Pure Cycle Corp Q1 FY2025 Earnings Call

Good morning. I want to welcome everyone to Pure Cycle Corporation's earnings presentation for the three months that ended on November 30th, 2024. We're utilizing a different format for this call through our Teams meeting, allowing for greater participation. For those who have dialed in but are not on the Teams call, you can view the presentation by visiting purecyclewater.com and accessing the link on the homepage. After the presentation, we will enable a camera for a visual Q&A session to make this earnings call more interactive. Joining me today is our controller, Cyrena Finnegan, who ensures that our numbers are presented accurately and fairly, as well as our CFO, Marc Spezialy. Also with us is Dan Kozlowski, a Director and one of our shareholders. We received positive feedback from shareholders about the interactive format of our annual presentation, and we would like to continue that approach. I'll now begin the presentation. We have a forward-looking statement regarding forward-looking statements under the Securities and Exchange Act that you are all familiar with, so I won’t dwell on that. I want to acknowledge our leadership team, which consists of outstanding professionals executing our business model successfully. It’s a privilege to work with this team that brings decades of industry experience to our work environment each day. The true success of the company lies with our employees. I would also like to recognize our Board of Directors, who provide excellent leadership and have experience in various relevant fields such as land development and corporate governance. Now, I'll dive into the financials. We’re continuing the momentum we saw at the end of fiscal year 2024, executing our business model exceptionally well. We achieved record revenues for our first quarter, totaling approximately $5.7 million, with impressive gross profits and margins. Our gross profits stand at about $3.67 million, reflecting a 64% gross margin. We also had a strong quarter regarding royalty income, earning roughly $2.6 million from oil and gas royalties associated with the land interests we have acquired, including six new wells at Sky Ranch. This has positively impacted our gross margins and quarterly income. Additionally, our net income for the quarter was nearly $4 million, equating to $0.16 per share. When comparing revenues to the previous quarter, we saw an almost 7% increase in revenues and a nearly 10% rise in gross profits. Our net income and earnings per share have nearly doubled compared to last year. Over the past 12 months, our revenues year-over-year and forward guidance remain strong, with an expected total revenue of around $31 million for 2025, starting strong with $5.8 million in the first quarter. Our forecast for gross profit is estimated at $20 to $23 million. Last year, we achieved earnings of $0.48 per share, and we are aiming for $0.52 per share this year, showing strong progress. I want to provide some insights into our individual segments. In the water utility segment, we anticipated slightly weaker performance, but we expect strong future growth due to the development of Sky Ranch. Output from oil and gas revenues was also expected to be weaker this year as operators focused on expanding infrastructure and obtaining new permits. However, we did see a significant increase in new connections, with our tap fees increasing by about 150%. Our recurring customer base grew by approximately 12%. The oil and gas segment still looks promising for the coming years, given the extensive development plans. In terms of sector performance, we consistently perform well compared to larger peers, particularly in our water segment, where we have a lot of opportunities to grow as we are still only utilizing about 5% of our assets. In land development, we are currently working on three phases at Sky Ranch. Phase 2 consists of approximately 890 units, and we are progressing well with vertical construction. Our rental income from single-family rentals is also up by 14%, strengthening our portfolio. Overall, we've seen significant growth and executed all aspects of our business efficiently, resulting in yet another record quarter. To summarize, our company operates in three business segments: water and wastewater utility, land development, and single-family rentals. Our entry into land development has allowed us to provide water rights for lands that otherwise could not develop. The partnerships we have nurtured allow for prompt execution by homebuilder partners. Our single-family rental segment is a recent addition that maximizes our land development opportunities, providing equitable value to each home. Lastly, our strategic growth opportunities and current balance sheet place us strongly in the market. We foresee significant revenue potential from Sky Ranch and a commitment to delivering shareholder value through efficient management and share repurchases. We invite questions and feedback, and I’ll now turn the presentation over to our Teams session. Thank you.

This will now begin the Q&A of our presentation. As you know, we're using Teams this quarter to create a more interactive experience with our investors. DJ, your mic might be muted. DJ, there you go.

Hi, can you hear me?

Yeah.

Great. Good morning.

Good morning.

I have a question regarding the projected asset value shown in the latter slides, specifically Slide 27. I would like more detail on how you arrived at that figure and what it represents.

So yeah, we'll say 26 and we show that...

Actually, it might have been 37.

I think that may have been related to land development. When you examine the asset growth of 37, it indicates that each segment is contributing, whether through land development opportunities by selling lots or the number of lots we still have in inventory. We're generating modest revenue from our homebuilders on lot sales and from reimbursables. Our balance sheet reflects ongoing growth in reimbursables, which we receive for public improvements we undertake. We get repaid through tax receipts. Periodically, we bond for the continued increase in homes, as each phase introduces a new set of homes, thereby enhancing the assessed value, which is calculated based on the home's value and the tax base. This is how we recover funds along with water tap fees and single-family homes. This analysis pertains exclusively to Sky Ranch and does not include the 60,000 connections available for other land interests or developments in our service area, like Lowry Ranch or other opportunities. It strictly pertains to what is listed on the balance sheet for properties we own.

Got it. Okay, thank you.

Alright. We'll take our next question from a caller with area code 201. Your line is open, but you’re muted. If you are the caller ending in 7586, you're muted, but you can speak if you still have a question. If anyone else has a question, please raise your hand.

Okay. While we're still sort of queuing up some of the questions on that. Maybe what we can do is turn it over and open it up to Dan and have you give maybe a little bit of perspective, both in terms of a Board perspective as well as kind of someone on the outside looking at valuations as to not only what you've seen since your participation on the Board, but kind of how you see this thing maturing quarter-over-quarter, year-over-year.

Thanks, Marc. It's great to be on the call again today. We received positive feedback from the last year-end call, which encouraged us to do it again. Although it wasn't something many people had experienced, Mark and I both received calls saying it was interesting to hear from a Board member working alongside the management team and as a significant shareholder. As you all know, I have a strong commitment to this company. We own over 10% of it and have been active participants. I'm pleased to report that we had another solid quarter. We followed up with increased earnings power in what is typically a quieter Q1, and our resource base allowed us to add more earnings per share to our figures. As I assess our situation today, based on the year-end numbers, we achieved $0.48. Now, over the last 12 months, our earnings run rate stands at $0.55, which is a record high. Looking back, there was a one-time accounting adjustment for reimbursables a couple of years ago that inflated our earnings in one quarter, but that was just a catch-up. So, if we compare like-for-like, we continue to make progress toward what are now record earnings. As Mark has indicated, the guidance for next year looks positive and continues to trend upward. Marc, do you have any comments on our ability to maintain these higher earnings run rates and their sustainability over the next 18 to 24 months?

I believe the real proof of our progress is evident in our ability to get all our segments operating simultaneously. We've made strategic investments in each segment, particularly in our water assets, which we have successfully expanded. Our investments have been consistent year after year, and we’re utilizing some of our fracking revenue to fund these efforts. This creates additional capacity within our system, which translates into our land development segment, where new connections generate amortized investments that ultimately enhance margins. We are also investing in parks, schools, and open spaces, which contribute to public infrastructure, uplifting community value and land worth. This is reflected in the appreciation of equity in our single-family rental segment, where we receive steady rental income from our homes. An unexpected highlight this quarter was the new wells coming online, significantly boosting our royalty income. Our strategic acquisition of Sky Ranch has already yielded returns just from oil revenues, in addition to what we’re monetizing through utilities and rental income. All these assets are creating momentum for the company simultaneously, which is exciting. We're also partnering with national homebuilders eager to expand beyond Sky Ranch, and we appreciate their enthusiasm as we explore further investment opportunities.

That's right, a couple of questions. Let me pause you for a second and get this interaction with. Dr. Anderson.

Your line is open if you want to unmute your computer? I can see you and hear you. Welcome. Good. Fantastic. Once I learn how to do this and get up to speed. Well, you know I've been with you for a long time, Mark.

You bet.

So, I told you I was a long-term investor. I have a couple of questions. First, on the oil and gas, what is the outlook going forward? Are there potential for more wells and more fracking to be done? Are we now on a gradual decline curve on the wells? Obviously, royalties are partially dependent on the price of oil and gas. But excluding that, how do we look for continuing royalties?

That's a great question with two parts to address. First, regarding royalties, we have six new wells drilled at Sky Ranch. Typically, royalties come in quickly, especially with shale oil, which shows high early returns but tends to decline steeply over time. I anticipate that we'll see strong performance throughout this fiscal year, followed by some decline. For the last four to five years, we've consistently received about $50,000 each month from the initial development of those wells, which started with just two wells. This suggests a positive long-term trend. Initially, new wells produce significantly higher revenues. As for frac revenue, we see a promising opportunity to support our oil and gas partners in new wells, even those where we don't hold mineral interests. They have numerous wells being permitted and developed in our service area, which should allow for continued field development, potentially leading to substantial revenue from 2026 through 2030 and beyond. Last year, we achieved record revenue of nearly $6 million from oil and gas water sales, and I believe that has the potential to grow even further over the next five to ten years. Overall, the outlook is very optimistic.

Thanks. The second question is, most homebuilders that I listen to their calls because I'm investing in several of them, at this level of interest rates to continue to get the sales or having to do mortgage buy-downs, could you talk specifically about the Denver area and what's happening there? And what sort of incentives your builders may have be having to give to, to continue to get the sales level?

It's interesting that you asked this because I recently discussed this with one of our builders. They really appreciate Sky Ranch due to the significantly lower buy-downs compared to other price points. For context, our entry-level price point is in the high 400s, so anything under $500,000 is regarded as the starter home market in Colorado, which is remarkable. It's surprising that this is still considered entry level in our market, especially given the affordability issues many major metropolitan areas are facing. The builders mentioned that while other market incentives average around $120,000, at Sky Ranch, it's only about $15,000. When looking at higher price points like $700,000 or $800,000, those incentives simply aren't available, as margins are squeezed in those ranges. Therefore, they're looking at Sky Ranch as a key opportunity since that's where the majority of buyer demand lies. For move-up buyers, it’s challenging right now to give up a 2.8% mortgage rate locked in two years ago. We expect that the strength will remain at the entry level, where incentives for homebuilders are the lowest. This conversation helped us realize the importance of continuing to deliver lots at that entry-level price point in the current interest rate environment.

Thanks. That's very helpful. The last question is sort of a philosophical question that you and your other team members may want to comment on. And as you, first, I'd like to congratulate you on the attempt to really lay out more of how your value creation works in the last few quarters and give us the extra charge and stuff like that. But as you think about balancing what I would call value creation versus reported earnings, which may not always coincide as you pointed out, the appreciation you're getting on your rental homes and things like that. How does the team think about that? And how important are just the ability to show continued progress in reported earnings, which may not equate to value creation?

That's a great question and one we find challenging because you're correct. We observe this not only in the rental segments and the equity value we carry forward, but also in our land development segment and water assets. Each of these assets holds significant equity value that isn't reflected on the balance sheet. We hope to continue demonstrating to the market how this translates into earnings per share. The gross margins we plan to deliver year-over-year will allow us to relate that gross margin back to the remainder of the inventory. This relates to PJ's earlier question about reaching a $700 million asset value when our current asset is only $100 million. It's truly about that equity value. You'll see us making impressive year-over-year returns driven by that equity value. Dan, you’ve seen this often in your career—how companies express this and demonstrate it. It's a frequent topic at the Board level.

I mean these assets were put on the table previously, and we discussed this a bit last call, Mark. What year was it when a majority of the water rights were purchased?

You're going to go back to almost 30. Again, this is my 35th year. So I think I bought it 30 years in, so more than 30 years.

So more than 30 years. And we talk about water out here in Colorado and other places. I mean there's been people who come to the market, they get excited. They try to buy some water. They try to flip it to a municipality and there's stories of that not working out perfectly, many stories. And so buying market water and trying to do something key with it and flipping it is not an easy thing. This is a very different situation. This is 30 years of embedded appreciation effectively of the water rights that were purchased. And so, one way I think about it, and you're just trying to triangulate valuation. We never know exactly what something is worth. But what was the price paid for the bulk of the water to recall, Marc?

The more recent acquisitions?

No, the one long time ago. Our capital basis in that is about $15 million.

So, $15 million. In some ways, this offers another perspective. With 30 years of appreciation on $15 million, you can choose your discount rate, whether it's 7%, 8%, or 9%. Consider the compounding impact using the rule of 72 or your current spreadsheet. It's not to claim that this reflects its exact worth today, but it serves as a reasonable starting point for discussion. The state landlord effectively sold that to Pure Cycle, which means they secured a significant deal. With the time value of money factored in, this worked out well. Pure Cycle has been able to monetize that for 30 years. Now, as pointed out, it's recorded on the balance sheet at historical values. This is why the returns in today's terms should be fairly strong and potentially increase in the future, making it quite an asset. While we’re not asserting that this is its current value, it's a reasonable assumption that water in the West has compounded or appreciated in value likely beyond inflation over the past 30 years, starting from over $13 million three decades ago. That's a more substantial figure than one might initially think. This is just one way to consider the situation; there are multiple perspectives. Regarding part of your question, Tucker, you mentioned the balancing act between reporting earnings and creating long-term value. Mark has done an excellent job of enhancing value at Pure Cycle over the past five years. Looking back, there have been quarters where we didn’t report significant EPS gains, but we were adding a lot of value to our portfolio or asset base, even if it didn’t show immediately. Currently, we have reached a stage where we are still undertaking those initiatives for future growth, but now, earnings power is no longer held back by those investments. We are exploring opportunities to expand our water portfolio, land holdings, and single-family rentals. We're pursuing all these avenues. Meanwhile, prior investments, such as Sky Ranch and those in oil and gas and commercial water sales, are now generating returns. We believe we are effectively managing both sides, and we possess the resources to do so. The earnings power is coming through, and we will continue to execute our plans for the future. Do you have anything to add?

No, I think that's great.

As Mark knows, I don't go back quite as far as he does, but I go back a long ways, way before Sky Ranch and those sort of things. And I would just make the comment that as a long-term shareholder, I am much happier for you to continue to build value and do things that make economic sense, including buying stock back, which clearly you are getting an excellent return on, and sort of let the earnings fall where they may within a reasonable area. And sort of that way your stockholder base will be aligned with people who are interested in making very long-term commitments to this company. And I say that even though I'm a lot older than I used to be when I was involved. So just keep up the good work, Mark.

Thank you. Thank you, Tucker.

So we'll take number three, which is area code 919, ends in 1214. So your line is open. If you're on a computer and a phone, you'll have to unmute your phone because this is coming through on the phone number, but if your phone number ends in 1214, your line is open.

Mark, can you hear me?

I can.

Mark, this is Jeff Scott. How are you?

I'm great. Nice to hear from you, Jeff. Are you there?

No, I'm in Telluride right now. I drove through about 10 days ago and I continue to be amazed at the progress up there. First question, when we started this, the combined tap and waste fees were kind of in the low 20s. And I think you said on the call that they're now 40. Are you starting to get any competitive or political pushback? And if you're not yet, kind of at what level would you expect to get some pushback?

Great question. And I didn't have that slide in this deck, but I do have it in the year-end deck. And what we try to do is keep consistent with where the market is for these tap fees. And so when you look at that, we're right in the meat of the market. We take a look at our most regionally competitor, which is going to be the neighbor, which is city of Aurora and our tap fees are just slightly less than city of Aurora tap fees. But when you look at the overall tap fees, there are water providers whose tap fees are reaching $60,000 a connection. And so it really is a play between what it costs you to develop that system, what your cost of capital and carrying those assets forward, together with the market appreciation and the cost of the next incremental amount of water that needs to get developed in the system. And so I would say we've been very good about keeping up with the bulk of the market and having that opportunity to continue to drive the investments that we're doing in oil and gas to be able to monetize that going forward.

So what I'm hearing is you're not seeing any pushback yet?

No, no. I think, and intentionally, right? We want to stay in the meat of that market.

Okay. On the commercial side, what are we looking at in terms of timing for kind of initial development?

Great question. We continue to have those conversations with some of those end users, right? We've got a lot of demand for our commercial for sort of the people that develop commercial, right? There's a lot of folks that want to come in and they want to buy that commercial land. And then they want to either flip it to the end user or they want to participate in some of that development with the end user. And I think our philosophy there is much like we've done with our residential is to vertically integrate ourselves. And we're really looking not for a commercial developer, but for a commercial user. I'm looking for the Kroger. I'm looking for a Walmart, a Home Depot. I'm looking for the folks that we can actually facilitate that role on delivering a pad site and then have them carry that forward. And what they're looking for is probably around 1,500 homes. We have about 800 now, and we have 700 under construction. And so as we carry forward through ‘25, we're going to deliver another, say, 200 to 300 homes at our fiscal year end and then probably another 400 homes by our calendar year end. That really puts us very close to that threshold of their number of rooftops where they like to see that economic opportunity. And then, the upgrades to the interstate, the interchange that we're working on, we have been working with the county with CDOT for the last three years on that. That looks to be a project where we'll start that construction in 2026, using some of the mill levies that we've reserved for that to be able to bond that particular project. So, all those things are coming together here in that, say, the next 18 to 24 months and then you'll start to see a lot of that commercial activity.

So, we're looking end of calendar ‘26 or ‘27 something like that?

I think that's a good time frame. We'll really start to get some transactions established in 2026 and then see significant monetization in 2027.

Okay.

Which is what you see a little bit in our forecast when I show a little bit of that forecast in that 2028 timeframe is really just the entrance, just the start of the commercial in that.

Okay. Completely different question. Of your homebuilders, do you track the metric of how many days on the market each house is?

I don't, but I know they do.

I know they do. Has it gone up at all?

That's a good question. At Sky Ranch, they've adjusted their approach since interest rates were at 2%. They used to take pre-orders and wouldn't start building a house until it was sold. Now, they maintain a model home and typically have three or four houses built for immediate availability. If someone enters looking for a home today, they can offer an available unit right away. They also have homes at different stages of completion for those who need a home in the near future. For instance, if a buyer needs a home in three weeks or three months, they can present specific addresses based on the timeline. They're managing their inventory closely to match the preferences of customers coming in, but I'm not sure what that specific number of phases is.

Okay, but there hasn't been any appreciable change over the last 12 months or so?

No, I think that's their model. At least that's how they presented it to us. It also depends on the builders. Some of the larger builders are simply going to want full inventory. They plan to start building all 40 homes at once, while others are starting three or four homes each week to stagger completion throughout the sales cycle.

Okay. Another completely different topic. The development of Lowry Ranch, that requires a lot of moving parts to come together. Where do you see that in kind of a time scale?

That's a good question. Certainly, the metropolitan area has grown out to it. And the state is evaluating a number of different options on it. So, they're looking at what partners can they bring in it for development, what partners can they bring in it from a lessor land use standpoint, what partners can they bring in it from a conservation standpoint. And sometimes when you look at all the options that you have, there's too many options that you have and it makes it complicated in making some of those things come to fruition. But certainly, the road ahead is a lot shorter than what we've seen over the last 30 years since we've been involved, just because of the growth and the maturation of the metropolitan area. I can, as many times as I've tried to give guidance as to what I think a third party is going to do, I have an absolute perfect record of being wrong every time.

Well, we all have that. Are we talking about a decade or more or less or...?

I put that in the two to five-year time frame. Pretty close to the commercial.

So you're actually seeing some momentum in terms of willingness to make decisions?

That's a different question. I would say the market would prefer them to be in the two-year time frame, while the land board might be looking at a five-year time frame.

They still have a mandate for the school system, don't they?

Yes, they are very aware of that. This is their most valuable asset, and they have numerous opportunities to maximize its potential. This includes generating revenue for the school trust and creating educational opportunities on the ranch, as well as generating consistent revenue from lessees. All these opportunities ultimately serve the purpose of benefiting K-12 public education.

Okay, Mark. That's all I have. Good luck to you.

Great. Good to hear from you.

Alright. We'll go back to the first caller, area code 20175, ends in 7586. If you're able to unmute, your line is open. While we're waiting, I'll leave your line open. You might click unmute on your computer or on your phone depending on how you're connected. But while we're waiting for that, Marc, there was a question in the chat. If you have any update on reoccurring revenue as a dividend, do we have any, the common question every quarter?

Yeah, no, that's a good, that's a good, we continue to monitor that, both at the corporate level as well as at the Board level. We want our recurring revenue, so that's growth in terms of the rental units as well as growth in our water accounts to really meet that nut of our annual overhead. And I see that happening sort of in this 2025 timeframe where we're delivering another, say, 20 single-family rental homes and then adding another 300 connections to that. So, that window continues to close. That conversation is more active at the Board level at each Board meeting and we continue to put up our metrics for the Board to understand that. And so it's very, it is at the forefront. I know some of you that are really pressing that pedal are a bit, like to see it sooner rather than later. And it's likely to be sooner rather than later.

Great. There's no more questions right now.

Okay. Well, if any of you that were listening to this that didn't quite want to weigh in on the Q&A session or if you listen to this on a rebroadcast and something comes up, don't hesitate to give us a call. We're very accessible and happy to give you color on how this thing goes. Dan, do you have any closing remarks?

I think our focus is on ensuring that our stock reflects the progress we've made in earnings. That has always been our goal. The shares responded positively after our year-end results, and we have continued this momentum into the first quarter. Mark has made significant strides in providing guidance for the remainder of this year and beyond. We are taking the necessary steps to connect our performance metrics with the movement of our share price. Many of our shareholders have been invested for two decades, and they deserve to see rewards from the operating earnings that our management team has delivered, indicating a bright future. Everything is functioning well, and I want to commend Mark and Marc for a strong quarter. We anticipate a fantastic year ahead. Thank you.

We plan to enhance our investor relations efforts for this campaign by reaching out to various markets, particularly New York, similar to our previous activities where we coordinated a lunch at NASDAQ. We may also arrange one-on-one meetings either in-office or while traveling through different regions. We'll notify everyone about our visit schedules in New York, Chicago, and the West Coast, providing an opportunity for you to connect with us in your local areas. If you haven't heard of us yet, please consider setting aside some time to learn more about what we're doing, as there's some exciting progress. Also, I want to take a moment to recognize President Carter for his significant contributions to our country and humanity. We structured this earnings call around certain dates, but it's important to acknowledge his impact on all of us. Thank you all, and Happy New Year.