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Pure Cycle is well
positioned with its valuable asset in a water short region to grow their water and
wastewater service business, serving customers in the Denver, Colorado metropolitan area
Utilities
Water Utilities
(PCYO-NASDAQ)
Pure Cycle Corporation
8451 Delaware Street
Thornton, CO 80260
Phone: 303-292-3456
Mark Harding
President
Interview conducted by:
Lynn Fosse, Senior Editor
CEOCFOinterviews.com
May 4, 2006
BIO:
MARK W. HARDING President and CFO joined Pure Cycle in April 1990. Mr. Harding has
been primarily responsible for the operations of the Company including the negotiation and
acquisition of the Company's principal assets. Mr. Harding brings a background in
public finance and management consulting. From 1988 to 1990, Mr. Harding worked for
Price Waterhouse, where he assisted clients in providing public finance and other
investment banking related services. Since joining the Company, he has negotiated
the financing necessary to acquire the Company’s assets as well as the negotiating
the privatization agreement with the State and area developers. Mr. Harding has
a B.S. Degree in Computer Science and a Masters in Business Administration from the University
of Denver.
Company Profile:
Pure Cycle Corporation owns water assets located in the Denver, Colorado metropolitan area
and on the western slope of Colorado. Pure Cycle provides water and wastewater services to
customers located in the Denver metropolitan area and provides services such as the
design, construction, operation and maintenance of water and wastewater systems. Pure
Cycle also owns patented water recycling technologies, which are capable of processing
wastewater into potable drinking water.
CEOCFO: Mr. Harding, please start by giving us an overview on
the water industry in general and Colorado, in particular.
Mr. Harding: “The water industry is comprised of
companies, either investor owned or government owned, that provide water and wastewater
services. It is a locally driven business; throughout the country, there are approximately
55,000 different water providers, providing service to customers in the United States.
Roughly 15% of the market is served by investor owned water companies, with government or
municipally owned providers serving the remaining 85%. The industry is heavily weighted by
municipal providers with Colorado being no different than the national picture. In the Denver
metropolitan area, serving a population of about 2.6 million people, the region has
roughly 55 different water providers with PureCycle as one of the few investor owned water
providers. We operate predominately in the southeast Denver metropolitan area, providing
water and wastewater service to our 24,000 acre service area, and other customers located
in the southeast metropolitan area.”
CEOCFO: Are you the only option for consumers in your service
area?
Mr. Harding: “Within our service area, we are the
exclusive provider. We have an agreement with the State of Colorado Board of Land
Commissioners, which is a unique division of the State of Colorado, who own assets it
manages to produce revenues for the State’s public education system. The federal
government granted many Western states certain lands that they were to manage for the
benefit of the state’s public education system.
Our Denver based water assets are a result of a
public/private partnership with the State Land Board whereby the private sector is
responsible for the design, construction, operation and maintenance of water and
wastewater facilities within our service area as well as other areas in the region. We
have exclusive rights to provide service to over 24,000 acres, which incorporates our
service area, and compete for service to other areas in the Denver metropolitan region.
Our service area, which is owned by the State Land Board known as the Lowry Range; is the
single largest contiguous parcel of property, owned by a single owner next to a
metropolitan area in the United States, so it is a very unique piece of property.
There are active residential developments along three boarders of the Lowry Range, and in
October of 2005 the State Land Board issued Requests For Proposals to solicit a
development partner to assist them in the initial development of a portion of the Lowry Range.”
CEOCFO: Do you have to pay the cost of developing?
Mr. Harding: “We are responsible for developing the
water and wastewater systems. Our business is divided into two segments; one segment
includes the design, construction, operation and maintenance of the water and wastewater
systems. The second segment is defined through growth; adding new connections to our
systems as well as expanding our water assets to increase our service capacities. We are
vertically integrated in our services, where we own the supply, we design, construct and
distribute the supply, collect and treat wastewater, and operate and maintain systems
owned by the Company as well as systems owned by others.”
CEOCFO: What is the growth like in Denver and how will that
impact your growth?
Mr. Harding: “Denver has an existing population of 2.6
million people and is forecasted to add an additional 1.3 million people over the next 20
years. This growth translates into an average annual growth rate of approximately
1.7% whereas the national average is closer to 1%. An additional 1.3 million people
will translate into approximately 400,000 single-family connections being added to the Denver
market. The company’s portfolio today has the capability of providing service to
approximately 80,000 single-family connections. Area real estate experts divide that
growth into various sub-regions in the Denver market.
Area forecasts indicate that approximately 50% of all
development activity will occur in the southeast metropolitan area, which is the area
where our water and service area are located. If you break that down, approximately
200,000 single family connections are going to occur in our sub-market, and we are well
positioned to capture a portion of that growth.”
CEOCFO: What does adding connections mean to your company in
terms of revenue opportunity?
Mr. Harding: “The company receives revenue from two
sources; first is a one time tap fee, paid typically by the developer which is amortized
into the cost of a house. As you buy a house, the cost of the house includes the cost of
all infrastructure that went into making that house including the water and wastewater
systems. Capital costs for water and wastewater systems are funded through tap fees.
Tap fees are relatively high in the Denver area, which is a reflection of the value
of water to the region. Our tap fees today are approximately $14,700.00 and will increase
to approximately $16,800.00 in July (2006).
On a marco scale if you apply the 80,000
single-family tap connection capacities of our portfolio to our $16,800.00 tap fee; that
generates roughly $1.3 billion in revenue from tap fees. Keep in mind that we have to
build the water and wastewater systems and our projected gross capital margins are
forecasted at approximately 50%.
Once the systems are constructed and customers are connected, we provide ongoing water
service and wastewater service. On average each single family home pays roughly $600.00
per year for water and $400.00 per year for sewerage, or roughly $1000.00 per year
connection per year. Again on a macro level multiplying annual water and wastewater
service revenues applied to our 80,000-connection capacity, this generates approximately
$80 million dollars in annual revenue. The operating margins on servicing our customers is
roughly 45%. The company currently provides service to approximately 250 single-family
connections and we have under contract approximately 5,000 single-family connections.
Therefore, we have a little more than 5% of our assets in total under contract and we are
looking to continue to expand those service connections and identify those areas where we
are going to provide service.”
CEOCFO: It sounds like you at the beginning of a potentially
very lucrative process.
Mr. Harding: “We certainly believe that to be true.
We’ve been quietly accumulating these water supplies over the last 10 years and
we’ve been patiently waiting for the Denver metropolitan area to continue its
migration out to our service area. There is now development on 3 boarders of our service
area and we are anxious to begin construction under our first substantial water service
agreement with a local developer who has now partnered with a national home builder
Neumann Homes to build a Master Planned community known as Sky Ranch. It is a 1,000 acre
tract of land along interstate 70 and we are actively working with Nuemann Homes to
engineering water systems for the community and awaiting a timeline for their construction
schedule.”
CEOCFO: What shape is the company in financially, while you
wait for all of this to happen?
Mr. Harding: “The company is well positioned
financially; we have roughly $5 million in cash and cash equivalents on the balance sheet.
We have a burn rate of approximately $1 million a year and we can stage our investments to
match revenues. Most of our investments in infrastructure will be self-funded, as an
example, under our Sky Ranch water service agreement, the developer must purchase 400 taps
prior to occupancy of their first house. Based on tap fees of $16,800, 400 taps will
generate revenues of $6.7 million and then the company will build the facilities necessary
to service 400 units. It will cost roughly $3.5 million to build those facilities.
Each incremental development of infrastructure will be cash funded and the company has a
good cash position in the event that we need to invest in additional infrastructure or
capacity, or fund operations.”
CEOCFO: Other than time for all of this to get into place and
continue, are there any challenges that you will need to be on the lookout for?
Mr. Harding: “We provide water and wastewater service to
new developing areas in the Denver region. We keep a strong eye on housing and
economic trends both nationally and more specifically here in Denver. There is a lot of
talk about, ‘will the current housing markets continue?’ Housing is divided into
local markets and in the 1990’s the Denver area and Colorado, ranked 3rd
in the nation for percentage growth. In the 2000’s, we continued the rank among the
leading metropolitan areas for growth, however Denver’s growth has been a bit slower
than some of the other southwestern markets. Denver has been characterized as having a
sustainable growth pattern. Denver has been adding approximately 20,000 single-family
connections each year, which has provided a stable, predictable pace for investment to the
region. We watch those statistics carefully and are able to match our investments to
coincide with the actual production capacities of our water and wastewater systems to
serve customers as they come online. The advantage is neither the Company nor the
developer has to inventory excess capacity, investing in a large amount of infrastructure
then waiting for demand to catch up to utilize that inventory.”
CEOCFO: Tell us about the strength of your water efforts?
Mr. Harding: “Investor owned water utilities provide a
service to local communities. Many times that service is to operate and maintain a
government owned water and wastewater system, or to operate and maintain systems owned by
companies themselves. Traditionally, the water utility business is a relationship driven
business whereby the investor owned companies develop and maintain relationships with
local governments, built on performance and trust that enables them to compete
periodically for their business.
One of the unique elements of PureCycle is in
addition to providing the service of operating and maintaining systems owned by the
Company as well as systems owned by others, we also own the water. Ownership of water give
us as asset component in addition to the service component to our business. If you view
the markets indicator for the value of water over time, the most tangible measure of that
value are the price of water taps in the region. The good news is that tap fees in the
region have been growing steadily. As an illustration, our tap fees are established on a
market based methodology. The State of Colorado as our partner, wanted an independent
mechanism to establish rates and charges, both to protect their royalty revenues, but also
so they as a customer were paying fair market value for the service. Thus, our rates
and charges are established based on the average of comparable rates from 3 surrounding
municipal water provider’s rates and charges. Between 2004 and 2005, tap fees in our
rate base district increased 18%; between 2005 and 2006, tap fees increased 14% moving
from $14,700 to $16,800. Tap fees are the market’s leading indication of how the
value of water continues to grow in our market.”
CEOCFO: Could you tell us about your plans for reaching out
beyond your current territory?
Mr. Harding: “Our company continues to seek to provide
water service to other surrounding areas and as I mentioned earlier, we entered into an
agreement with a local developer who is now partnered with a national builder for a master
planned development approximately 4 miles north of our service area. There are several
properties that surround that property which have all changed hands from local ranching or
agricultural interests to developers and PureCycle continues to market its services to
those builders and developers. We continue to explore opportunities to grow our assets and
grow our service capability beyond the 80,000 single-family connections. One way we do
that is to try and leverage our existing portfolio to be able to acquire additional water
supplies.
I’ll illustrate by using the agreements we’ve reached with the developer of Sky
Ranch. The developer had some water beneath this property, but it wasn’t enough water
to build urban densities on the property, so we provided the developer an opportunity to
monetize their water assets, while at the same time adding water to the Company’s
portfolio to increase the number of units, which can be developed on the site. This
mechanism affords the developer the opportunity to monetize their water, it allows us to
expand our portfolio, and we enhance the number of taps per surface acre, so the developer
could get higher density zoning on the property. We will continue to seek opportunities to
expand our portfolio in conjunction with service contracts.”
CEOCFO: Just to be clear; he didn’t have enough water
under his property, so you will mix that with other water that you have?
Mr. Harding: “Correct. We added the developer’s
water to our portfolio so the developer can gross up densities on their overall
project.”
CEOCFO: What about the cost of construction when you are
going further away geographically from what you already own?
Mr. Harding: “Typically, water is a localized commodity.
The nice thing about our particular assets are that we source our water supplies
right where we are using those water supplies. That is not to say that the Denver area
hasn’t reached out extensively to acquire new water supplies, but the only available
new water supplies are going to be to reach from the other side of the continental divide,
or in other river basins and bring water to the Denver area. The State of Colorado is
unique having 80% of the state’s precipitation falls west of the continental divide,
while 80% of the state’s population lives east of the continental divide with
approximately 120 miles separating those two areas. In order for Denver to continue
to grow, it must reach farther and farther away to obtain new water supplies. It takes a
tremendous investment and time to bring those systems online. The area has as many as 11
different diversions that take water from the west slope and bring it over to the east
slope and will continue to expand those systems and reach farther and farther away for
water. What that tells us is that water will continue to experience increasing price
pressures, as it costs more and more to get water to the region. We believe we are on the
right side of that demand curve having the largest unallocated portfolio of water in the Denver
area.”
CEOCFO: You’ve started to reach out to the investment
community; why at this the time and why should people be interested in Pure Cycle?
Mr. Harding: “We’ve carefully maintained a low
profile on corporate investor relations and public relations, because the Company has been
quietly acquiring its water portfolio and until that time when the Company can provide
stronger guidance on revenues and margins we have been cautious about setting guidance. We
seek to inform the investment community of the value of our assets and the opportunity of
the Company to monetize these assets. The Company is in the early stages of monetizing
these assets and as I mentioned we have roughly 5% of our assets under contract and we are
under construction on a number of facilities in 2006 and we will continue to grow our
service capabilities through 20006 and 2007. We are much more active about informing the
investor community and the public about these assets, how they have been monetized and
also the value of water in the region. I think we are an excellent opportunity for the
investment community as an investment in water and the value of water in a water short
region.”
CEOCFO: Any final thoughts?
Mr. Harding: “The company has a unique position in the
industry, compared to other investor owned utilities, through its ability to capitalize on
the market value of its water assets. Most investor owned utilities are regulated and are
allowed to earn a rate of return based on invested capital. Pure Cycle is much different;
due to water in Colorado being a protected real property interest, the public utilities
commission has not sought to be an intermediary, determining what a real property seller
and a real property purchaser will pay for that interest.”
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