Greetings and welcome to the Pure Cycle Corp's second quarter 2018 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mark Harding. Thank you. You may begin.

Thanks very much. Good Morning or good afternoon, depending on what part of the country you are in. I would like to welcome you all to our midyear earnings call. We have got a slide deck for this call which you going to find on our website. So if you go to purecyclewater.com and you go over to the Investor page, then there will be an icon that will allow you to click open the presentation and follow along with us on the presentation. I will try and note the transition of the slides as we work through the presentation. So with that, I would like to get started. We will have some prepared remarks and then we will open it up to some Q&A towards the end of the call. So first slide is always to get the lawyers out of the room. So it's our Safe Harbor statement that says that statements that are not historical facts contained in this corporation are forward-looking statements in the context of the meaning with Private Security Reform Act of 1995. You all, I am sure, are very familiar with that. So we will move on to kind of an overview of the company and I am going to blow by this pretty quickly because most of you will be familiar with the company and where, what operations that we play with. But we are a water utility company. We have a portfolio of water that we own or control. So water outlets is one where you can own that asset as a real property asset. We generate revenues on that from selling water to customers, both residential customers, commercial customers, as well as industrial customers. A large segment of that is to the oil and gas industry and then we also…

[Operator Instructions]. Our first question is from Bill Smith with Wm Smith & Co. Please proceed with your question.

Hi Mark. Congratulations on your progress. With the announcement of Aurora Highlands and Aerotropolis and the agreements with Adams and Arapahoe and Denver counties, what impact do you think that could have on Pure Cycle on your water over the next several years? We are talking 60,000 residents, I think, is what they are talking about, a whole new city.

Yes. What that really illustrates, Bill and thanks for the question, the Aerotropolis, if some of you have been following the local press on that, it's really a development that's, I would say, three miles west of our borders. So it really is very close to where Sky Ranch is. And it has a couple of advantages. Certainly, if it's in the city of Aurora, they are going to get their utilities from the City of Aurora. But what really it shows you is the emphasis that the I-70 corridor is receiving from almost every segment, whether that's residential, whether that's commercial, whether that's employment, all of the energy is really being spent in this corridor, which that's tied to this. So we are very excited about that. They are not in the ground. So they have got a few, I would say, maybe a couple of years before they start breaking ground on some of their major developments. That's not to say that they don't have some builders that are already working on projects that are either adjacent to or in proximity to that particular development, but what it really does is it brings more demand for activity in the corridor. Second side of it is, it's going to expand the Aurora utility system and then there is opportunities for us to participate in regional assets, whether that's extensions or expansions to the WISE agreement or whether that's stories opportunities or number of other areas. So we will wait to see what happens with additional opportunities as it relates to utilities, where Aurora, Denver and the South Metro Group can work together on efficiencies on delivering water utilities to the region as well. So it's a very exciting project. It's very exciting for us because it's bringing more investment into the corridor. I think those price points will be a little bit higher than ours just because of the level of what that overall project is looking for. So we don't look at it as a direct competitor to our lots out at Sky Ranch. But it does certainly add more emphasis to it.

In terms of selling water, you have 27,000 or 28,000 acres feet of water that can serve 60,000 homes, at $30,000 a tap and $1,500 sewer fees, isn't that a new market for your water assets then? Wouldn't that be a new market?

Yes. Probably not, Bill. Mostly because it's going to be in the City of Aurora. So those are utilities that are going to be provided by the City of Aurora. But there are a lot of adjacent properties to that. And the reason we are excited about the energy that that produces for the I-70 corridor is it puts more of those lands into play. And so those are opportunities for us to be able to extend service to the adjacent properties where they don't get their utilities from the City of Aurora. And they would logically be extending our system and very cost-effective for us to extend our system to the adjacent properties than be able to incrementally provide water and sewer service to them, not necessarily Aerotropolis but a lot of the adjacent properties.

And would that really bring into play the reservoir that you have kind of gone back and forth on for a number of years with Aurora? Could that bring that into play in terms of storage capacity that they might require?

It could. It just grows that system. And so whether it's our storage, whether it's our supply capacity, whether it's our peaking capacity, there could be not just storage but many other opportunities as you look at regional cooperation.

Okay. What do you think your revenues could be over the next, say, two years with the activities that you have found what you are looking going forward? Just do you have any thoughts on what that might be?

The thump in the room was my controller following up his chair going, no, no. Good question. Difficult for us to, what we look to, I will give you the areas of our revenue. So take a look at the oil and gas stuff. So I think our oil and gas revenues continue to strengthen. So this year, first six months we have got $1.5 million. I think we get a little bit better for the next six months. So maybe we get between $3 million and $4 million in oil and gas revenue this year. Where does that project for the next two years? We are still in HBP drilling. So if oil continues to remain strong, I think you start to convert over to some more field development. So that number could strengthen very nicely for us. I hate to give guidance on that but you can do your own sensitivity analysis on that and say, okay, if we had two rigs doing HBP wells, that could be as many as 40 to 50 wells a year. So if you do the math on that and see how that sustains itself over a period of time. So that's kind of the oil and gas activity. As we develop lots, we are going to be selling lots. We will get some revenue for lots this year. I don't want to give too much guidance on that. We have contractual issues with the builders and they will be buying X number of lots and I don't have those numbers off the top of my head but, let's say we sell, we will more revenue coming in, in the various stages. So I can say, on the lot development agreements, we might sell 100 lots in the lot development side. We might sell 50 or 75 lots on wet utilities and then might sell maybe 50 lots on finished lot deliveries in two of the delivery agreements and then maybe 25 to 35 finished lot deliveries with another builder. So those are at that $70,000 to $75,000 number. And then as they as they apply for building permits, them we will get those tap fees attributable to those and then the recurring revenue following up on those. So it starts to ramp pretty quickly because when we are getting a couple hundred lot sales over a period of time at between the real estate side and the tap fee side, that could be close to $100,000. And then you combine that into the oil and gas revenues, things start to look very exciting.

Yes. And one other question. The six builders, you started with three. It sounds like you have a potential up to six now. Is there a reason that that's been extended? Is it to accelerate development? What was the reason for that?

Yes. So two reasons. One is that we will have a bigger footprint on the second phase of this. So instead of us having 500 units, we might have as many as 2,500 units. And there will be a cross section of products. So we will have standard detached product, which we have now. We will have some sort of alley load product, which is going to be higher clustering of density. We will have paired product, which is going to be side-by-side units. There is some builders that have very nice product that they want to build in a paired product standpoint. And then we will have maybe multifamily builders. So you have got a number of different players that are in each of those segments in addition to the portfolio of standard detached single-family home builders. So it's not that we are renting up, it's just that we have more product offerings to make available to the market.

Great. Thank you Mark. Congratulations on your progress.

You bet. Thanks.

[Operator Instructions]. Our next question is from Bill Miller, a private investor. Please proceed.

Mark, hi. It seems to me, just looking at your --

Good morning or good afternoon.

Good morning, good afternoon, good evening or whatever. Just looking at your balance sheet, your outline of what cash flows could be, you are going to have a great deal of cash. I guess I have two questions. One, what are you going to try to emphasize as we look out over the three to five years? Recurring revenue lot sales, which are onetime and with the recurring revenue, which we hope you are going to generate, why aren't you thinking about and maybe even at this time, going to buy back stock? Dividend, I don't care about. But buying back stock, I do care about. Is that something that is on the table? Or is it off the table? Or you are going to have to wait for a while? Or what are the elements that go into that decision? And when do you think it will take place?

Boy, that's a good probing questions. A tough one. So that nobody can accuse you of giving me a softball here, Bill.

I wouldn't want to. You are used to softball questions?

Well, yes, sure. So let me talk ideologically or philosophically. Certainly, the high quality problem is we are going to have a good balance sheet to consider options with. So we are thrilled about that. And we are thrilled about really demonstrating that return for our shareholders. And then it becomes how effective are we going to utilize that. Are there other opportunities for us to invest into? That magic word of yours is recurring revenue. Are there opportunities to invest in where a company can utilize its assets for more of those recurring revenues? And those are sort of the acquisition side of things where we can find opportunities to connect existing systems, be able to leverage our supply capacity to bring new supplies to them and expand the number of connections that we get beyond just Sky Ranch. Sky Ranch is great. We are vertically integrated there. We can control the timing and develop and bring those customers online into the market. But we would like to have more Sky Rancher going on concurrently. So, you know, there is opportunities, as Bill Smith brought up, with the neighboring property owners where we might be able to expand our systems and have multiple projects going on at the same time and organically serving new connections. But then how about existing connections? And so kind of like what we saw with Wild Pointe, are there opportunities for us to pick up existing systems and be able to serve water to them as well as manage and maintain their existing operations? So that's probably the first area of interest to management to our Board. As we look at, if we can't find good opportunities there and we build the continuing balance sheet and find out opportunities where we can return those back to our investors, the value of our stock is important. If the market isn't able to appreciate what all you folks understand and appreciate by seeing the capacity and the opportunity withholding this stock, then that's certainly an option. Buying back shares on an undervalued stock is certainly something I can't speak for the Board. Those are Board level decisions notwithstanding whatever it is that I think is a good idea. They are going to make that as a policy issue. And then lastly is the dividend. We are a water utility company and people own water utility companies because they also provide dividends. And so you know we look at dividends from recurring revenue as opposed to the capital base, but there is opportunities for that. So all those options are on the table and we like to be able to discuss those with the high quality problem of having the money to do something about it.

Mark, do you think there are a lot of opportunities for recurring revenues in the Metropolitan Denver area where they have a good system but guess what, housing is expanding faster than their water supply. And therefore, you can sell them new and higher quantities of water. Or do you have to buy the whole system?

So buying the whole system or operating the system, there is a number of ways that you actually can do that that don't require them having to transfer the ownership but you get the same effect. That's kind of how we structured the Wild Pointe acquisition. Yes, there are a lot of those opportunities in the Metropolitan area. We are careful about how we look at those, how we modeled those, what type of an investment we need to bring to the table in order to make those transactions work. A lot of times it's much beyond just the existing system itself. They have other, sometimes these are deferred maintenance systems. And so when we look at them, we sort of say, we would need to make these investments and then it's a matter of walking them through the realities of what it is that they have and what we can bring as value to the equation. Certainly, our ability to operate systems is of value but they are operating their systems to a certain degree. A lot of times they will rob Peter to pay Paul. And if there is something going on in public works that needs capital as opposed to the public water utility, sometimes those cross over and it's a piggy bank for them that may or may not be, it has a short-term opportunity but long-term deferred maintenance opportunities. So we evaluate those situations as well. So it's a very dynamic process. You would think acquisitions are all about price, but they are not. Not in this industry. There is a lot more factors that go into evaluating those systems. So I am excited about those. Hopefully we will have some of those opportunities that we can announce this year, but we are fairly selective about how it is that we are going after those.

Mark, why can't you increase the price of your water? It's becoming an increasingly scarce commodity, even without droughts which you are having. So why can't you increase the price?

So pricing is a sensitive topic for us and our customers. When you take a look at the price that a homeowner pays, you are in a fairly monopolistic environment. It's not a monopoly but that customer had a hard time replacing your water supply. So we are cost sensitive about those rates per kgal on our users. We try and attribute that to the actual usage per individual house to make it actual, not only in terms of the tap fee but also it's easy for us to be able to say, okay, this is the meter deliveries for that particular house. If you take a look at some of those customers that don't pay tap fees that are sort of at the market on that, that's mostly going to be our oil and gas customers. And we are delivering continued value to them. So as we add more system capacity, we make more of our system available for their use. We add assets to that as it relates to pipelines and reservoirs and all that stuff really does go into our calculus on the rate that we charge them. So I would say, we do see rate increases and we see rate increases each year for those customers. The perceptual value or scarcity value in a drought year versus a wet year, we try not to market our pricing based on that type of activity. But when you have sustained dry years, you have more assets that come into play. So then that naturally comes into the pricing equation of what it is that you are selling your water for. So we do have a very sensitive customer in that and then we also have a very sophisticated pricing methodology that really connects both the commodity, being the water supply, as well as the infrastructure that's delivering that so that somebody is paying the appropriate rate. I will tell you unequivocably and this is categoric in our industry is that people don't appreciate the value that you get in getting clean water to a single-family house. The amount of technology and investment and sophistication that goes into that, we should be paying three times what we are for the privilege of getting clean water. And there is not a water manager or CEO of a water company that wouldn't tell you the same thing but by the same token, it's one of those commodities that people assume to have value for. So there is a delicate balance there.

So what do you think you will be able to increase the price? With inflation or with some other --?

No. We do better than inflation just because of the assets that we continue to add into the equation. So I can't say that you can plan on a 6%, 7% increase in water rates over time. You may see that. You may see that in the tap fee. You may see that less, more of a cost of living index as it relates to the monthly fees, but as more development continues to constrain the market and continues to make water availability even more scarce, those tap fees are going to go up, Bill. And they are going to go up for everybody. That's not going to go up for us. So on a comparative market, getting your tap connections from Pure Cycle as compared to getting your tap connections from any of the other hundred different water providers in the Denver area are all going to go up more.

And what about the commercial properties? Can you charge them more?

Well, we typically gauge that based on the amount of water used. And I am agnostic as to if that's a single-family house or a bottling plant or brew pub, they are going to pay the same rate based on the amount of water. So the customer is agnostic too. It's just a use calculation.

Okay. Great. Thanks.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back over to Mr. Harding for closing remarks.

Actually, let's see if we can take one more call or one more question.

You did just get one in there. This is Bill Cunningham, a private investor. Please proceed.

Hi Mark. How are you?

I am great. You made it just in the wire.

Yes Well, I tried earlier. Apparently, it didn't take. So when they said, there were no more calls, I pushed for a second time and it worked that time. I am actually looking at trying to sort out from an analytical point of view, the potential profitability of Phase 1 and I am looking at slide seven. We have the infrastructure costs, et cetera on the right-hand side there. And I guess for starters, you are collecting, you ultimately collect a little over $100,000 per lot with $70,000 or so for the payment from the builder and another $30,000 or so for the tap fees. Is that right?

Right. That's right.

Okay. So we are talking gross $50 million there. Then I am looking at the cost items. The Monaghan Road, $2 million. That will actually, it's going to be of benefit to Sky Ranch for more than this particular section. Is that correct?

Yes. That's right. Some of these investments, most of the offside investments, actually the four of the six that are really labeled here do benefit more than just our first 500 lots.

Yes. That's exactly where I was going with my questioning. So probably fair to say no more than half of the Monaghan Road $2 million would be allocated to this section, maybe even less than that?

Well, that's certainly the full cost of it and then the capacity can be probably about maybe another 30% at some point. So what we are doing on Monaghan, if we start to drill down in the weeds on this, we are building three of the six lanes on that and those three lanes will handle traffic up to about 800 units rather than 500 units to give you just some capacity numbers.

And then the drainage, it looks like that's entirely this section that's impacting that.

It is, but it receives drainage from the other sections. So as you see that line, that line continues on and it goes up front. So the size of the pond is actually for the full drainage allocation.

Okay. So this will be a minimal expense probably in some of the other section that you develop.

Exactly right. That's what it exactly translates to.

Okay. And then the wastewater facility and the word water storage treatment facilities, are they going to be for the entire Sky Ranch? Or just for this section?

No. They are their master planned locations, but they do have some micro phasing in them as well. So the wastewater plant can handle probably about 1,000 connections. Similarly, the water and wastewater are really designed for about 1,000 connections on this phase. And as you always know on construction projects, it's more expensive to come out of the ground. So it's not as though the next 1,000 connections cost us another $5 million. I think our buildout for the wastewater treatment plant is somewhere around $12 million. So the next increment is much, much smaller than the first increment.

Okay. Good. And then obviously the overlot grading is pretty straightforward. That's $15,000 a lot.

Right.

And then the roads, curbs, other utilities, actually it's all utilities, right, because it's your sewer and water connections that are in that number?

That is the retail system. Yes.

Excuse me?

That's the retail system in all the streets of the subdivision itself.

Yes. And what's your responsibility for the water and sewer lines? Is it to the homes? Or is it to the property lines?

To the property line.

Okay. Very good. That's great. Very helpful. Thanks.

You bet. Thanks.

So if any of you who wanted to ask a question, didn't quite get in or technology wasn't allowing you in, certainly feel free to give me a call. I have been dilatory on not being out on the road much over the last six months. So hopefully as things get more open, it will free up a little bit of time for me to get out to the various markets, New York, Boston, Chicago, out to the West Coast as well, just to kind of meet with folks and catch them up a little bit, not only of what we are doing and also maybe what it is that we are planning for our second phase. One of the things that we are going to try to do is have a day here for those that have an interest that can come here. There is nothing like seeing this with your own eyes, seeing the grader, seeing the streets come in and seeing some lots being delivered. So that's something that we will put some thought into. We will send out maybe some invites to the market or a press release and then really kind of collect some interest on folks that might like to come out and do a day here, see what's going on, not only on the residential side but see a little bit more of our system, see a little bit more some of how we are delivering water to the oil and gas industry and those types of things. So be on the lookout for something towards the latter part of the spring for a date sometime this summer on that. So with that, I want to continue to thank you all for your support and confidence in management as well as our Board and if you have anything that comes up, don't hesitate to give me a holler.

Thank you. This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.