Pure Cycle Corp Q4 FY2021 Earnings Call

Good day, ladies and gentlemen. And welcome to the Pure Cycle Corporation Year Ended August 31, 2021 Earnings Call. At this time, all participants have been placed on a listen-only mode. And the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Mark Harding. Sir, the floor is yours.

Thank you very much. And welcome, good afternoon. I'd like to welcome you all to our 2021 year-end earnings call, a bit of housekeeping upfront. For those of you listening in on the call, I have a slide deck for this; if you can log into our website at purecyclewater.com, there'll be a banner across the homepage that will help you click on that to direct you to the slide presentation itself. We've got this enabled so that I can actually advance the slides through the website itself. So you'll be able to keep up with us as we go along. If you're logged on to the website alone, without logging into the call, you can hear the audio, but you won't be able to press in for questions and answers. So if you do want to log into the audio presentation, you must have the dial-in number on that. So with that, let's get started. First thing, we always want to do is get the lawyers out of the room and note our safe harbor statement, which states that any statements that are not historical facts contained or incorporated by reference in this presentation are forward-looking statements. I'm sure all of you are familiar with the safe harbor statement, forward-looking statements. So with that, I want to highlight the various business aspects of the company. We have three lines of business. At a DNA level, the company is a water utility company. So we develop water and wastewater services in the Denver metropolitan area. We own a portfolio of water rights here in Denver in an area of the country where you can own water as real property rights. Taking a look at our water portfolio, we measure our level of service in terms of the number of connections. We define those as single-family equivalents, and we shorten those to SFEs. So our portfolio can serve approximately 60,000 SFEs, which will define what that translates to in terms of connections and accounts for us. In addition to the water portfolio, we provide land development opportunities. So we own about 780 plus or minus acres of land, which started out at about 930 acres, but we have been 2 years into that development, and we've been able to sell lots to national homebuilders that have constructed homes. So we have about 150 acres that we've constructed approximately 500 homes on. So in total, the project has about 3,400 residential units, which will be a mix of detached residential units, attached units, duplexes, and multi-family properties that run the spectrum of price points. We also have a commercial area associated with a project where we have a little over 2 million square feet of commercial zoning for that, which will accommodate retail, commercial, and light industrial uses. Finally, our new segment is really to leverage the land development segment and the successes that we've seen there as we continue to build a great master-planned community. We are holding back some lots from our homebuilders and then working and partnering with our homebuilder partners and independent contractors to construct homes that we will retain and enter into the single-family home rental market. We have some exciting details to update you on that as well. I want to note for those who have not been to our website, we have a very robust website at purecyclewater.com, providing a lot of information. There are several presentations, videos, and podcasts that walk you through a lot of the details of the company. So outside this call, it will certainly be a resource for you all to monitor the company's success. With that, let me open up and talk a little bit about the wholesale water and wastewater segment, where we construct and manage our system, owning a portfolio of water alongside all of the infrastructure that diverts, treats, and distributes that water. We have two fee instruments for that: we charge a connection fee, which is paid by our homebuilders at the time of obtaining a building permit. That fee covers the cost of the wholesale system and all of the large infrastructure required for a water utility system. Here in Colorado, that's kind of the pricing mechanism as opposed to incorporating that into the property tax area of a lot. We have these connection charges. Different providers in that area may refer to those as system development fees or tap fees; they're all the same mechanism. We receive water tap fees and sewer tap fees, which are large capital fees. On a combined basis, these fees amount to about $32,000 per connection. Doing the math on that, looking at the 60,000 connections we have, that's a little more than $2 billion worth of topline capital attributable to that, and we use those dollars to construct the necessary systems. We will likely spend about $1 billion of that on building facilities that serve those 60,000 connections. Once we establish a connection, we have an annual usage rate, and that's what our customers are accustomed to paying. They receive their monthly water and sewer bills. So here in Colorado, specifically in our service areas, we collect about $1,000 per connection on the water side, and we collect about $500 per connection on the sewer side. Therefore, each SFE generates about $1,500 per year per customer. We also manage a zero-discharge system; we bring all that water back and reuse it through outdoor irrigation for some of our industrial customers, contributing a significant component of our business through water conservation and reuse. I will not detail this too much, but you can study this at your leisure as it shows where we are in the metropolitan area and our service areas, specifically providing service to locations like Sky Ranch and Lowry Ranch, as well as a service area we acquired a couple of years ago called Wild Pointe. We have licensed operators who manage both our water and wastewater systems for our customers. This chart illustrates some of the growth potential we have. If we have 60,000 connections, where are we today? We're just getting started. We have about 650 water connections, so we have a long runway of opportunity here. Those customers come from residential and commercial sectors, whether at Sky Ranch or the Albert Highway 86 connections, and from other opportunities as the Lowry Ranch continues to build out. Those connections will come from there. This projection illustrates just the 5,000 connections related to Sky Ranch alone, with a projected build-out within a 9-year timeframe; we have 8 more years to go on that. We'll talk about that in our land development update, but this is a successful master-planned project with Sky Ranch. A common question I receive, and certainly something that impresses folks when they come and explore our company, is the proximity of our service area at Lowry Ranch to the metropolitan area. This is a good illustration for you; the left side of that roadway is in the city of Aurora, while the right side primarily covers our service area—undoubtedly, a very attractive piece of land in the right location of the metropolitan area. The Lowry Ranch is owned by the state of Colorado, held in trust with the Colorado State Land Board, responsible for developing assets for the public education system here in Colorado, with K-12 public education as the largest beneficiary. They handle the land development side, while we manage all the utilities attached to it. This highlights some of the investments we continue to make in our water and wastewater utilities. We've experienced tremendous growth in recent years, mainly from adding capacity for Sky Ranch and increasing capacity for industrial water customers in oil and gas. I'm providing an overview of our tap fee revenue year-over-year over the last three years, taps that will be sold both in Sky Ranch and Wild Pointe, our service areas. Drilling down into our land development, as mentioned, we started with 930 acres; we've come down to about 780 due to continued development of single-family lots. That area can accommodate about 3,200 units, potentially bumping up to 3,400 when including some multifamily segments, while there are a couple of million square feet of commercial development opportunities, estimated to translate into about 1,800 SFEs. It could be significantly more depending on the types of commercial customers we attract. We're ideally located in the Denver metropolitan area, where all activity is centered around the I-70 corridor; we have about 0.5 miles of frontage along I-70 with an interchange situated right at our development, putting us in a prime area for growth. Regarding our initial phase, we initially had 509 lots; approximately 375 occupied structures exist today, while there are about 90 units under construction. We have 100 homes currently going up within the 509 lots offered in Phase 1. We're estimating that two of the three homebuilders are completely sold out of their lots. The remaining homebuilder has a few lots left, and we expect those to sell out by the end of Q2 '22. Any available lots are moving quickly. We've achieved $36 million in lot fee revenue to date, with almost $14 million recognized in tap fees revenue. We also have some reimbursement costs for public improvements—roads, curbs, gutters, and drainage that other governmental entities will own. In our first phase, we're looking at about $20 million worth of reimbursement costs, of which we've received about $10.5 million so far, with the balance coming in as the project continues to develop. Our portfolio of homebuilders includes KB, Taylor Morrison, and Richmond in our first phase. Looking at our second phase, we opened up a total of about 850 lots, and 804 of those will be contracted for by our homebuilder partners. KB is returning, along with D.R. Horton, Challenger, and Lennar, building in our second phase. We've retained about 46 lots in there with an additional 100 lots that can be added as we continue to expand. Those 46 lots are reserved for our single-family rental market segment. We expect to deliver our first lots later this year, with some model homes available for our homebuilders to construct around February or March timeframe. The lot revenue for our contracts on the 804 lots will generate about $70 million for the company, with about $21 million in tap fees. We anticipate about $61 million worth of reimbursable costs attributable to the roads and curbs and improvements we will construct, resulting in an estimated total development cost of $73.4 million for our second phase. We’re structuring the project into incremental phases to match the pace at which our builders want to take them down, segmented almost equally into four installations. Phases 1 and 2 are under construction; we’re quite close to completing our utilities and grading work in Phase 1 while still working in Phase 2. This breakdown provides an idea of lot revenue attributable to each phase, the number of tap fee connections, and total infrastructure costs in each of those phases. Some of this won't be linear—frequently, we incur higher costs in Phase 1 than in later phases—but this gives you insight into how our operations work. Each 850 lots in Phase 2 will provide full visibility into our operational strategy and estimated gross margin potential close to $80 million for this particular phase. Additionally, we have statistics on the total number of lots by our builders, types of lots, and their distribution. For those who follow our company, we have an agreement structure where our homebuilder partners will pay us in three installments or a finished lot delivery. Depending on what your preference is and tolerance per lot, if we carry the cost until finished lot delivery, where the homebuilder pays all at once, that lot price is significantly higher than those in our lot development agreement. We've closed on the platted lots for the three builders in our LDA structure; this is the first takedown. We're projecting to close the second takedown by the end of the first quarter of '22, which will involve our second payment when we deliver the wet utilities, with the final payment for the three builders under the LDA structure and one builder under the finished lot delivery. This revenue comes in block by block, so we deliver those on a real-time basis, expecting all to be finalized by next summer. The lot delivery pricing mechanism for this first sub-phase totals $18.4 million, which provides more context on builders and their product types. Quickly moving on, regarding our single-family rental segment, we wouldn't be in this segment without our role as land developers. Our objective is to continue to translate the equity value we're building through the lots themselves, capturing some appreciation from the community and the lots through our growth. We're experiencing substantial price appreciation here at Sky Ranch; homebuyers from 18 months ago are seeing up to 30% appreciation in their home values, primarily due to community growth in the metropolitan area and this market segment's growth. This strategy aims to enhance shareholder value while generating recurring revenue attributable to highly appreciated asset value. We appreciate steady lease price increases; while other rental types maintain or show slight weakness, we have diverse product offerings with detached homes, townhouses, and duplexes of varying square footage and bedroom configurations. Demand is tremendous. We started with three homes in our first phase, constructed within a competitive process, and all three were rented within 14 days—positioning us optimally in the market. Here are general statistics about the Denver market reflecting strength in single-family home price appreciation and constrained availability. We view this market segment favorably and see a chance to leverage our balance sheet, financing the vertical costs with inexpensive money through lines of credit while facilitating further development. Our capital cost for the initial three homes was approximately $320,000, while their market value appraised at nearly $350,000—indicating a tremendous opportunity, and we've utilized a 70% loan-to-value for financing. Our bank appreciates it thus far; it's working well for us across the board. We're forecasting the construction of 12 to 20 homes per year as we venture into our second phase. This slide outlines the project from start to delivery; we conceptualized the process successfully from March to November. Our offerings look fantastic—feel free to visit our website for more detailed images of the floor plans and their positioning. Moving on to the oil and gas sector, we provide water to several local operators; the largest is a new company formed from the combination of three previous entities called Civitas. They possess significant leasehold positions, a multitude of formations, and the capability to drill horizontally with 40-acre spacing, extending sometimes as much as 15,000-foot laterals. We have tremendous capacity in this field to support over 10,000 wells at full build-out. Our average revenue from water sales for each well that gets fracked totals $250,000, with 120 wells fracked to date. Oil prices are substantially more favorable at $80 a barrel than they were at $45, resulting in heightened activity. This slide illustrates our wholesale system's expansive infrastructure; we manage a large footprint of water distribution across the county. Fiscal 2021 proved to be an exceptional year for us by nearly every metric. We successfully completed our first filing for Sky Ranch, which was a challenging year for all companies concerning employee retention and growth. That said, our team continued to deliver, and we were in the office as a critical company operationally. We have a full portfolio of skilled personnel accomplishing the job excellently. We launched a brand-new business line, with successful execution from start to finish, yielding significant performance on operational and financial fronts. Revenues reached $17 million; if we examine those revenues, the difference between $17 million and our net income of $20 million—a challenging figure to explain—can be attributed to our ability to book the receivable from the reimbursements on our balance sheet, impacting our net income line. Currently, our Sky Ranch receivables sit at around $25 million. Our total number of utility customers stands at approximately 650. Overall, 2021 was a lucrative year for us financially as well, reflecting robust performance across both our balance sheet and income statement. I won’t provide details for that, but this has resulted in a strong liquidity position alongside a high degree of asset potential with negligible liabilities. The only liability we carry is that income tax payable, which always weighs on you by contributing to federal coffers; however, we appreciate this position as a taxpayer rather than accruing cumulative losses. With that, I would like to turn it back over to the operator for questions, and I’ll drill down on specifics for any of you interested in exploring any concluded details of our year-end.

Your first question for today is coming from Bill Miller. Bill, your line is live.

Mark, terrific quarter. Great year. Congratulations on all fronts.

Thank you, Bill.

In your earlier work, you mentioned many opportunities to acquire additional land and metro districts or take over utilities from prime water sources, but don’t have the water. Where do we stand currently? Are you still active in those endeavors, or is there anything more you want to share? Secondly, you have extraordinary liquidity and cash receivables; could you explain why you're not buying back more stock? You could always leverage financing for acquisitions by borrowing if necessary, and your strong balance sheet suggests you could easily buy back substantial amounts of stock while preserving some for acquisition opportunities.

I will break that down into three segments. Addressing our wish list, channeling the board: with Sky Ranch and our significant building opportunity, we want to continue focusing on that; I think our team has performed exceptionally, and the combination of water and land development has delivered dividends. We do have an appetite for additional acquisitions. While the market is strong due to housing growth, we’re undeterred, knowing we can bring substantial value through our water services. We're eager to identify land opportunities lacking water sources, bringing our water supply to contribute and facilitate zoning and building efforts. We are aggressive about this pursuit, requiring willing sellers, often essential for long-standing burdened families who've held onto these lands for extended periods. Therefore, we are actively engaged in this segment. Regarding our robust balance sheet, we can develop without borrowing costs, but capital is available to us. As this presentation noted, our stock's year-over-year performance is marked; we've seen a significant rise, which we’re pleased about; the market values us better now. If it were trading at $7 or $8 a share instead of $15, the conversation about stock buybacks would be significantly different. Yet, that conversation comes up at every board meeting—assessing the appropriate timing to enter the market to buy back stocks and considering how this impacts our broader shareholder base. Thus far, we've chosen not to be competitive with potential buyers, allowing them the opportunity to have their say, but addressing shareholder value through a repurchase program hasn’t yet aligned as an actionable item.

Mark, between last year and this year, the progress you've made is still not reflected in your stock price. You're undervalued now. Analyzing cash generation, recurring revenue from rental sales—you're a much stronger company in every respect than you were a year ago.

Thank you, Bill.

If that's accurate, given your projections for next year, you actually are likely to be even more undervalued right now. The authorization to buy back stock seems to validate your statements.

You're right; maintaining some liquidity is critical for pursuing acquisitions, particularly concerning their sizes. So we aim to stay prepared while demonstrating strength in our acquisition proposals. I'll leave it there as I cannot provide further clarity on this topic, but it remains a focus for us.

Your next question comes from Elliot Knight. Elliot, your line is live.

Thank you, hi Mark.

Elliot, nice to talk to you.

Could we discuss the fracking situation in the oil and gas sector? Given the current global oil industry landscape in the US, this should ideally be the time for companies to engage in fracking and maximize production. Can you update us on your frac water supply, especially concerning permitting? I've heard there were permitting halts, but companies approached the issue aggressively leading up to that.

That’s a good question, one I can update you on. Colorado has historically approached oil and gas regulations in a more environmentally-sensitive manner. We’ve altered and examined state-level regulations over the past several years, achieving some stability in our approach. This transition had constrained activity when oil prices were low at $45 a barrel, but with current prices around $80 a barrel, companies are now more aggressive in developing supplies. They must stay ahead of urban development, resulting in a spike in permitting as they prepare for growth. We see thousands of well permits submitted as companies establish pad sites; we are now a central player in this urbanized area of Colorado, navigating growth eastward as the demand increases. We expect a notable rise in oil and gas revenues in 2022; previously, we achieved about $3.5 million in our highest year and anticipate surpassing that this year due to increased drilling and permit activity. Looking ahead to 2023 and 2024, the forecasts remain strong as companies drill and utilize the permits available, ensuring robust ongoing activity ahead.

Civitas is on board with this; it sounds like you reflect their plans. Is that a fair understanding?

Yes, that’s accurate. They are dedicated to drilling and remaining ahead of urbanization. Their well pad locations will push into the neighborhoods, while their laterals move under existing communities, continuously advancing east.

Thank you.

We do have a follow-up question from Elliot Knight. Elliot, your line is live.

Thank you for taking my question, Mark. Can we discuss your timeline for developing commercial properties?

Great question. We have a detailed master plan for our commercial site, outlining all the various uses we're considering—the logical retail options include grocery formats, big box availability for stores like Home Depot or Walmart, and opportunities for fast-casual dining. Additionally, we have set aside space for distribution centers, which the supply chain crisis has highlighted in the current economy. One of the growing needs is for these distribution centers, which function on a just-in-time model. Given the tremendous demand, we hope to initiate discussions for these transactions next year and moving into 2023. Retail developments will likely take longer due to the requisite number of rooftops, necessary to support larger retail operations. Retailers typically require certain volume metrics—e.g., a grocery store requires a $1 million daily volume, translating into a corresponding number of rooftops. We are dedicated to ensuring these businesses include our development in their plans, focusing on both grocery and larger retailers alike, while actively marketing the site to those entities. Although retail will take a little while to actualize, we are consistently engaging with relevant stakeholders to ensure we remain on their radar as they make decisions.

Lastly, regarding stock buybacks, cash dividends are an option. A modest dividend could turn Pure Cycle into a dividend-paying stock. I believe this would attract more interest, potentially broadening your investor base.

I appreciate that, and you're correct in noting that dividends can attract a different trading segment. Strategically, putting dividends in place typically correlates with annual revenues rather than one-time income from land sales or tap sales. However, this remains a key consideration for our Build To Rent segment. The recurring revenue model allows us to contemplate dividends from our utility operations sooner. This topic remains a constant at every board meeting.

That is great to hear. Thank you, Mark.

And I’m sure others listening are pleased to hear that as well.

You have no additional questions in the queue.

To wrap up, if you're listening to this replay and have questions or technology challenges, feel free to reach out. We're thrilled about the year—it’s been a better year performance-wise for our stock, with trading volume up. Currently, we're averaging about $1 million in equity traded daily, improving overall liquidity. We aim to enhance outreach for investor relations, and I anticipate an opportunity to travel to New York soon, aiming for a meetup for lunch sometime in December, exploring face-to-face discussions. Thank you for your continued support and interest in the company. We expect great results in 2022, so stay tuned.

Thank you, ladies and gentlemen. This concludes today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.