In Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A), "we," "us," "our" and "Pure Cycle" refer to Pure Cycle
Corporation and all entities owned or controlled by Pure Cycle Corporation. You
should read the following discussion in conjunction with our consolidated
financial statements and accompanying notes, related MD&A and discussion of our
business included in our Annual Report on Form 10-K for the year ended August
31, 2021 ("2021 Annual Report") filed with the United States (U.S.) Securities
and Exchange Commission (SEC) and the unaudited consolidated financial
statements and accompanying notes included in this Form 10-Q. The results of
operations reported and summarized below are not necessarily indicative of
future operating results, and future results could differ materially from those
anticipated in forward-looking statements (refer to "Disclosure Regarding
Forward-Looking Statements" in this Form 10-Q; Part II, Item 1A. "Risk Factors"
in this Form 10-Q; and Part I, Item 1A. "Risk Factors" in our 2021 Annual Report
for further discussion).
We are a diversified water resource and land development company. At our core,
we are a wholesale water and wastewater service provider, and we develop land we
own into master planned communities. Our newest business is the development of
single-family homes held for rental purposes. Both the land development and
single-family home rental lines of business generate customers and usage fees
for our water and wastewater development business.
Our Business Strategy
Over the past 30+ years, we have accumulated a large portfolio of valuable water
rights and land interests in Colorado. We have added an extensive network of
wholesale water production, storage, treatment and distribution systems, and
wastewater collection and treatment systems that we use to serve domestic,
commercial, and industrial customers in the eastern Denver metropolitan region.
Our primary land asset, Sky Ranch, is in one of the most active development
areas in the Denver metropolitan region along the rapidly developing I-70
corridor, and we are developing lots at Sky Ranch for residential, commercial,
retail, and light industrial uses. We also have launched a single-family rental
business where we are renting homes in Sky Ranch to families under annual lease
agreements. We plan to expand this new line of business to more than 200 rental
units over the next several years.
Although we currently report our results of operations in two segments, our
water and wastewater resource development segment and our land development
segment, we operate these segments as a cohesive business designed to provide a
cost effective, sustainable, and value-added business enterprise. As our
single-family rental business grows and becomes material, it could likely become
our third reportable business segment.
Water and Wastewater
Water resources throughout the western United States and more prominently in
Colorado are a scarce and valuable resource. Our portfolio of 29,500 acre-feet
is comprised of groundwater and surface water supplies. Our other significant
water assets include 26,000 acre-feet of adjudicated reservoir sites, two
wastewater reclamation facilities, multiple water treatment facilities, potable
and raw water storage facilities, wells and water production facilities, and
roughly 50 miles of water distribution and wastewater collection lines. Our
water supplies and wholesale facilities are in southeast Denver, an area which
is limited in both water availability and infrastructure to produce, treat,
store, and distribute water and wastewater. We believe this provides us with a
unique competitive advantage in offering these services.
We provide wholesale water and wastewater service to local governments,
including the Rangeview Metropolitan District (Rangeview District), Arapahoe
County, the Sky Ranch Community Authority Board (Sky Ranch CAB), and the Elbert
and Highway 86 Commercial Metropolitan District (Elbert 86 District). Our
mission is to provide sustainable, reliable, high-quality water to our customers
and collect, treat, and reuse wastewater using advance water treatment systems,
which produce high quality reclaimed water we can reuse for outdoor irrigation
and industrial demands. By using and reusing our water supplies, we proactively
manage our valuable water rights in the water-scarce Denver, Colorado region
which dramatically reduces the environmental impact of our water resource
operations. We design, permit, construct, operate and maintain wholesale water
and wastewater systems that we own or operate on behalf of governmental
entities. We also design, permit, construct, operate, and maintain retail
distribution and collection systems that we own or operate on behalf of our
governmental customers. Additionally, we handle administrative functions,
including meter reading, billing and collection of monthly water and wastewater
revenues, regulatory water quality monitoring, sampling, testing, and reporting
requirements to the Colorado Department of Public Health and Environment.
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Revenues for our water operations are dependent on us growing the number of
customers we serve. If we are unable to add customers to our systems and sell
taps to builders, our revenues could be negatively impacted. We currently are
the developer of the Sky Ranch community which is the main driver of our tap
sales. Additionally, prolonged periods of hot and dry weather generally cause
increased water usage for watering lawns, washing cars, and keeping parks
irrigated. Conversely, prolonged periods of dry weather could lead to drought
restrictions and limited water availability. Despite our substantial water
supply, customers may be required to cut back water usage under such drought
restrictions which would negatively impact metered usage revenues. We have
addressed some of this vulnerability by instituting minimum customer charges
which are intended to cover fixed costs of operations under all likely weather
conditions.
Land Development
Our Land Development segment is primarily focused on the developing the Sky
Ranch Master Planned Community located along the booming I-70 corridor to
provide residential, commercial, retail, and light industrial lots. Sky Ranch is
zoned to include up to 3,400 single-family and multifamily homes, parks, open
spaces, trails, recreational centers, and schools. Additionally, Sky Ranch is
zoned to include over two million square feet of retail, commercial, and light
industrial space, which is the equivalent of approximately 1,600 residential
units, meaning the Sky Ranch community at build-out will include a total of
roughly 5,000 residential and equivalent units. Our land development activities
include the design, permitting, and construction of all the horizontal
infrastructure, including, storm water, drainage, roads, curbs, sidewalks,
parks, open space, trails, and other infrastructure to deliver "ready to build"
finished lots to home builders and commercial customers. Our land development
activities generate revenue from the sale of finished lots as well as
construction revenues from activities where we construct infrastructure on
behalf of others. Land development revenues come from our home builder customers
under specific agreements for the delivery of finished lots. Additionally,
pursuant to certain agreements with the Sky Ranch CAB and its related
metropolitan districts, on their behalf we construct public infrastructure such
as roads, curbs, storm water, drainage, sidewalks, parks, open space, trails
etc., the costs of which are reimbursed to us by the Sky Ranch CAB through funds
generated from property taxes, fees or the issuance of municipal bonds.
Our land development activities provide a strategic complement to our water and
wastewater services because a significant component of any master planned
community is providing high quality domestic water, irrigation water, and
wastewater to the community. Having control over land and the water and
wastewater services enables us to build infrastructure for potable water and
irrigation distribution, wastewater and storm water collection, roads, parks,
open spaces, and other investments efficiently and to manage delivery of these
investments to match take-down commitments from our home builder customers
without significant excess capacity in any of these investments.
We have been developing the Sky Ranch community since 2017. We are developing it
in phases, which is anticipated to take at least ten years until its fully built
out. In 2017, we began the initial development phase of Sky Ranch when we
entered into separate contracts with Richmond American Homes, Taylor Morrison,
and KB Home, pursuant to which we sold 505 total single-family, detached
residential lots at Sky Ranch. Pursuant to these agreements, we were obligated
to construct infrastructure and other public improvements as well as wholesale
infrastructure improvements (i.e., a wastewater reclamation facility and
wholesale water facilities), all of which are substantially complete as of
November 30, 2021. As of November 30, 2021, we have incurred $35.8 million of
the total estimated $35.9 million in costs related to the development of the
first phase of Sky Ranch. We anticipate all the remaining estimated costs will
be incurred during fiscal 2022. We believe most of the remaining costs will be
reimbursable to us from the Sky Ranch CAB as described in greater detail below.
The total cost of the initial development phase included $32.2 million of
estimated public improvements which are reimbursable to us from the Sky Ranch
CAB. Of this amount, as of November 30, 2021, we have received a total of $10.9
million in reimbursements from the Sky Ranch CAB. We believe remaining
reimbursables, and associated interest, will be repaid to us from future fees,
property taxes, and municipal bonds generated by the Sky Ranch CAB as the
project continues to grow its assessed value and tax base. As homes at Sky Ranch
have sold faster than anticipated (as of November 30, 2021, there are
approximately 435 homes sold and occupied in the first development phase), and
assessed values have exceeded early estimates, the Sky Ranch CAB has developed
an established tax basis, which we believe supports the intent and ability of
the Sky Ranch CAB to repay us being probable of occurrence. We also believe a
substantial portion of the amounts owed to us by the Sky Ranch CAB will be
repaid when the Sky Ranch CAB issues municipal bonds. We anticipate the next
bond offering will be during our fiscal 2022.
During our fiscal 2021, we began construction on the second development phase at
Sky Ranch. For this phase we entered into separate contracts with KB Home,
Lennar Colorado, Melody (a DR Horton Company) and Challenger Homes to sell 804
single-family attached and detached residential lots at Sky Ranch. The second
development phase will incorporate approximately 250 acres and is planned to be
completed in four sub-phases. Due to our strong performance in the first phase
of the Sky Ranch project, we were able to realize an
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approximate 40% increase in our average lot prices. For example, we increased
our sales price for a 50' foot lot from $75,000 to $108,000 and added an
escalation clause that increases the prices depending on timing of payments. The
timing of cash flows includes certain milestone deliveries such as the
completion of governmental approvals for final plats, installation of wet
utilities, and final completion of lot deliveries.
In February 2021, we began construction on the first subphase of the second
development phase at Sky Ranch, which is platted for 229 residential lots. We
have retained ten of these lots for use in our single-family rental business. As
of November 30, 2021, we have received plats and substantially completed the
grading and wet utilities installation for the first subphase. Contracts with
three of the four homebuilders include milestone payments as construction
progresses. We recognize the revenue earned under these contracts over time
using the percentage of completion method to measure progress. As a result of
the construction activities completed on this first subphase of the second
development phase, we have received a total of $7.7 million in milestone
payments. We estimate the first subphase is just over 43% complete, which
resulted in the recognition of $2.7 million of lot sale revenue during the three
months ended November 30, 2021. The final milestone payments of $3.6 million
from these three builders will be due when we complete the lots, which is
anticipated to be in fiscal 2022. The remaining $6.4 million of revenue will be
recognized over time as the first subphase of construction is completed, which
we expect to be substantially done with this first subphase within
twelve-months. The fourth builder contract is a finished lot contract
recognized at the point-in-time control transfers to the builder, which means
when we complete their 64 first subphase lots, anticipated to be in June 2022.
We will receive $7.0 million in cash as control of the completed lots is
transferred to that builder.
Payments for lot sales and the related revenue for the remaining three subphases
of the second development phase will occur as construction of those phases
occurs. We believe the next subphase construction will begin in the fall of
2022. We further believe it will take three years to complete construction and
sell the finished lots in all four subphases of the second development phase,
depending on the market conditions and permitting process.
In addition to the lot sales and reimbursables described above, from the start
of development at Sky Ranch through November 30, 2021, we have received $14.2
million of water and wastewater tap fees from the three homebuilders, and we
expect an additional $1.0 million of tap fees will be received during fiscal
2022 related to the first development phase. Timing of tap sales on the second
development phase is dependent on when homebuilders begin requesting building
permits. Total tap revenue from the 219 lots under contract with the
homebuilders are dependent on lot sizes and average water use across a broad
range of housing product types including duplexes and townhomes, which we
estimate will exceed $4.0 million.
Single-Family Rentals
During our fiscal 2021, we launched a new line of business we are referring to
as our single-family rental business. During our initial development phase of
Sky Ranch, we retained ownership of four residential lots for use in this
business. As of November 30, 2021, we have finished building three single-family
homes which we own, maintain, and have leased to qualified renters under
one-year lease terms. The fourth home is in the planning and permitting stage,
and we expect to begin construction before the end of our second quarter of
fiscal 2022. We intend to expand our single-family rentals in our second
development phase of Sky Ranch by building and renting homes on the 46 lots we
did not sell to our home builder partners.
We capitalize the costs of the homes and amortize the costs over five to
thirty-years depending on the asset class. Lease income is recorded monthly as
earned. We began recognizing monthly lease income for the first three rental
units on November 1, 2021.
COVID-19
As the COVID-19 pandemic continues, we have continued to enforce many safety
measures enacted to protect the health and well-being of our employees,
customers, business partners, and their families. While state and local mandates
have been eased, we continue to encourage voluntary vaccinations and healthy
practices such as hand washing, disinfecting, social distancing, and face
coverings when necessary. We have been able to maintain our level of efficiency
with the use of video conferencing and electronic data sharing platforms. We
were informed that our builder customers also took precautionary measures to
ensure the safety of their employees, customers, business partners, and their
families. These measures varied by builder. As a result, some of our builder
customers reported material net housing order declines in 2021. However, they
are also reporting material increases in orders since the stay-at-home orders
have been reduced. The most dramatic impact on our operations has been the delay
in inspections, the permit process and other activities requiring governmental
agencies due to expansive work restrictions imposed on their operations. We
expect COVID-19 to continue to play a role
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in potential delays related to the second filing at Sky Ranch due to rapidly
changing governmental orders, city and country shutdowns, and public health
concerns. Mainly, we have experienced delays in the permitting process through
the county which has delayed the construction progress of the Phase two of the
Sky Ranch development. All our operations are located in Colorado and travel and
related restrictions have not impacted our operations. Like many other
businesses, our contractors have experienced delays in receiving materials and
parts, but we have been able to adjust our purchases and operations enough to
reduce the impact this has had on our construction and other activities.
Results of Operations
Executive Summary
For the first quarter of fiscal 2022 we generated net income of $1.5 million or
$0.06 per common share. This is an increase of 79.2% over the first quarter of
fiscal 2021 net income of $0.8 million or $0.04 per common share. The growth in
net income was positively impacted by increased lot sales due to construction of
the second phase progressing, for which our margins increased substantially as a
we are no longer recognizing reimbursable public improvements as part of the
cost of development. Instead, they are now recorded as receivable from the Sky
Ranch CAB. Additionally, we recognized interest income on the note receivable
from the Sky Ranch CAB. These increases were partially offset by declines in
water usage revenues from oil and gas sales, declines in tap sales and increases
in general and administrative expenses.
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