Pure Cycle Corp Q1 FY2020 Earnings Call

Good day, ladies and gentlemen, and welcome to the Pure Cycle Corporation 2020 First Quarter Financial Result Conference Call. All lines have been placed in a listen-only mode, and the floor will be opened for your questions and comments following the presentation. [Operator Instructions] At this time, it is my pleasure to turn the floor to your host for today, Mr. Mark Harding. Sir, the floor is yours.

Thanks, Jess, and I'd like to welcome you all to our first quarter earnings call. It's a bit out of cycle for us as we typically do two calls a year, but due to the results that we have and the uniqueness of some of these results, I thought it might be important to share some insights. And give you an update on what we are doing and where we are headed. So with that, we do have a slide deck for this. If you can get to our website, purecyclewater.com, and in the Investor tab, you will find this presentation's slide deck. I'll try to note the transitions of the slides as we work through the presentation. So our first slide, the second slide actually, is our safe harbor statement where those statements are not historical facts and are forward-looking statements. I think you are all familiar with our safe harbor statement. I'm going to run through the company story because I'm certain that most of you are fairly familiar with the company and the assets. We are a water utility company and also develop land. We've been developing our Sky Ranch project, which we broke ground on this year. I will provide a lot of color on that, as well as on our water utility services for industrial sales and some oil and gas royalties. Slide 4 is just a summary of our water utility assets and a depiction of where we're located in the Denver metro area. We're in the southeast area, and as you can see, growth in the metropolitan area has kind of grown up around our assets. We find ourselves located in the right segment of the Metroplex. Let's drill down specifically to Sky Ranch. Our master plan community is about 938 acres, sitting right on the I-70 corridor, about 16 miles east of downtown, and directly south of the Denver International Airport. We have a mixed-use community, with zoning for around 3,500 homes, and a product mix that ranges from single-family detached to attached to multifamily housing. We have about half a mile of frontage—about 160 acres—adjacent to the interstate for commercial development. In total, if you look at all types of uses—residential, commercial, multi-family—we estimate that is about 5,000 single-family equivalent connections, which gives us a marker for how we connect to our water utility. Now let's talk about what's new and an update to our Q1 results. We've delivered about 372 finished lots, which is far ahead of our original forecast. Each of our three builders has accelerated their take-down of lots, and we have capitalized on some good weather towards the back half of the year, completing infrastructure like roads, curbs, and gutters. We've been paid for 372 of the 506 lots so far through Q1. We're about 90% complete on all wet utilities and dry utilities. The only remaining work for the 1,334 lots will be the high-cost items, mainly curb, gutter, and pavement. We have about 40 residents in the community now. So we’re not only delivering finished lots; the home builders are also delivering homes, and we have residents, water and sewer customers, and taxpayers in our community today. We've issued about 152 building permits and sold around 175 water and wastewater taps. This indicates continued success in selling homes in the community. We expect to finalize the remaining portion of these by September 2020, which could accelerate our lot deliveries by as much as two years, pulling forward lots we expected to deliver in late 2021 or early 2022. Some of our key infrastructure components are complete. We would not have been able to proceed without the off-site road infrastructure, which we’ve also completed along with the water and the water treatment facility. These are all complete and in service. Moving to the next slide, I want to highlight the sales rate. We're getting about 6 to 8 homes per builder per month, indicating strong absorption for the community as a whole. We did notice some inflators from our original take-down schedules from our home builder purchases, resulting in an overall increase in average home prices due to these inflators. So we’re experiencing slightly favorable margins on the price of the lots we're delivering. In the first quarter, we closed on financing a portion of the public improvements we installed for this community. We were able to attain repayments totaling $10.5 million, averaging about another $20,000 to almost $21,000 per lot in reimbursable costs. We still have other reimbursable amounts that will be paid from future bond offerings, and that’s likely to be slightly better than the $20,000 we projected. I want to clarify how that will ultimately affect our lot sales numbers on this first stage. Moving on to the second phase, I'll highlight some financial results as they relate to the Sky Ranch development. We have also observed considerable oil and gas activity in the region. ConocoPhillips has entered into an agreement with Crestone Peak Resources to sell their position in this field. This acquisition is expected to close at the end of February or the first part of March. As most of you know, Occidental Petroleum entered into an agreement to acquire Anadarko Petroleum, which also has significant ownership interests in the minerals in this area. I think we now have three major operators with substantial positions in this area and three smaller operators. The field was once almost exclusively dominated by one operator. Our industrial, oil, and gas water sales have been quite light, which likely reflects the transition of ownership in this area. Conoco had drilled 13 wells but had not fracked them yet. We sell water to each of these wells for about $210,000 to $220,000 per well, amounting to a total value of $2.7 million to $2.8 million. This is reflected in our first and second quarter numbers, explaining why those are slightly weaker than anticipated. We remain bullish on the industrial water segments for oil and gas. Moving on to phase 2 of Sky Ranch, we're still finishing the balance of phase 1 lots, which will take us through delivery by our fiscal year-end. Builders will continue constructing homes on these for the next two years. They will probably sell out of lots in 2021 but will want us to keep delivering more lots. Our existing builders are excited about phase 2, along with other builders, indicating strong interest in the project. In phase 2, we have a bit more acreage, including some commercial space, additional residential lots, school sites, and various product types. We are finalizing land plans and construction drawings and hope to have a grading permit in summer, with grading starting in late summer to early fall. The excavation and dirt work will take about 9-10 months. The builders’ interest from phase 1 gives us an opportunity to expand from three builders to potentially six or seven in phase 2, depending on product mix and the number of units offered. Regarding commercial opportunities, we’ve received inquiries, but they’ll be different from the residential side. We've completed early costing and expect phase 2 to be inflation-adjusted in line with phase 1 costs, with a portion of reimbursable costs expected to be lighter in phase 2 due to some off-site costs incurred in phase 1. Our water and sewer systems have capacity to meet the demand, and we may have a small incremental investment in the water system to support annual expansion. I anticipate that we may see some price adjustments from phase 1. We are still discussing commitments with several players regarding revenue opportunities and will share more details as they are finalized. Our financial metrics indicate strong growth again this quarter. We continue to grow our operating revenues, now at $10 million for Q1, just half of what we earned last year! We experienced a significant increase, almost a sevenfold jump in revenues for Q1, 2020 over Q1, 2019. Our municipal revenues are also up, thanks to significant monetization of tap fees. We've been able to drill down into details on specific segments, better estimating our future royalties and revenues from property production. The bonding transaction we executed has some unique accounting elements and was done with Citi Corp, who successfully evaluated our bonding capacity based on our anticipated home values. The total assessed value for the 506 homes allowed us to secure $10.5 million in bonds. GAAP guidance allows us to take the total costs we've incurred as of the bond issue date as a percentage of the total project costs, and as such, we booked revenue based on that. Our bond proceeds led to increased profit margins on the remaining lots, raising our projected margins significantly. It was a terrific quarter for our strategy and execution, and we are optimistic about the year ahead. I will now turn the call back over to Jess for any questions or specifics you'd like me to drill down on.

[Operator Instructions] We have a question from Geoffrey Scott at Scott Asset Management.

Mark, how are you?

Very well, thank you.

A couple of questions. Can you size the infrastructure expenditures for Phase 2 for us?

I can't size them just yet. If you look at the lot delivery, taking out some heavy public improvements like drainage channels, the 506 lots would be around $30 million. We're looking at maybe a little more than twice that for the next increment, with a focus on economies of scale. We aim to phase the deliveries and have commitments from builders.

Okay, sounds good. You talked about 40 residents. Is that 40 human beings or 40 houses?

40 houses, so 40 families out there. I don’t have a census count. It's predominantly families, lots of children enjoying the updated play structures we’ve installed at our parks.

Yes. But it's 40 houses that are inhabited now.

Correct.

Yes. I've driven through and been surprised at the amount of activity. It's really going very well from an outsider's perspective.

Yes, it’s exciting to see the community grow. It’s no longer the middle of nowhere; we've got a lot going on with 150 homes.

The next question is really kind of about the first houses. Since lots are less valuable with no commercial activity, would you say that once commercial comes in, the next set of residential will be more valuable?

That’s correct. It’s a cyclical value that comes with creating a Master Planned Community. Initially, the residential opportunity may have a lower value, but as development occurs and commercial services set in, the value of existing homes and future lots will both appreciate, generating more tax revenue for us.

And you’ll keep that agreement for Phase II?

That’s what we’re looking to do. We'll try to structure the same delivery agreement for Phase 2 to allow for price adjustments as well as back-end true-ups on home sales.

Is the residential development sufficient for commercial interest, or do you have to go out to them?

It’s about 50-50. Some are just looking to lock up long options, which isn’t our focus. We prefer to engage with builders and actual users rather than speculators, and we’re happy to be patient in this regard.

That was my impression; it sounds like commercial becomes more valuable once Phase 2 becomes evident.

Yes.

Of the 2.3 million square feet of commercial space, how much is in Phase 2 and how much remains?

That will span the whole project; we’ll develop part of it in Phase 2 and some in Phase 3.

And Mr. Harding, I have no other questions holding. I'll turn the conference back to you for any additional or closing comments.

Okay. Did we get one that wanted to jump in there at the end, Jess?

We just did. Absolutely, Robert [Sloce]. Your line is open. Please go ahead, sir.

Mark, great job. I'm inquiring about subsequent quarters this year where you might not have a CAB reimbursement, so earnings might be less than this quarter. Could you comment on that?

Good question. We tried to smooth out those results. In Q1, we recognized 60% of the revenues, with the remaining 40% still to come in subsequent quarters. While it will be less in those quarters, there will still be some bond proceeds evening out EPS. These bond events are periodic and depend on the timing of construction start, expected home sales, and subsequent bonding capacity. We'll see that cycle in Phase 2 but might have a larger scope.

It's a hard concept to grasp, but thank you for the clarification.

Just a quick follow-up. What’s the real estate tax on your average house, around $325,000?

Very modest. Compared to somewhere like New Jersey, it's quite favorable. The total annual levy will be about $3,800 to $4,000.

So $4,000 on a $325,000 house?

Yes, around a $350,000 house. Okay. It's going to be disappointing if Pat didn't have a question.

Thanks, Mark. I have a follow-up question. That $4 million you mentioned isn't on the balance sheet—where is it?

It is in the inventory number. The $4 million will be recognized as we sell additional lots, which will then show up in our income and boost margins significantly.

But if you're going to move that $4 million asset, shouldn't it be on the balance sheet?

It is in cash. We'll recognize it as we sell lots, which will increase our margins. Timing is essential in such transactions.

It’s challenging to gain a holistic view of business worth, but thanks for clarifying.

I appreciate your understanding. We’re working to clarify these processes. So we do have our shareholder meeting next week. I invite all of you—anyone interested—to attend on the 15th at 2 PM at our attorney's office. It’s a great opportunity to meet the Board and ask questions about the first half and future of the phases. Thank you all for your continued support. We hope to continue delivering positive results through this year and beyond. Should you have further questions, feel free to reach out directly. Thank you, and I will close the call.

Ladies and gentlemen, we thank you for your participation. You may disconnect at this time, and have a great day.