessed by the Company recently are discussed below:
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards
Update (“ASU”) 2010-06, “Improving Disclosures about Fair Value Measurements” (ASU 2010-06). This
update requires additional disclosure within the roll forward of activity for assets and
liabilities measured at fair value on a recurring basis, including transfers of assets and
liabilities between Level 1 and Level 2 of the fair value hierarchy and the separate presentation
of purchases, sales, issuances and settlements of assets and liabilities within Level 3 of the fair
value hierarchy. In addition, the update requires enhanced disclosures of the valuation techniques
and inputs used in the fair value measurements within Levels 2 and 3. The new disclosure
requirements are effective for interim and annual periods beginning after December 15, 2009, except
for the disclosure of purchases, sales, issuances and settlements of Level 3 measurements. Those
disclosures are effective for fiscal years beginning after December 15, 2010 (September 1, 2011 for
the Company). As ASU 2010-06 only requires enhanced disclosures, the Company does not expect that
the adoption of this update will have a material effect on its financial statements.
In October 2009, the FASB issued ASU No. 2009-13 “Multiple-Deliverable Revenue Arrangements-a
Consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”) which updates ASC Topic 605,
“Revenue Recognition.” ASU 2009-13 provides another alternative for determining the selling price
of deliverables and will allow companies to allocate arrangement consideration in multiple
deliverable arrangements in a manner that better reflects the transaction’s economics and could
result in earlier revenue recognition. ASU 2009-13 is effective for the Company prospectively for
revenue arrangements entered into or materially modified on or after October 1, 2010; however,
early adoption is permitted. The Company is currently evaluating the impact of adopting ASU
2009-13 on its financial statements.
In June 2009, the FASB issued ASU 2009-17, “Consolidations: Improvements to Financial Reporting by
Enterprises Involved with Variable Interest Entities.” ASU 2009-17, which amends ASC 810-10,
“Consolidation”, prescribes a qualitative model for identifying whether a company has a controlling
financial interest in a variable interest entity (“VIE”) and eliminates the quantitative model. The
new model identifies two primary characteristics of a controlling financial interest: (1) provides
a company with the power to direct significant activities of the VIE, and (2) obligates a company
to absorb losses of and/or provides rights to receive benefits from the VIE. ASU 2009-17 requires a
company to reassess on an ongoing basis whether it holds a controlling financial interest in a VIE.
A company that holds a controlling financial interest is deemed to be the primary beneficiary of
the VIE and is required to consolidate the VIE. ASU 2009-17 is effective as of the beginning of
each reporting entity’s first annual reporting period that begins after November 15, 2009, which
for the Company was September 1, 2010. The adoption of this guidance did not have an impact on the
Company’s results of operations, financial position or cash flows.
10
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
Reclassifications. Certain amounts in the February 28, 2010 financial statements have been
reclassified to conform to the current presentation.
NOTE 2 — FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date in the
principal or most advantageous market. The Company uses a fair value hierarchy that has three
levels of inputs, both observable and unobservable, with use of the lowest possible level of input
to determine fair value.
Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the New
York Stock Exchange. The Company had none of these instruments at February 28, 2011.
Level 2 — Valuations for assets and liabilities obtained from readily available pricing sources
via independent providers for market transactions involving similar assets or liabilities. The
Company had one Level 2 asset at February 28, 2011, its marketable securities. The Company’s
principal market for these securities is the secondary institutional markets and valuations are
based on observable market data in those markets.
Level 3 — Valuations for assets and liabilities that are derived from other valuation
methodologies, including discounted cash flow models and similar techniques, and not based on
market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain
assumptions and projections in determining the fair value assigned to such assets or liabilities.
The Company had one Level 3 liability at February 28, 2011, the “Tap Participation Fee” liability,
which is described in greater detail in Note 1 above.
The Company maintains policies and procedures to value instruments using the best and most relevant
data available.
The Company applied the new accounting guidance issued by the FASB for all non-financial assets and
liabilities measured at fair value on a non-recurring basis at September 1, 2009. The Company’s
non-financial assets measured at fair value on a non-recurring basis consist entirely of its
investments in water and water systems and other long-lived assets. Since the Company performed
its annual impairment analyses of its long-lived assets as of August 31, 2010, with no indicators
of impairment, and since no impairment trigger event occurred during the first three months of
fiscal 2011, the adoption of the new FASB standard for non-financial assets and liabilities
measured at fair value on a non-recurring basis did not have an impact on the Company’s financial
position, results of operations or cash flows.
Level 2 Asset — Marketable Securities Measured on a Recurring Basis. The Company’s marketable
securities are the Company’s only financial assets measured on a recurring basis. The fair values
of the marketable securities are based on the values reported by the financial institutions where
the funds are held. These securities include only federally insured certificates of deposit.
Level 3 Liability — Tap Participation Fee. The Company’s Tap Participation Fee liability is the
Company’s only financial liability measured on a non-recurring basis. As further described in Note
1 above, the Tap Participation Fee liability is valued by projecting new home development in the
Company’s targeted service area over an estimated development period.
11
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
The following table provides information on the assets and liabilities measured at fair value as of
February 28, 2011:
| Fair Value Measurement Using: | ||||||||||||||||||||||||
| Quoted Prices | ||||||||||||||||||||||||
| in Active | Significant | |||||||||||||||||||||||
| Markets for | Other | Significant | Total | |||||||||||||||||||||
| Identical | Observable | Unobservable | Unrealized | |||||||||||||||||||||
| Cost / Other | Assets | Inputs | Inputs | Gains and | ||||||||||||||||||||
| Fair Value | Value | (Level 1) | (Level 2) | (Level 3) | (Losses) | |||||||||||||||||||
Marketable securities |
$ | 4,152,500 | $ | 4,157,700 | $ | — | $ | 4,152,500 | $ | — | $ | (5,200 | ) | |||||||||||
Tap Participation Fee liability |
$ | 63,035,300 | $ | 63,035,300 | $ | — | $ | — | $ | 63,035,300 | $ | — | ||||||||||||
Although not required, the Company deems the following table, which presents the changes in
the Tap Participation Fee for the six months ended February 28, 2011, to be helpful to the users of
its financial statements:
| Fair Value Measurement using Significant Unobservable | ||||||||||||
| Inputs (Level 3) | ||||||||||||
| Discount - to be | ||||||||||||
| imputed as | ||||||||||||
| Gross Estimated | Tap Participation | interest expense | ||||||||||
| Tap Participation | Fee Reported | in future | ||||||||||
| Fee Liability | Liability | periods | ||||||||||
Balance at August 31, 2010 |
$ | 113,147,700 | $ | 61,141,300 | $ | 52,006,400 | ||||||
Total gains and losses (realized and unrealized): |
||||||||||||
Imputed interest recorded as “Other Expense” |
— | 1,894,000 | (1,894,000 | ) | ||||||||
Increase in estimated value (to be realized in future periods) |
— | — | — | |||||||||
Purchases, sales, issuances, payments, and settlements |
— | — | — | |||||||||
Transfers in and/or out of Level 3 |
— | — | — | |||||||||
Balance at February 28, 2011 |
$ | 113,147,700 | $ | 63,035,300 | $ | 50,112,400 | ||||||
The methodologies for estimating the fair value of financial assets and liabilities that are
measured at fair value are discussed above. The methodologies for other financial assets and
liabilities are discussed below.
Cash and Cash Equivalents: The Company’s cash and cash equivalents are reported using the
values as reported by the financial institution where the funds are held. These securities
primarily include balances in the Company’s operating and savings accounts. The carrying amount of
cash and cash equivalents approximate fair value.
Accounts Receivable and Accounts Payable: The carrying amounts of accounts receivable and
accounts payable approximate fair value due to the relatively short period to maturity for these
instruments.
Notes Receivable and Construction Proceeds Receivable: The carrying amounts of the
Company’s notes receivable and construction proceeds receivable approximate fair value as they bear
interest at rates which are comparable to current market rates.
Off-Balance Sheet Instruments: The Company’s off-balance sheet instruments consist
entirely of the contingent portion of the CAA (described further in Note 5 below). Because
repayment of this portion of the CAA is contingent on the sale of Export Water, the Company has
determined that the contingent portion of the CAA does not have a determinable fair value.
NOTE 3 — INVESTMENTS IN WATER AND WATER SYSTEMS
The Company’s water rights and current water and wastewater service agreements are more fully
described in Note 4 to the financial statements contained in the Company’s 2010 Annual Report on
Form 10-K. With the exception of the Sky Ranch acquisition which is described below, there have
been no significant changes to the Company’s water rights or water and wastewater service
agreements during the three and six months ended February 28, 2011.
12
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
The Company’s water and water systems consist of the following approximate costs and accumulated
depreciation and depletion as of February 28, 2011 and August 31, 2010:
| February 28, 2011 | August 31, 2010 | |||||||||||||||
| Accumulated | Accumulated | |||||||||||||||
| Depreciation | Depreciation | |||||||||||||||
| Costs | and Depletion | Costs | and Depletion | |||||||||||||
Arkansas River Valley assets |
$ | 81,318,700 | $ | (1,058,200 | ) | $ | 81,318,700 | $ | (972,400 | ) | ||||||
Rangeview water supply |
14,295,800 | (6,200 | ) | 14,285,700 | (6,000 | ) | ||||||||||
Paradise water supply |
5,540,200 | — | 5,536,500 | — | ||||||||||||
Sky Ranch water rights |
3,828,100 | — | 100,000 | — | ||||||||||||
Fairgrounds water and water system |
2,899,900 | (59,800 | ) | 2,899,900 | (358,400 | ) | ||||||||||
Rangeview water system |
167,700 | (402,400 | ) | 167,700 | (57,200 | ) | ||||||||||
Water supply — other |
25,700 | (11,500 | ) | 25,700 | (8,900 | ) | ||||||||||
Totals |
108,076,100 | (1,538,100 | ) | 104,334,200 | (1,402,900 | ) | ||||||||||
Net investments in water and water systems |
$ | 106,538,000 | $ | 102,931,300 | ||||||||||||
Depletion and Depreciation. The Company recorded less than $100 and approximately $200 of
depletion charges during each of the three and six month periods ended February 28, 2011 and 2010,
respectively. This related entirely to the use of the Rangeview Water Supply. No depletion is
taken against the Arkansas River water, the Paradise Water Supply or Sky Ranch water because these
assets have not been placed into service as of February 28, 2011. The Company recorded
approximately $75,100 and $150,200 of depreciation expense during the three and six months ended
February 28, 2011, respectively. The Company recorded approximately $96,600 and $193,300 of
depreciation expense during the three and six months ended February 28, 2010, respectively.
Acquisition of Sky Ranch. Effective July 30, 2010, the Company entered into a Loan Sale and
Assignment Agreement (the “Loan Sale Agreement”) with the Bank of America, N.A. (“BofA”), to
acquire from BofA loan instruments secured by approximately 940 acres of undeveloped land located
in unincorporated Arapahoe County and known as Sky Ranch. The Company acquired the promissory note
payable by Sky Ranch, LLC (a wholly owned subsidiary of Neumann Homes, Inc.) and the deed of trust
granted by Sky Ranch, LLC to secure the promissory note from BofA for cash payments totaling $7.0
million. The Company made a $700,000 escrow payment to BofA on July 30, 2010 and paid the
remaining $6.3 million of the purchase price on October 18, 2010. On October 26, 2010, the United
States Bankruptcy Court, Northern District of Illinois, entered an order granting the Company’s
motion requesting that title to the Sky Ranch property be deeded to the Company. Pursuant to the
order, the Company owns the Sky Ranch property effective as of November 2, 2010.
The property includes approximately 820 acre feet of water, 89 acre feet of which were previously
purchased by the Company pursuant to agreements with the former developer.
Total consideration for the land and water included the approximately $7.0 million purchase price,
plus direct costs and fees of approximately $554,100. The Company allocated the total acquisition
cost to the land and water rights based on estimates of each asset’s respective fair value, as
described in the table below. Because the total acquisition cost was less than the total estimated
fair value of the assets acquired by the Company, the relative values assigned to the land and
water have been ratably reduced (allocated values are detailed in the table below). The estimated
fair value of the land and water rights were determined by internal analysis of estimated future
cash flows from land water rights sales and supplemented with an external appraisal of the land
acquired.
13
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
The following table presents the allocation of the acquisition costs (and the relative fair values
of each asset), including professional fees and other costs related to the acquisition, to the land
and water based on their relative fair values:
| Total Values | ||||||||||||||||||||||||
| Assigned to | ||||||||||||||||||||||||
| Estimated Fair | % of Total | Allocable | Fair Value | Costs Specific | Identifiable | |||||||||||||||||||
| Asset | Value | Fair Value | Acquisition Costs | Allocation | to Land 1 | Assets | ||||||||||||||||||
Land |
$ | 10,637,900 | 48.13 | % | $ | 7,187,900 | $ | 3,459,800 | $ | 279,100 | $ | 3,738,900 | ||||||||||||
Water 2 |
11,462,700 | 51.87 | % | 7,187,900 | 3,728,100 | — | 3,728,100 | |||||||||||||||||
| $ | 22,100,600 | 100 | % | $ | 7,187,900 | $ | 279,100 | $ | 7,467,000 | |||||||||||||||
Costs of acquisition 3 |
87,100 | |||||||||||||||||||||||
Total capitalized costs related to Sky Ranch |
$ | 7,554,100 | ||||||||||||||||||||||
| 1. | Includes approximately $71,000 of property taxes. |
|
| 2. | The water rights value does not include the $100,000 of costs already capitalized on the
Company’s balance sheet related to the 89 acre feet of water acquired from the prior owner of
the land and not pursuant to the Loan Sale Agreement. |
|
| 3. | The amounts recorded as costs of acquisition consist of professional fees and other related
costs. Approximately $12,500 of the acquisition costs are unpaid as of February 28, 2011,
and are therefore included in the accrued liabilities account at February 28, 2011. |
The assets acquired by the Company are being depleted and depreciated consistent with the Company’s
depletion and depreciation policies.
The funding for this acquisition was completed in September 2010, when the Company entered into the
$5.2 million Convertible Negotiable Promissory Note (the “Convertible Note”) with PAR Investment
Partners, L.P. (“PAR”), a 5% or greater shareholder of the Company, and sold approximately 1.8
million shares of its common stock for approximately $5.5 million. Both financing transactions are
described below, including the conversion of the Convertible Note on January 11, 2011. Of the
combined $10.7 million raised by the Company, $6.3 million was used to complete the Loan Sale
Agreement with BofA and the remaining funds, approximately $4.4 million, are being used for working
capital and other general corporate purposes.
Issuance and Conversion of the Convertible Note
The Company issued the $5.2 million Convertible Note to PAR on September 28, 2010. The Company’s
shareholders authorized conversion of the Convertible Note at the January 11, 2011 annual
shareholders’ meeting. Following the meeting, PAR surrendered the Convertible Note for conversion
and the Company issued 1,982,099 shares of its restricted common stock to PAR. From issuance until
conversion, the Convertible Note accrued interest at a rate of 10% per annum. During the three and
six months ended February 28, 2011, the Company accrued approximately $60,700 and $151,700 of
interest on the Convertible Note, respectively. The number of restricted shares issued was based
on the outstanding balance of approximately $5.35 million (principal and accrued interest) divided
by a conversion rate of $2.70. Since the Convertible Note included a conversion feature that was a
standard conversion feature not subject to change, the Company determined this was not an embedded
derivative. Additionally, at the date of issuance, the market price of the Company’s common stock
was less than the conversion price; therefore, the Company determined that the instrument did not
contain a beneficial conversion feature. In conjunction with the Convertible Note, the Company
granted PAR one demand right and piggyback rights to register the shares of common stock issuable
upon conversion of the Convertible Note.
Sale of common stock pursuant to the shelf registration statement
On September 29, 2010, the Company sold 1,848,931 shares of its common stock for approximately $5.5
million or $3.00 per share. These shares were sold pursuant to a $10.0 million shelf registration
statement (Registration Number 333-168160) filed with the SEC which became effective on July 28,
2010. The Company may issue up to an additional $4.45 million of its common stock pursuant to the
shelf registration statement. Approximately 930,600
shares of common stock sold in this offering were sold to PAR for approximately $2.8 million or
$3.00 per share.
14
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
NOTE 4 — HP A&M PROMISSORY NOTES
Certain of the properties acquired from HP A&M are subject to outstanding promissory notes with
principal and accrued interest totaling approximately $10.7 million at February 28, 2011 and $11.0
million at August 31, 2010. Additional information regarding these promissory notes, the
circumstances under which the Company would be required to make payments pursuant to these notes
and the accounting treatment of these notes are more fully described in Note 7 to the financial
statements contained in the Company’s 2010 Annual Report on Form 10-K.
NOTE 5 — PARTICIPATING INTERESTS IN EXPORT WATER
The Company acquired its Rangeview Water Supply through various amended agreements entered into in
the early 1990’s. The acquisition was consummated with the signing of the Comprehensive Amendment
Agreement No. 1 (the “CAA”) in 1996. Upon entering into the CAA, the Company recorded an initial
liability of approximately $11.1 million, which represents the cash the Company received and used
to purchase its Export Water, which is described in greater detail in Note 4 to the financial
statements contained in the Company’s 2010 Annual Report on Form 10-K. In return, the Company
agreed to remit a total of $31.8 million of proceeds received from the sale of Export Water to the
participating interest holders. The obligation for the $11.1 million was recorded as debt, and the
remaining $20.7 million contingent liability was not reflected on the Company’s balance sheet
because the obligation to pay this is contingent on sales of Export Water, the amounts and timing
of which are not reasonably determinable.
The CAA obligation is non-interest bearing, and if the Export Water is not sold, the parties to the
CAA have no recourse against the Company. If the Company does not sell the Export Water, the
holders of the Series B Preferred Stock are also not entitled to payment of any dividend and have
no contractual recourse against the Company.
As the proceeds from the sale of Export Water are received and the amounts are remitted to the
external CAA holders, the Company allocates a ratable percentage of each payment to the principal
portion (the Participating Interests in Export Water Supply liability account) with the balance of
the payment being charged to the contingent obligation portion. Because the original recorded
liability, which was $11.1 million, was approximately 35% of the original total liability of $31.8
million, 35% of each payment remitted to the CAA holders is allocated to the recorded liability
account. The remaining portion of each payment, or approximately 65%, is allocated to the
contingent obligation, which is recorded on a net revenue basis.
In order to reduce the long term impact of the CAA, the Company previously repurchased various
portions of the CAA obligations in priority. The Company did not make any CAA acquisitions during
the three and six months ended February 28, 2011 or 2010.
15
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
As a result of the CAA acquisitions, and due to the sale of Export Water, as detailed in the table
below, the total remaining potential third party obligation as of February 28, 2011 is
approximately $3.5 million:
| Export Water | Initial Export | Total Potential | Paticipating | |||||||||||||||||
| Proceeds | Water Proceeds | Third party | Interests | |||||||||||||||||
| Received | to Pure Cycle | Obligation | Liability | Contingency | ||||||||||||||||
Original balances |
$ | — | $ | 218,500 | $ | 31,807,732 | $ | 11,090,630 | $ | 20,717,102 | ||||||||||
Activity from inception
until August 31, 2010: |
||||||||||||||||||||
Acquisitions |
— | 28,077,500 | (28,077,500 | ) | (9,789,983 | ) | (18,287,517 | ) | ||||||||||||
Option payments — Sky Ranch
and The Hills at Sky Ranch |
110,400 | (42,280 | ) | (68,120 | ) | (23,754 | ) | (44,366 | ) | |||||||||||
Arapahoe County tap fees * |
532,968 | (373,078 | ) | (159,890 | ) | (55,754 | ) | (104,136 | ) | |||||||||||
Export Water sale payments |
60,584 | (42,408 | ) | (18,176 | ) | (6,340 | ) | (11,836 | ) | |||||||||||
Balance at August 31, 2010 |
703,952 | 27,838,234 | 3,484,046 | 1,214,799 | 2,269,247 | |||||||||||||||
Fiscal 2011 activity: |
||||||||||||||||||||
Export Water sale payments |
7,425 | (5,198 | ) | (2,228 | ) | (777 | ) | (1,451 | ) | |||||||||||
Balance at February 28, 2011 |
$ | 711,377 | $ | 27,833,036 | $ | 3,481,818 | $ | 1,214,022 | $ | 2,267,796 | ||||||||||
| * | The Arapahoe County tap fees are less $34,522 in royalties paid to the
Land Board. |
The CAA includes contractually established priorities which call for payments to CAA holders
in order of their priority. This means the first three payees receive their full payment before
the next priority level receives any payment and so on until full repayment. The Company will
receive approximately $5.1 million of the first priority payout (the remaining balance of the first
priority payout totals approximately $7.3 million as of February 28, 2011).
NOTE 6 — SHAREHOLDERS’ EQUITY
The table below summarizes the significant changes in the Company’s equity accounts during the six
months ended February 28, 2011:
| Additional | Accumulated | |||||||||||||||||||
| Common Stock | Paid-in | Comprehensive | Accumulated | |||||||||||||||||
| Shares | Par Value | Capital | Income (loss) | Deficit | ||||||||||||||||
August 31, 2010 balance: |
20,206,566 | $ | 67,360 | $ | 92,341,555 | $ | (1,580 | ) | $ | (49,947,769 | ) | |||||||||
Sale of common stock, less fees and
expenses of approximately $120,200 |
1,848,931 | 6,163 | 5,395,442 | — | — | |||||||||||||||
Issuance of restricted common stock upon
conversion of Convertible Debt |
1,982,099 | 6,607 | 5,345,060 | — | — | |||||||||||||||
Share-based compensation |
— | — | 44,050 | — | — | |||||||||||||||
Unrealized loss on investments |
— | — | — | (3,590 | ) | — | ||||||||||||||
Net loss |
— | — | — | — | (3,241,771 | ) | ||||||||||||||
February 28, 2011 balance: |
24,037,596 | $ | 80,130 | $ | 103,126,107 | $ | (5,170 | ) | $ | (53,189,540 | ) | |||||||||
Sale of common stock and issuance of common stock upon conversion of Convertible Note. See
Note 3 above regarding the issuance of the common stock and the issuance of stock upon conversion
of the Convertible Note, both done in connection with the Sky Ranch acquisition.
Equity Compensation Plan. The Company maintains the 2004 Incentive Plan (the “Equity Plan”),
which was approved by stockholders in April 2004. Executives, eligible employees and non-employee
directors are eligible to receive options and restricted stock grants pursuant to the Equity Plan.
Pursuant to the Equity Plan, options to purchase shares of stock and restricted stock awards can
be granted with exercise prices and vesting periods determined by the Compensation Committee of
the Board. The Company initially reserved 1.6 million shares of common stock for issuance under
the Equity Plan. As of February 28, 2011, the Company has 1,285,811 common shares that can be
granted to eligible participants pursuant to the Equity Plan.
16
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
The Company is required to estimate the fair value of share-based payment awards on the date of
grant using an option-pricing model and to expense the fair value over the vesting period of the
grant. For additional information on the Equity Plan, including a summary of the significant
assumptions, refer to the Company’s Form 10-K for the year ended August 31, 2010.
The following table summarizes stock option activity for the Equity Plan for the six months ended
February 28, 2011:
| Weighted- | ||||||||||||||||
| Average | Approximate | |||||||||||||||
| Weighted- | Remaining | Aggregate | ||||||||||||||
| Number of | Average | Contractual | Instrinsic | |||||||||||||
| Options | Exercise Price | Term | Value | |||||||||||||
Oustanding at beginning
of period |
262,500 | $ | 6.26 | |||||||||||||
Granted |
17,500 | $ | 3.67 | |||||||||||||
Exercised |
— | $ | — | |||||||||||||
Forfeited or expired |
— | $ | — | |||||||||||||
Outstanding at
February 28, 2011 |
280,000 | $ | 6.10 | 6.5 | $ | 107,800 | ||||||||||
Options exercisable at
February 28, 2011 |
214,500 | $ | 6.97 | 5.7 | $ | 58,900 | ||||||||||
The approximate aggregate intrinsic value represents the value of the Company’s closing stock
price on the last trading day of the fiscal period in excess of the weighted-average exercise price
multiplied by the number of options outstanding or exercisable. The aggregate intrinsic value
excludes the effect of stock options that have a zero or negative intrinsic value.
The following table summarizes the activity and value of non-vested options as of and for the six
months ended February 28, 2010:
| Weighted- | ||||||||
| Average Grant | ||||||||
| Number of | Date Fair | |||||||
| Options | Value | |||||||
Non-vested options oustanding at beginning of period |
60,500 | $ | 2.67 | |||||
Granted |
17,500 | 3.11 | ||||||
Vested |
(12,500 | ) | 2.49 | |||||
Forfeited |
— | — | ||||||
Non-vested options outstanding at February 28, 2011 |
65,500 | $ | 2.82 | |||||
The total fair value of options vested during the three and six month periods ended February
28, 2011, was approximately $31,200. The total fair value of options vested during the three and
six month periods ended February 28, 2010, was approximately $36,300.
Stock-based compensation expense for the three and six months ended February 28, 2011, was
approximately $22,600 and $44,100, respectively. Stock-based compensation expense for the three
and six months ended February 28, 2010, was approximately $19,600 and $42,300, respectively.
At February 28, 2011, the Company has unrecognized expenses relating to non-vested options that are
expected to vest totaling approximately $143,000. The weighted-average period over which these
options are expected to vest is approximately two years. The Company has not recorded any excess
tax benefits to additional paid in capital.
There were no options exercised during the three or six months ended February 28, 2011.
17
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
In January 2011, the Company granted its directors options to purchase a combined 17,500 shares of
the Company’s common stock pursuant to the Equity Plan. 12,500 of the options vest one year from
the date of grant and expire ten years from the date of grant. 5,000 of the options vest one-half
at the first anniversary of the grant date and one-half at the second anniversary of the grant
date. The Company calculated the fair value of these options at approximately $54,500 using the
Black-Scholes model with the following variables: weighted average exercise price of $3.67 (which
was the closing sales price of the Company’s common stock on the date of the grant); estimated
option lives of ten years; estimated dividend rate of 0%; weighted average risk-free interest rate
of 3.37%; weighted average stock price volatility of 84.7%; and an estimated forfeiture rate of 0%.
The $54,500 of stock-based compensation is being expensed monthly over the vesting periods.
In January 2010, the Company granted its directors options to purchase a combined 12,500 shares of
the Company’s common stock pursuant to the Equity Plan. The options vest one year from the date of
grant and expire ten years from the date of grant. The Company calculated the fair value of these
options at approximately $31,200 using the Black-Scholes model with the following variables:
weighted average exercise price of $2.88 (which was the closing sales price of the Company’s common
stock on the date of the grant); estimated option lives of ten years; estimated dividend rate of
0%; weighted average risk-free interest rate of 3.74%; weighted average stock price volatility of
88.4%; and an estimated forfeiture rate of 0%. The $31,200 of stock-based compensation was expensed
monthly over the vesting period.
Comprehensive Loss. In addition to net loss, comprehensive loss includes the unrecognized changes
in the fair value of marketable securities that are classified as available-for-sale as noted in
the following table:
| Three Months Ended: | Six Months Ended: | |||||||||||||||
| February 28, 2011 | February 28, 2010 | February 28, 2011 | February 28, 2010 | |||||||||||||
Net loss |
$ | (1,778,000 | ) | $ | (1,514,300 | ) | $ | (3,241,800 | ) | $ | (2,793,000 | ) | ||||
Unrealized loss on
marketable
securities |
(1,400 | ) | (2,300 | ) | (5,200 | ) | (4,000 | ) | ||||||||
Comprehensive loss |
$ | (1,779,400 | ) | $ | (1,516,600 | ) | $ | (3,247,000 | ) | $ | (2,797,000 | ) | ||||
NOTE 7 — RELATED PARTY TRANSACTIONS
In 1995, the Company extended a loan to the District, a related party. The loan provided for
borrowings of up to $250,000, is unsecured, bears interest based on the prevailing prime rate plus
2% (5.25% at February 28, 2011) and matures on December 31, 2011. The approximately $525,800
balance of the note receivable at February 28, 2011 includes borrowings of approximately $229,300
and accrued interest of approximately $296,500.
See also Note 3 above regarding the sale of common stock and the issuance and conversion of the
Convertible Note to a related party.
NOTE 8 — SIGNIFICANT CUSTOMER
The Company had accounts receivable from one customer that accounted for approximately 86% and 82%
of the Company’s trade receivables balances at February 28, 2011 and August 31, 2010, respectively.
The Company earned revenues from the same customer that accounted for approximately 64% and 63% of
the Company’s total revenues for the three and six months ended February 28, 2011, respectively.
The Company earned revenues from the same customer that accounted for approximately 66% and 65% of
the Company’s total revenues for the three and six months ended February 28, 2010, respectively.
That customer was the Ridgeview Youth Services Center.
NOTE 9 — ACCRUED LIABILITIES
At February 28, 2011, the Company had accrued liabilities of approximately $120,500, of which
approximately $77,000 was for costs associated with the Sky Ranch acquisition as well as accrued
property taxes on the Sky Ranch property, approximately $38,300 was for professional fees with the
remainder related to operating payables. At August 31, 2010, the Company had accrued liabilities
of approximately $70,700, of which $65,000 was for professional fees with the remainder relating
to operating payables.
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PURE CYCLE CORPORATION
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 2011
FEBRUARY 28, 2011
NOTE 10 — SUPPLEMENTAL DISCLOSURES OF NON-CASH ACTIVITIES
| Six months ended | ||||||||
| February 28, | ||||||||
| 2010 | 2009 | |||||||
Issuance of shares of restricted common stock
upon conversion of the Convertible Note |
$ | 5,351,700 | $ | — | ||||
NOTE 11 — SUBSEQUENT EVENTS
On March 14, 2011, the Company entered into a Paid-Up Oil and Gas Lease (the “O&G Lease”) and a
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. Pursuant to the O&G Lease,
the Company will receive a bonus payment of approximately $1,268,000 from Anadarko for the purpose
of exploring for, developing, producing and marketing oil and gas on approximately 634 acres of
mineral estate owned by the Company at its Sky Ranch property. The oil and gas rights under the
remaining approximately 304 acres at Sky Ranch are already owned by Anadarko. The Company expects
to receive this payment by April 22, 2011.
In addition to the upfront fee, the Company will receive, as a royalty, 20% of the gross proceeds
(less certain taxes) from the sale of any oil and gas produced from the Company’s property.
The O&G Lease has a term of three (3) years commencing on March 14, 2011, which can be extended by
two (2) years at Anadarko’s sole discretion. If Anadarko wishes to extend the O&G Lease for an
additional two (2) years, the Lease requires Anadarko to pay the Company another bonus payment
equal to the initial bonus payment noted above.
Pursuant to the Surface Use Agreement, Anadarko is restricted to drilling three wells on the Sky
Ranch property covered under the O&G Lease, which will minimize the oil and gas exploration and
extraction footprint when the Company is ready to develop the Sky Ranch Property. Additionally,
the Company will receive $3,000 per acre that is permanently disturbed for use in the oil and gas
exploration and production.
*****
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
Disclosure Regarding Forward-Looking Statements
Statements that are not historical facts contained in this Quarterly Report on Form 10-Q are
forward looking statements that involve risk and uncertainties that could cause actual results to
differ from projected results. The words “anticipate,” “believe,” “estimate,” “expect,” “plan,”
“intend” and similar expressions, as they relate to us, are intended to identify forward-looking
statements. 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 our expectations
will be realized. Factors that may cause actual results to differ materially from those
contemplated by such forward-looking statements include, without limitation: the timing of new home
construction and other development in the areas where we may sell our water, which in turn may be
impacted by credit availability, population growth, employment rates and general economic conditions;
the market price of water; changes in customer consumption patterns; changes in applicable
statutory and regulatory requirements; uncertainties in the estimation of water available under
decrees; costs of delivery of water and treatment of wastewater; uncertainties in the estimation of
costs of construction projects; the strength and financial resources of our competitors; our
ability to find and retain skilled personnel; climatic and weather
conditions, including flood and
droughts; labor relations; availability and cost of material and equipment; delays in anticipated
permit and construction dates; environmental risks and regulations; our ability to raise capital;
our ability to negotiate contracts with new customers; and uncertainties in water court rulings.
Overview
The following sections focus on the key indicators reviewed by management in evaluating our
financial condition and operating performance, including the following:
| • | Revenue generated from providing water and wastewater services; |
| • | Expenses associated with developing our water assets; and |
| • | Cash available to continue development of our water rights and service agreements. |
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 2010 Annual Report on Form 10-K. This overview summarizes the MD&A,
which includes the following sections:
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 Estimates — a discussion of our critical accounting policies
that require critical judgments, assumptions and estimates.
Our Business
We are a water and wastewater service provider that contracts with land owners, land developers,
home builders, cities, and municipalities to design, construct, operate and maintain 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 cash
flows and revenues by (i) selling taps (connections) to our water and wastewater systems and/or
(ii) monthly service fees and consumption charges from metered deliveries.
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Results of operations
Executive Summary
The results of our operations for the three months ended February 28, 2011 and 2010 are as follows:
| Summary Table 1 | ||||||||||||||||
| Three Months Ended February 28: | ||||||||||||||||
| 2011 | 2010 | $ Change | % Change | |||||||||||||
Millions of gallons of water delivered |
3.5 | 2.2 | 1.3 | 59 | % | |||||||||||
Water revenues generated |
$ | 25,300 | $ | 20,500 | $ | 4,800 | 23 | % | ||||||||
Operating costs to deliver water (excluding depreciation and depletion) |
$ | 7,200 | $ | 10,700 | $ | (3,500 | ) | -33 | % | |||||||
Water delivery gross margin % |
72 | % | 48 | % | ||||||||||||
Wastewater treatment revenues |
$ | 17,700 | $ | 16,700 | $ | 1,000 | 6 | % | ||||||||
Operating costs to treat wastewater |
$ | 4,600 | $ | 4,800 | $ | (200 | ) | -4 | % | |||||||
Wastewater treatment gross margin % |
74 | % | 71 | % | ||||||||||||
General and administrative expenses |
$ | 767,100 | $ | 582,800 | $ | 184,300 | 32 | % | ||||||||
Net losses |
$ | 1,781,000 | $ | 1,514,300 | $ | 266,700 | 18 | % | ||||||||
The results of our operations for the six months ended February 28, 2011 and 2010 are as
follows:
| Summary Table 1a | ||||||||||||||||
| Six Months Ended February 28: | ||||||||||||||||
| 2011 | 2010 | $ Change | % Change | |||||||||||||
Millions of gallons of water delivered |
11.1 | 8.1 | 3.0 | 37 | % | |||||||||||
Water revenues generated |
$ | 61,600 | $ | 49,400 | $ | 12,200 | 25 | % | ||||||||
Operating costs to deliver water (excluding depreciation and depletion) |
$ | 21,700 | $ | 25,400 | $ | (3,700 | ) | -15 | % | |||||||
Water delivery gross margin % |
65 | % | 49 | % | ||||||||||||
Wastewater treatment revenues |
$ | 35,400 | $ | 33,500 | $ | 1,900 | 6 | % | ||||||||
Operating costs to treat wastewater |
$ | 9,400 | $ | 10,400 | $ | (1,000 | ) | -10 | % | |||||||
Wastewater treatment gross margin % |
73 | % | 69 | % | ||||||||||||
General and administrative expenses |
$ | 1,188,600 | $ | 940,200 | $ | 248,400 | 26 | % | ||||||||
Net losses |
$ | 3,241,800 | $ | 2,793,000 | $ | 448,800 | 16 | % | ||||||||
Water and Wastewater Usage Revenues
Our water service charges include a base monthly fee and a usage fee 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.
Our wastewater customers are charged flat monthly fees based on their number of tap connections.
Water deliveries increased approximately 59% and 37% during the three and six months ended February
28, 2011 compared to the three and six months ended February 28, 2010, mainly as a result of the
Denver metropolitan area experiencing less precipitation during the start of fiscal 2011 compared
to 2010 which resulted in our customers using more water for irrigation. Water revenues increased
23% and 25% during the three and six months ended February 28, 2011 compared to the three and six
months ended February 28, 2010, as a result of increased usage and increases in water usage fees
effective July 1, 2010. The water delivery gross margin increased from 48% during the three months
ended February 28, 2010, to 72% for the three months ended February 28, 2011. The water delivery
gross margin increased from 49% during the six months ended February 28, 2010 to 65% during the six
months ended February 28, 2011. These increases were due to our efforts to manage costs and increases
in water service charges.
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Wastewater fees increased approximately 6% during each of the three and six month periods ended
February 28, 2011 compared to the three and six month periods ended February 28, 2010, which is a
result of increased monthly fees effectively July 1, 2010. The wastewater gross margin increased
from 71% during the three months ended February 28, 2010 to 74% for the three months ended February
28, 2011. The wastewater gross margin increased from 69% during the six months ended February 28,
2010, to 73% during the six months ended February 28, 2011. These increases were due mainly to
increased fees but also due to decreased testing fees during fiscal 2011.
Tap Fees
We recognized approximately $3,600 and $7,100 of water tap fee revenues during each of the three
and six month periods ended February 28, 2011 and 2010, respectively, related to the Agreement for
Water Service (the “County Agreement”) with Arapahoe County (the “County”). In accordance with
accounting principles generally accepted in the United States of America (“GAAP”), we began
recognizing the water tap fees as revenue ratably over the estimated service period upon completion
of the Wholesale Facilities in fiscal 2006. The water tap fees to be recognized over this period
are net of the royalty payments to the State Board of Land Commissioners (the “Land Board”) and
amounts paid to third parties pursuant to the Comprehensive Amendment Agreement No. 1 (the “CAA”)
as further described in Note 5 to the financial statements contained in our 2010 Annual Report on
Form 10-K.
We recognized approximately $10,400 and $20,800 of “Special Facilities” (as defined in Note 4 to
the financial statements contained in our 2010 Annual Report on Form 10-K) funding as revenue
during each of the three and six month periods ended February 28, 2011 and 2010, 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 financial statements
contained in our 2010 Annual Report on Form 10-K.
As of February 28, 2011, we have deferred recognition of approximately $1.4 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.
General and Administrative and Other Expenses
General and administrative (“G&A”) expenses for the three and six months ended February 28, 2011
and 2010 were impacted by the share-based compensation expenses as follows (amounts are
approximate):
| Table 2 - G&A Expenses | ||||||||||||||||
| Three Months Ended: | ||||||||||||||||
| February 28, 2011 | February 28, 2010 | $ Change | % Change | |||||||||||||
G&A expenses as reported |
$ | 767,100 | $ | 582,800 | $ | 184,300 | 32 | % | ||||||||
Share-based compensation expenses |
(22,600 | ) | (19,600 | ) | (3,000 | ) | 15 | % | ||||||||
G&A expenses less share-based
compensation expenses |
$ | 744,500 | $ | 563,200 | $ | 181,300 | 32 | % | ||||||||
| Table 2a - G&A Expenses | ||||||||||||||||
| Six Months Ended: | ||||||||||||||||
| February 28, 2011 | February 28, 2010 | $ Change | % Change | |||||||||||||
G&A expenses as reported |
$ | 1,188,600 | $ | 940,200 | $ | 248,400 | 26 | % | ||||||||
Share-based compensation expenses |
(44,100 | ) | (42,300 | ) | (1,800 | ) | 4 | % | ||||||||
G&A expenses less share-based
compensation expenses |
$ | 1,144,500 | $ | 897,900 | $ | 246,600 | 27 | % | ||||||||
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G&A expenses, with and without share-based compensation expenses, increased approximately 32%
during the three months ended February 28, 2011, as compared to the three months ended February 28,
2010. G&A expenses, with and without share-based compensation expenses, increased approximately
26% and 27% during the six months ended February 28, 2011, as compared to the six months ended
February 28, 2010, respectively. The increases are mainly due to $180,000 of bonuses paid in
fiscal 2011, increases in professional fees and the accrual of property taxes on Sky Ranch (refer
to Note 3 to the accompanying financial statements regarding the acquisition of Sky Ranch). The
significant components of our G&A expenses for the three and six months ended February 28, 2011 and
2010 are as follows:
| Table 3 - Signficant Balances in G&A | ||||||||||||||||
| Three Months Ended: | ||||||||||||||||
| February 28, 2011 | February 28, 2010 | $ Change | % Change | |||||||||||||
Salary and salary related expenses: |
||||||||||||||||
Including share-based compensation |
$ | 349,800 | $ | 148,900 | $ | 200,900 | 135 | % | ||||||||
Excluding share-based compensation |
$ | 327,100 | $ | 129,300 | $ | 197,800 | 153 | % | ||||||||
Directors fees (including insurance) |
$ | 92,500 | $ | 78,800 | $ | 13,700 | 17 | % | ||||||||
FLCC water assessment fees |
$ | 85,400 | $ | 84,700 | $ | 700 | 1 | % | ||||||||
Professional fees |
$ | 85,500 | $ | 72,200 | $ | 13,300 | 18 | % | ||||||||
Public entity related expenses |
$ | 33,400 | $ | 34,900 | $ | (1,500 | ) | -4 | % | |||||||
| Table 3a - Signficant Balances in G&A | ||||||||||||||||
| Six Months Ended: | ||||||||||||||||
| February 28, 2011 | February 28, 2010 | $ Change | % Change | |||||||||||||
Salary and salary related expenses: |
||||||||||||||||
Including share-based compensation |
$ | 499,600 | $ | 292,100 | $ | 207,500 | 71 | % | ||||||||
Excluding share-based compensation |
$ | 455,500 | $ | 249,800 | $ | 205,700 | 82 | % | ||||||||
Directors fees (including insurance) |
$ | 108,700 | $ | 92,400 | $ | 16,300 | 18 | % | ||||||||
FLCC water assessment fees |
$ | 170,900 | $ | 187,500 | $ | (16,600 | ) | -9 | % | |||||||
Professional fees |
$ | 189,400 | $ | 113,500 | $ | 75,900 | 67 | % | ||||||||
Public entity related expenses |
$ | 50,500 | $ | 48,800 | $ | 1,700 | 3 | % | ||||||||
Salary and salary related expenses including share-based compensation increased 135% and 71% during
the three and six months ended February 28, 2011, compared to the three and six months ended
February 28, 2010, respectively. The increase is a result of the payment of $180,000 of bonuses to
company employees and management as a result of the successful acquisition of Sky Ranch and the
successful completion of the stock offering and the issuance and conversion of the Convertible
Negotiable Promissory Note (the “Convertible Note”) (see Note 3 to the accompanying financial
statements). The increase is also a result of the addition of a farm manager to our payroll on
January 1, 2010. Pursuant to the agreement with High Plains A&M, LLC (“HP A&M”) as described in
Note 4 to the financial statements included with the 2010 Annual Report on Form 10-K, we pay 50% of
the farm manager’s salary and HP A&M pays the other 50%. Prior to January 1, 2010 our portion of
his salary was included with the farm management expenses, which is also a component of G&A
expense. It is now included in our salary account because effective January 1, 2010, the farm
manager became an employee of Pure Cycle and HP A&M now reimburses us 50% of his salary.
The Fort Lyon Canal Company (“FLCC” — defined in Note 4 to the financial statements for the 2010
Annual Report on Form 10-K) water assessment fees are the fees we pay for our share of the
maintenance of the Fort Lyon Canal in the Arkansas River Valley. The fees are approved by the
shareholders of the FLCC and changes during the years presented are a result of approved fee
changes by the FLCC shareholders. As of February 28, 2011, we hold approximately 26% of the voting
shares of the FLCC. The decrease during the six months ended February 28, 2011, is a result of the
FLCC acquiring additional water in 2010 which was passed through to the FLCC shareholders in 2010
via a special assessment.
Professional fees (legal and accounting) increased during the three and six months ended February
28, 2011, mainly due to additional legal and consulting fees related to the Lowry Range and the
potential development at Lowry, as well as costs related to the acquisition of Sky Ranch which were
not capitalized.
Costs associated with corporate governance and costs associated with being a publicly traded entity
increased during the six months ended February 28, 2011, primarily as a result of additional
filings and press releases we issued related to Sky Ranch and the related financing.
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Other income and Expense Items
| Table 4 - Other Items | ||||||||||||||||
| Three Months Ended: | ||||||||||||||||
| February 28, 2011 | February 28, 2010 | $ Change | % Change | |||||||||||||
Other expense items: |
||||||||||||||||
Depreciation and depletion expense |
$ | 75,200 | $ | 96,700 | $ | (21,500 | ) | -22 | % | |||||||
Imputed interest expense |
$ | 954,000 | $ | 898,000 | $ | 56,000 | 6 | % | ||||||||
Interest expense on Convertible Note |
$ | 60,700 | $ | — | $ | 60,700 | 100 | % | ||||||||
Other income items: |
||||||||||||||||
Interest income |
$ | 10,300 | $ | 16,500 | $ | (6,200 | ) | -38 | % | |||||||
| Table 4a - Other Items | ||||||||||||||||
| Six Months Ended: | ||||||||||||||||
| February 28, 2011 | February 28, 2010 | $ Change | % Change | |||||||||||||
Other expense items: |
||||||||||||||||
Depreciation and depletion expense |
$ | 150,400 | $ | 193,500 | $ | (43,100 | ) | -22 | % | |||||||
Imputed interest expense |
$ | 1,894,000 | $ | 1,782,000 | $ | 112,000 | 6 | % | ||||||||
Interest expense on Convertible Note |
$ | 151,700 | $ | — | $ | 151,700 | 100 | % | ||||||||
Other income items: |
||||||||||||||||
Interest income |
$ | 27,100 | $ | 37,200 | $ | (10,100 | ) | -27 | % | |||||||
Depreciation and depletion decreased entirely due to the Arkansas River water acquisition costs
being fully depreciated during a prior period.
Imputed interest expense represents the expensed portion of the difference between the relative
fair value of the Tap Participation Fee liability payable to HP A&M and the net present value of
the liability recognized under the effective interest method. The increase in the imputed interest
expense is a result of the updated valuations performed in the second quarter of fiscal 2009, which
is explained in greater detail in Note 7 to the accompanying financial statements.
The interest expense on the Convertible Note is new for the three and six months ended February 28,
2011, which is a result of the issuance of the Convertible Note in September 2010, which bore
simple interest at 10% per annum (see Note 3 to the accompanying financial statements). This will
not be a recurring expense item for the remainder of fiscal 2011, because as discussed in Note 3 to
the accompanying financial statements, we issued approximately 1.9 million shares of restricted
common stock upon conversion of the Convertible Note on January 11, 2011.
Interest income represents interest earned on the temporary investment of capital in cash
equivalents or available-for-sale securities, interest accrued on the note payable by the Rangeview
Metropolitan District (the “District” which is defined in Note 1 to the accompanying financial
statements and Note 4 to the financial statements to the 2010 Annual Report on Form 10-K) and
interest accrued on the “Special Facilities” construction proceeds receivable from the County. The
decrease is due to a significant decline in interest rates due to the recessionary economy and
decreasing levels of cash investments.
Acquisition of Sky Ranch
As described in Note 3 to the accompanying financial statements, during the six months ended
February 28, 2011, we acquired approximately 940 acres of undeveloped land located in
unincorporated Arapahoe County known as Sky Ranch. We acquired the land and water rights for
payments totaling approximately $7.0 million, with acquisition costs totaling approximately
$554,100. The identifiable assets that we acquired included the undeveloped land, which is zoned
for residential and commercial development, and approximately 820 acre feet of water, 89 acre feet
of which we previously purchased pursuant to agreements with the former developer.
Consideration for the land and water and the costs of the acquisition were paid in cash which was
raised through sale of common shares pursuant to an effective shelf registration statement and the
issuance of the Convertible Note. Both financing transactions are described below and in Note 3 to
the accompanying financial statements.
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Issuance and conversion of the Convertible Note
We issued the $5.2 million Convertible Note to PAR on September 28, 2010. Our shareholders
authorized conversion of the Convertible Note at the January 11, 2011 annual shareholders’ meeting.
Following the meeting, PAR surrendered the Convertible Note for conversion and we issued 1,982,099
shares of our restricted common stock to PAR. From issuance until conversion, the Convertible Note
accrued interest at a rate of 10% per annum. During the three and six months ended February 28,
2011, we accrued approximately $60,700 and $151,700 of interest on the Convertible Note,
respectively. The number of restricted shares issued was based on the outstanding balance of
approximately $5.35 million (principal and accrued interest) divided by a conversion rate of $2.70.
Sale of common stock pursuant to the shelf registration statement
On September 29, 2010, we sold 1,848,931 shares of our common stock for approximately $5.5 million
or $3.00 per share. These shares were sold pursuant to a $10.0 million effective shelf
registration statement. Following this issuance, we may issue up to an additional $4.45 million of
common stock pursuant to the shelf registration statement.
Subsequent Event — Oil and Gas Lease with Anadarko
On March 14, 2011, we entered into an oil and gas lease and a surface use agreement with Anadarko
E&P Company, L.P. (“Anadarko”) a wholly-owned subsidiary of Anadarko Petroleum Company. Pursuant
to the oil and gas lease we will receive a bonus payment of approximately $1,268,000 from Anadarko
for the purpose of exploring for, developing, producing and marketing oil and gas on approximately
634 acres of mineral estate at our Sky Ranch property. The oil and gas rights under the remaining
approximately 304 acres at Sky Ranch are already owned by Anadarko. We anticipate receiving this
payment by April 22, 2011. The oil and gas lease has a term of three (3) years commencing on March
14, 2011, which can be extended by two (2) years at Anadarko’s sole discretion. If Anadarko wishes
to extend the lease for an additional two (2) years, Anadarko would be required to pay us another
bonus payment equal to the initial bonus payment noted above.
In addition to the upfront fee, we will receive, as a royalty, 20% of the gross proceeds (less
certain taxes) from the sale of any oil and gas produced from our Sky Ranch property.
Pursuant to the surface use agreement, Anadarko is restricted to drilling three wells on our Sky
Ranch property which will minimize the oil and gas exploration and extraction footprint when we are
ready to develop the Sky Ranch Property.
Liquidity, capital resources and financial position
At February 28, 2011, our working capital, defined as current assets less current liabilities, was
approximately $4.4 million, of which approximately $4.3 million was cash, 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. Additionally, pursuant to the oil and
gas lease with Anadarko, we expect that within 15 days of the filing of this Form 10-Q we will
receive the $1,268,000 up-front bonus payment from Anadarko. We believe that as of the date of the
filing of this quarterly report on Form 10-Q and as of February 28, 2011, we have sufficient
working capital to fund our operations for the next fiscal year.
Pursuant to the Arkansas River Agreement, we agreed to pay HP A&M 10% of the tap fees we receive
from the next 40,000 water taps we sell from and after the date of the Arkansas River Agreement. As
of February 28, 2011, we have estimated the value of the Tap Participation Fee at approximately
$63.0 million based on a discounted cash flow valuation analysis, which was originally prepared at
August 31, 2006, and was updated as of November 30, 2007, and February 28, 2009. See Note 7 to the
financial statements contained in the 2010 Annual Report on Form 10-K for the impact of the
revaluation. The actual amount to be paid will inevitably differ from our estimates. Tap
participation payments are not payable to HP A&M until we receive water tap fee payments. We did
not sell any taps during the three and six months ended February 28, 2011 or 2010. As of February
28, 2011, there are 38,937 taps that remain subject to the Tap Participation Fee.
FLCC water assessment fees are payable to the FLCC each calendar year. In December 2010, the board
and shareholders of the FLCC voted to keep the calendar 2011 assessments at $15.50 per share.
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Pursuant to agreements we entered into with HP A&M, described in greater detail in Note 7 to the
financial statements contained in the 2010 Annual Report on Form 10-K, our farm leases are being
managed by HP A&M through August 31, 2011 (which shall be extended until September 23, 2014 under
circumstances defined in the Arkansas River Agreement). After that date the management services
agreement may be extended by the mutual agreement of us and HP A&M or we may assume management of
the farms. Pursuant to the management services agreement, while HP A&M is managing the farm
leases, HP A&M is responsible for all expenses associated with maintaining the leases with the
exception of the water assessment fees paid to the FLCC, which fees are borne by us. As
compensation for their management responsibilities, HP A&M retains all lease and certain other
non-crop income associated with the farms and the water used thereon.
Summary Cash Flows Table
| Table 5 - Summary Cash Flows Table | ||||||||||||||||
| Six Months Ended: | ||||||||||||||||
| February 28, 2011 | February 28, 2010 | $ Change | % Change | |||||||||||||
Cash (used) provided by: |
||||||||||||||||
Operating acitivites |
$ | (886,300 | ) | $ | (824,100 | ) | $ | (62,200 | ) | 8 | % | |||||
Investing activities |
$ | (9,541,500 | ) | $ | 973,100 | $ | (10,514,600 | ) | -1081 | % | ||||||
Financing activities |
$ | 10,633,600 | $ | 39,200 | $ | 10,594,400 | 27027 | % | ||||||||
Changes in Operating Activities
Operating activities include revenues we receive from the sale of water and wastewater services to
our customers, costs incurred in the delivery of those services, G&A expenses, and
depletion/depreciation expenses.
Cash used by operations increased approximately 8% during the six months ended February 28, 2011
mainly as a result higher G&A expenses due to employee bonuses offset by increased revenues due to
increased water usage and increased water and wastewater usage fees.
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 pay 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 six months ended February 28, 2011, consisted of the use of
approximately $6.8 million for the acquisition of Sky Ranch (approximately $12,000 of costs are
accrued but unpaid at February 28, 2011), and we invested approximately $3.3 million into
certificates of deposit.
Changes in Financing Activities
Financing activities for the six months ended February 28, 2011 consisted mainly of the issuance of
the $5.2 million Convertible Note and the sale of approximately $5.4 million of common stock (net
of issuance costs).
Critical Accounting Policies and Use of Estimates
The preparation of financial statements in conformity with 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.
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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 and monthly service fees. 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 six months ended February 28, 2011 or 2010.
Tap fees derived from agreements for which we own the infrastructure are recognized as revenue
ratably over the estimated service life of the assets constructed with said fees. Although the cash
will be received up-front and most construction will be completed within one year of receipt of the
proceeds, revenue recognition may occur over 30 years or more. Management is required to estimate
the service life, and currently the service life is based on the estimated useful accounting life
of the assets constructed with the tap fees. The useful accounting life of the asset is based on
management’s estimation of an accounting based useful life and may not have any correlation to the
actual life of the asset or the actual service life of the tap. This is deemed a reasonable
recognition life of the revenues because the depreciation of the assets constructed generating
those revenues will be matched with the revenues.
Monthly water usage fees and monthly wastewater service fees are recognized in income each month as
earned.
Impairment of Water Assets and Other Long-Lived Assets
We review our long-lived assets for impairment at least annually or whenever management believes
events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. We measure recoverability of assets to be held and used by a comparison of the
carrying amount of an asset to estimated future undiscounted net cash flows we expect to be
generated by the eventual use of the asset. If such assets are considered to be impaired and
therefore the costs of the assets deemed to be unrecoverable, the impairment to be recognized would
be the amount by which the carrying amount of the assets exceeds the estimated fair value of the
assets.
Our water assets will be utilized in the provision of water services which inevitably will
encompass many housing and economic cycles. Our service capacities are quantitatively estimated
based on an average single family home utilizing .4 acre-feet of water per year. Our water
supplies are legally decreed to us through the water court. The water court decree allocates a
specific amount of water (subject to continued beneficial use) which historically has not changed.
Thus, individual housing and economic cycles typically do not have an impact on the number of
connections we can serve or the amount of water legally decreed to us.
We report assets to be disposed of at the lower of the carrying amount or fair value less costs to
sell. We have no assets to be disposed of at February 28, 2011.
Our Front Range and Arkansas River Water Rights
We determine the undiscounted cash flows for our Denver based assets and the Arkansas River Valley
assets by estimating tap sales to potential new developments in our service area and along the
Front Range using estimated future tap fees, less estimated costs to provide water services, over
an estimated development period. Actual new home development in our service area and the Front
Range, actual future tap fees, and actual future operating costs, inevitably will vary
significantly from our estimates, which could have a material impact on our financial statements
as well as our results of operations. We performed an impairment analysis as of August 31, 2010,
and determined that our Rangeview Water Supply and Arkansas River water assets were not impaired
and their costs were deemed recoverable. Our impairment analysis is based on development
occurring within areas in which we have service agreements (e.g. Sky Ranch and the Lowry Range) as
well as in surrounding areas, including the Front Range and the I-70 corridor. We estimate that
we have the ability to provide water service to approximately 180,000 Single
Family Equivalents (“SFE’s”) using our combined Rangeview Water Supply and Arkansas River water
assets which have a carrying value of approximately $104.9 million as of February 28, 2011. Based
on the carrying value of our water rights, the long term and uncertain nature of any development
plans, current tap fees of $22,500 and estimated gross margins, we estimate that we would need to
add approximately 8,600 new water connections (requiring approximately 5.1% of our portfolio) to
generate net revenues sufficient to recover the costs of our Rangeview Water Supply and Arkansas
River water assets. If tap fees increase 5%, we would need to add approximately 8,200 new water
taps (requiring approximately 4.8% of our portfolio) to recover the costs of our Rangeview Water
Supply and Arkansas River water assets. If tap fees decrease 5%, we would need to add
approximately 9,100 new water taps (requiring approximately 5.4% of our portfolio) to recover the
costs of our Rangeview Water Supply and Arkansas River water assets.
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Although changes in the housing market throughout the Front Range have delayed our estimated tap
sale projections, these changes do not alter our water ownership, nor our service obligations to
existing properties or the number of SFE’s we can service.
Our Paradise Water Rights
Every six years the Paradise Water Supply is subject to a finding of reasonable diligence review by
the water court and the State Engineer. For a favorable finding we must demonstrate that we are
diligently pursuing the development of the water rights. If we do not receive a favorable finding
of reasonable diligence, our right to the Paradise Water Supply would be lost and we would be
required to impair the Paradise Water Supply asset. The most recent diligence review was started
in our fiscal 2005 and was completed in 2008, but not without objectors and not without us having
to agree to certain stipulations to remove the objections. In order to continue to maintain the
Paradise water right, over the next six years we must (i) select an alternative reservoir site;
(ii) file an application in water court to change the place of storage; (iii) identify specific end
users and place(s) of use of the water; and (iv) identify specific source(s) of the water rights
for use. We fully intend to meet the stipulations by the date of the next diligence review in
2014.
For our Paradise Water Supply, we determined the undiscounted cash flows by estimating the
proceeds we could derive from the leasing of the water rights to commercial, industrial, and
agricultural users along the western slope of Colorado, and based on the impairment analysis we
completed at August 31, 2010, we believe at February 28, 2011, the Paradise Water Supply is not
impaired and the costs are deemed recoverable.
Tap Participation Fee
In 2006 we acquired approximately 17,500 acres of irrigated land together with approximately
60,000 acre-feet of Arkansas River water rights from HP A&M. Along with common stock issued to HP
A&M, we agreed to pay HP A&M 10% (this may increase to 20% under circumstances described in Note 7
to the financial statements contained in our 2010 Annual Report on Form 10-K) of tap fees we
receive from the next 40,000 water taps we sell from and after the date of the Arkansas River
Agreement, of which 38,937 water taps remain to be paid as of August 31, 2010. The Tap
Participation Fee is payable when we sell water taps and receive funds from such water tap sales
or other dispositions of property purchased in the HP A&M acquisition. The Tap Participation Fee
liability is valued by estimating new home development in our service area over an estimated
development period. This was done by utilizing third party historical and projected housing and
population growth data for the Denver metropolitan area applied to an estimated development
pattern supported by historical development patterns of certain master planned communities in the
Denver metropolitan area. This development pattern was then applied to projected future water tap
fees determined by using historical water tap fee trends. Based on updated new home activity in
the Denver metropolitan area, we updated the estimated discounted cash flow analysis as of
February 28, 2009. We completed an update to our analysis of the fair value of the Tap
Participation Fee as of August 31, 2010. We determined that changes in the projected estimated
discounted cash flows did not materially impact our February 28, 2009 fair value analysis. Actual
new home development in our service area and actual future tap fees inevitably will vary
significantly from our estimates which could have a material impact on our financial statements as
well as our results of operations. An important component in our estimate of the value of the Tap
Participation Fee, which is based on historical trends, is that we reasonably expect water tap
fees to continue to increase in the coming years. Tap fees are market based and the continued
increase in tap fees reflects, among other things, the increasing costs to acquire and develop new
water supplies. Tap fees are thus partially indicative of the increasing value of our water
assets. We continue to assess the value of the Tap Participation Fee liability and update its
valuation analysis whenever events or circumstances indicate the assumptions used to estimate the
value of the liability have changed materially. The difference between the net present value and
the estimated realizable value will be imputed as
interest expense using the effective interest method over the estimated development period
utilized in the valuation of the Tap Participation Fee.
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Obligations Payable by HP A&M
60 of the 80 properties we acquired pursuant to the Arkansas River Agreement are subject to
outstanding promissory notes with principal and accrued interest totaling approximately $10.7
million and $11.0 million at February 28, 2011 and August 31, 2010, respectively. These notes are
secured by deeds of trust on the properties. We did not assume any of these promissory notes and
are not responsible for making any of the required payments under these notes. This responsibility
remains solely with HP A&M. However, in the event of default by HP A&M, we may make payments on
any or all of the notes and cure any or all defaults. If we do not cure the defaults, we will lose
the properties securing the defaulted notes and the water rights associated with said properties.
If HP A&M defaults on any of the promissory notes, we can foreclose on a defined amount of Pure
Cycle common stock issued to HP A&M being held in escrow and reduce the Tap Participation Fee by
two times the amount of notes defaulted on by HP A&M. Although the likelihood of HP A&M defaulting
on the notes is deemed remote, which is the primary reason these notes are not reflected on our
balance sheet, we continue to monitor the status of the notes for any indications of default. We
are not aware of any defaults by HP A&M as of February 28, 2011.
Share-based compensation
We estimate the fair value of share-based payment awards made to key employees and directors on the
date of grant using the Black-Scholes option-pricing model. We then expense the fair value over
the vesting period of the grant using a straight-line expense model. The fair value of share-based
payments requires management to estimate/calculate various inputs such as the volatility of the
underlying stock, the expected dividend rate, the estimated forfeiture rate and an estimated life
of each option. These assumptions are based on historical trends and estimated future actions of
option holders and may not be indicative of actual events which may have a material impact on our
financial statements. See Note 8 to the financial statements contained in the 2010 Annual Report
on Form 10-K for further details on share-based compensation expense.
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist entirely of the contingent portion of the CAA, which is
more fully described in Note 5 to the accompanying financial statements.
Recently Adopted and Issued Accounting Pronouncements
See Note 1 to the accompanying financial statements for a discussion of recently adopted and issued
accounting pronouncements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
General
Pure Cycle has limited exposure to market risks from instruments that may impact the Balance
Sheets, Statements of Operations, and Statements of Cash Flows, such exposure is due primarily to
changing interest rates.
Interest Rates
The primary objective for our investment activities is to preserve principal while maximizing
yields without significantly increasing risk. This is accomplished by investing in diversified
short-term interest bearing investments. As of February 28, 2011, the majority of our capital is
invested in certificates of deposit with stated maturities and locked interest rates and therefore
not subject to interest rate fluctuations. We have no investments denominated in foreign country
currencies and, therefore, our investments are not subject to foreign currency exchange risk.
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Item 4. Controls and Procedures
Evaluation
of Disclosure Controls and Procedures
We maintain disclosure controls and procedures as defined in Rules 13a—15(e) and 15d-15(e) of the
Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that
information required to be disclosed in our reports filed or submitted to the Securities and
Exchange Commission under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified by the Commission’s rules and
forms, and that information is accumulated and communicated to management, including the principal
executive and financial officer as appropriate, to allow timely decisions regarding required
disclosures. The President and Chief Financial Officer evaluated the effectiveness of disclosure
controls and procedures as of February 28, 2011, pursuant to Rule 13a-15(b) under the Exchange Act.
Based on that evaluation, the President and Chief Financial Officer concluded that, as of the end
of the period covered by this report, the Company’s disclosure controls and procedures were
effective. A system of controls, no matter how well designed and operated, cannot provide absolute
assurance that the objectives of the system of controls are met, and no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if any, within a company
have been detected.
Changes in Internal Control Over Financial Reporting
No changes were made to our internal control over financial reporting during our most recently
completed fiscal quarter that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
PART II
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Effective September 28, 2010, we issued the Convertible Note to a single accredited investor, PAR,
as described in more detail in a current report on Form 8-K filed on September 29, 2010, and in
Note 3 to the accompanying financial statements. The issuance of the Convertible Note was not
registered under the Securities Act of 1933, as amended (the “Securities Act”), in reliance on the
exemption from registration available pursuant to Section 4(2) of the Securities Act. On January
11, 2011, following approval by our shareholders, we issued 1,982,099 shares of restricted common
stock to PAR upon conversion of the Convertible Note. The restricted shares issued to PAR were not
registered under the Securities Act in reliance on the exemption from registration available
pursuant to Section 4(2) of the Securities Act.
Item 6. Exhibits
| Exhibits | ||||
| 31 | Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002.* |
|||
| 32 | Certification pursuant to section 906 of the Sarbanes-Oxley Act of 2002.* |
|||
| * | Filed herewith. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned hereunto duly authorized.
PURE CYCLE CORPORATION |
||
/s/ Mark W. Harding
|
||
President and Chief Financial Officer |
||
April 8, 2011 |
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